Sunday, June 15, 2008

LA Times: Even the Chinese Expect Subsidy Decreases post Olympics

We've been developing a thesis regarding a global slowdown caused by rising prices everywhere - steel is causing it, crude is causing it [Jun 2: China Leads Asia in Retreat from Inflation Battle], etc. Inflation is a tax on all things, consumers and producers. (except in the US where there is little to no inflation of course). The economic cycle elsewhere has not stopped happening but the overreaching power of 1 economy is truly buffering the cycle.

China remains the inflection point of almost every major bull market at this point; thus we must monitor this Ferrari going at 165 mph down a careening oil slick mountain road. Recall, we are already seeing smaller Asian governments buckle under the global commodity price boom [May 23: Smaller Asian Countries Begin to Buckle Under Oil] and we are seeing the impact of steel [May 17: WSJ - Fast Rising Steel Prices Set Back Big Projects] Just speaking from a local perspective the impact on automotive of this steel issue is simply untenable. Hot rolled steel prices have risen from $830 metric ton in April to $1035 in mid May. Folks, thats in 6 weeks; this product was $500 a few years ago (and $150-$200 a few years in the early part of the decade).

Since those posts even India has begun to buckle [Jun 3: India Warns they too Cannot Subsidize Energy Costs Forever]. The open question is when/if China would buckle - when it does, a lot of investing thesis that have caused the most pleasure will see damage in the near term. Throw a "strong dollar" on top of it, and the pleasure from US multinationals deriving huge gains from currency dislocations goes away (be careful what you wish for, strong dollar advocates) along with "huge growth in developing markets". So we could have a rocky road ahead of us in the markets - since if there is a true correction (all it takes is a sentiment shift for stocks to be bludgeoned) in items tied to China engulfing every product worldwide at any price, finding areas to hide in the stock market will be tough. You'll be stuck with financials, retailers, or technology I suppose. Again it won't change the long term story one iota, but stocks and the emotional human beings buying and selling said stocks won't care to hear about the long term in the middle of a correction...

Again China is so flush with cash they could in theory subsidize for a long while (whats $30 Billion to them? a month or two of Americans buying Chinese products at Walmart?), but it appears even the citizenry of China are expecting some level of subsidisation to be stripped away post Olympics. Stay tuned - this will get very interesting.
  • The lines are getting longer, and Tang Yao is finding fewer gasoline stations open in his neighborhood here. But the 48-year-old motorist has no gripes about the price at the pump. While consumers in much of the world have been reeling from spiraling fuel costs, the Chinese government has kept the retail price of gasoline at about $2.60 a gallon, up just 9% from January 2007.
  • During that same period, average gas prices in the U.S. have surged nearly 80%, to about $4 a gallon.
  • But Tang and millions of other Chinese are bracing for a big jump in pump prices. The day of reckoning? Everybody believes it's coming right after the Summer Olympics in Beijing conclude in late August.
  • The reason, as most see it, is that the central government doesn't want to risk doing anything that could upset the populace before the Games, which open Aug. 8. China is already grappling with inflation running at an annual pace of more than 8%, mostly because of higher food costs.
  • "Before the Olympics, stability is paramount," said He Jun, an oil analyst at Beijing Anbound Consulting Co.
  • Other countries that subsidize fuel costs have boosted prices recently, in some cases stirring unrest. Protests flared late last week in India, where the government upped prices by about 10%, and there were calls for mass rallies in Malaysia after gasoline prices jumped 41% overnight.
  • China is the world's second-largest consumer of petroleum, behind the U.S.
  • China relies on imports for roughly half its oil use, which is growing at about 7% annually.
  • China raised pump prices only once in the last year, in November, by a little more than 9%.
  • Refined-oil prices in China are half of international levels, leaving Beijing to shell out about $30 billion in subsidies in 2007 (that was at $70, $80, $90 oil)
  • But even worse than their draining effect on government coffers, China's price controls create market distortions and disincentives for consumers and businesses to reduce consumption and conserve energy, many analysts have long argued.
  • The transportation industry uses about half of the gasoline and diesel in China, while ordinary motorists accounted for 7% of gas consumption in 2006, according to China International Capital. But the number of car owners is growing rapidly. ("only" 7%, 2006, for ordinary motorists is scary when you consider in Beijing alone 1000 new cars are sold... a day)
  • Farmers, who are a major user of diesel, say they're struggling to buy fuel for their trucks, tractors and harvesting equipment. Some complain that the government's price control amounts to a subsidy for the rich who can afford to buy a car. Why not subsidize farmers directly, they wonder.
  • "We want to hoard some diesel too if possible," said Wang, who grows wheat, soybeans, corn and sweet potatoes. "But in order to do that, you have to have some connections. And we don't."
Keep in mind folks, in a World of Shortages we are in competition with emerging powers that be for resources. You can see now just a small sample of potential suffering - that great sucking sound Ross Perot talked about is US dollars flooding into coffers in the Middle East and China. And that money is being used against us in this competition. This is what a massive debtor nation faces, in much larger magnitude in the decades to come. This episode is just a preview of things to come - a world of both heightened inter country and intra country (rich v poor) social strife is sure to be the ultimate path. An interesting opinion piece to finish off this entry.
  • Can China afford its own oil subsidies at a time when it is spending billions on post-earthquake reconstruction?
  • The short answer is yes, because China is blessed with both large trade account and fiscal surpluses. (The U.S. has neither of course) The reconstruction cost is projected to amount to about 1 percent of China's gross domestic product, while the fuel subsidies account for another 1 percent, JP Morgan estimates.
  • Remember that China had a fiscal surplus of 0.7 percent of GDP last year, or $174 billion. So even if spending on post-earthquake rebuilding and fuel subsidies were to cause a 1 percent fiscal deficit, that would still be very manageable. (this is why I openly wonder if they will even bother to cut subsidies at all - they don't have to in a fiscal sense)
  • But here's a more important question: Why should China keep domestic fuel prices at about half of the global average?
  • What's more, a worsening fiscal situation might put downward pressure on the yuan. Fuel subsidies have exaggerated inflation in the developed world, while understating inflation in the developing world. China's inflation could well hit 15 percent if Beijing were to free up caps on energy prices.
  • "If China is not able to take away the subsidy and cut down its demand, it will have huge implications for the world," said Shikha Jha, a senior economist at Asian Development Bank.
  • While the West is critical of China's energy policy, there is little outcry for change within the country, except for complaints from two loss-making refineries.
  • "The people need to wonder, who pays for the subsidies?" said Louis Vincent Gave, chief executive of research and asset management firm GaveKal. "Most Asian countries are printing money to pay for them." (goodie, more inflation as more paper currency chases fixed amounts of hard goods)
  • Morgan Stanley expects some emerging market currencies to face downward pressure, probably for the first time in a decade, as those countries unwind their fuel subsidies and domestic inflation shoots up.
  • "Giving out subsidies is an easy and popular thing to do," said Bill Belchere, an economist with Macquarie Securities. "But getting rid of it is like hell."
Interesting times indeed.

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