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Thank God for China!

Jim O'Neill
August 15, 2007
--While credit jitters are now dominating many markets, don't lose sight of the "big picture".
--In this regard, China remains crucial.
--Chinese growth powers on.
--Chinese consumption is not far off contributing as much as the US consumer already.
--And BRICs countries in total, are contributing more.
--Headline inflation is rising, raising risks of more tightening.
--But there is little sign of dramatic action.
--Other BRIC markets have also only corrected modestly.
--Other big economies continue to benefit a lot from China.
--Which is important as downside risks for the US increase.
--World markets should not persistently suffer from credit woes.

1. Thank God for China
As credit jitters are spreading to virtually all markets, more and more questions arise about the strength of global economic growth. Market
participants should not forget how much the world is changing. In simple, today's title sums it up. Chinese growth is likely to continue both directly and
indirectly to, (through strong exports for many other countries) support the world economy. Yesterday, China reported retail sales growth of 16.4pct in July,
the highest in more than 3 years, a welcome sign of optimism amidst the recent doom elsewhere. Accelerating domestic demand in China offers hope to many
countries that a strong export market is still open in the event of a continued period of sustained below trend growth in the US. Of course, some other important developing countries are also continuing to sustain strong growth, led (in terms of importance) by the other BRICs. As to their self sustainability of
growth, the other major developed countries are showing mixed signs.

Real GDP
in both the Eurozone and Japan "disappointed" in Q2, and based on the most recent evidence, private consumption is not showing major signs of acceleration.
Robust growth (which is likely to remain above trend in the second half) for both remains dependent on business investment and exports, both of which are probably greatly due to China (and in Germany's case especially, the other BRICs too).
If the ongoing and broadening credit challenges add to the rising woes in the US housing and mortgage business, the risk of persistent sub trend growth in the US becomes obvious, and not surprisingly, the real gloomsters are out in force.

If the US were to slip into a full blown recession, then of course,
China itself
would slow, and in any case, could not fully replace lost US
consumption. If
new evidence to suggest that the US economy is slowing further, we are
very
confident that the Fed would quickly ease monetary policy, so we doubt
the
gloomier views are likely. It should also not be forgotten that exports
to China
and elsewhere continue to provide momentum to the US also.
Remarkably, all of our coincident and leading indicators suggest that
Chinese
growth might be accelerating, which for the rest of the world, starved
of the
same impact from the US, remains good news. As Hong Liang and team have
remarked
recently, together with rising headline inflation, perhaps the
policymakers in
Beijing are likely to tighten policy more aggressively. However there
are few
signs of that being telegraphed, and as we have written about endlessly
in
recent years, without a major rise in the value of the CNY, it is
unlikely that
China will be able to find a mechanism that is successful to slow
growth

significantly.
If China wants to tighten effectively and least disruptively, then the
appropriate choice is easy; accelerate significantly CNY appreciation.
It should not be lost on market participants during the recent turmoil,
that the
often regarded overvalued Chinese stock market has continued to make
new highs,
indeed almost daily, so not all is ill with the world (except for
those
that
worry about a growing Chinese bubble). Moreover, while there have been
corrections in some of the other BRIC markets, they have been
relatively
minor.
Brazil remains up close to 20pct year to date, and the Indian market is
still up
around 9pct. (Russia is up 15%). While many gloomier inclined
commentators are
out in force, calling for an end to the strong markets in place since
2003, so
long as China and the rest of the BRICs keep doing their "thing", this
is
unlikely.
2. Latest Global Growth Evidence
With Q2 real GDP now published for a number of important countries,
recent
signals are more mixed. While the US bounced back to an above trend
number of
3.4pct - which after the latest trade numbers, could now be more than
4%
- both
the Euro zone and Japan "disappointed" this week, with growth below
expectations. These disappointments, not for the first time, raise the
possibility that they remain as vulnerable as ever to a more persistent
slowing
in the US. Luckily, because of the strength of their export sectors,
and
the
probable link to business fixed investment spending, growth in both
Japan and
the Eurozone is likely to pickup from the Q2 levels, as our regional
economists
have explained this week. As discussed more below, so long as China
(and
other
BRICs) remains strong, then exports will also remain strong. Any
acceleration in
private consumption in either Japan or the Euro zone would be a bonus,
indeed,
one that we expect.
Both Europe and Japan (and everyone else that exports!) continue to
show
strong
export growth to China.
In Japan, in June, the latest month available, exports to China rose by
21.3pct
yoy in value and 22.6pct in volume. (in contrast, exports in value to
the US
were up by just 0.7pct). In terms of levels, exports to China are now
close to
80pct of the level of exports to the US. Japanese exports to Asia as a
whole are
now considerably more important than to the US, around 50pct of the
total (the
US is 20pct). As our Japanese team have often suggested, once exports
to
Hong
Kong are considered, it is highly likely that exports to China are
already more
important than exports to the US. The Japanese Weekly analyst of August
10th had
a detailed discussion of Japanese trade trends.
It should be also noted that year on year growth in Japan was an above
trend
2.3pct in Q2 with personal consumption up both 1.4pct on the quarter
and
year on
year. Much of the "weakness" in Q2 was due to a large drop in
residential
investment and a probable "payback" for robust 3.4pct annualized growth
in Q1.
Other data in Japan this week is mixed. Yesterday's tertiary data was
stronger
than expected. Today's Reuters Tankan for July included stronger than
expected
manufacturing optimism but weaker than expected in non manufacturing,
led by
real estate.
As far as the Euro zone is concerned, yesterday's weaker than expected
Q2 GDP
was due to disappointments in Germany, France and Italy, and we have a
suspicion
that strangely weak IP numbers for June have biased the estimate down.
As is
becoming the norm, it is quite likely that the next estimate might be
higher
than the first. We don't know all the components of growth yet, but it
is likely
that for Germany especially, net trade remains an important source of
support.
Exporting to the BRICs in general is now a favourite German pastime.
Space doesn't permit me to discuss the US at great length today, but
our
US
analysts revised lower their estimates of growth for late 2007/early 08
last
Friday, and highlighted downside risks.
As emphasized by the gloomier forecasters, US personal consumption is
about
21pct of world GDP (70pct of the US share of world GDP around 30pct),
while
China is perhaps only around 3.5pct (40pct of around 6.5-7pct). China
could not
replace an absolute collapse of US consumption.
However, these gloomsters are not correct to focus on levels. Since
2000, we
estimate that domestic demand from the BRICs has contributed around 1/3
of all
global growth, compared to around 40pct from the US. China appears to
have
contributed around 20pct, half that of the US (and the same as the Euro
zone).
In terms of most recent trends, taking the latest retail sales (which
of
course
are not complete assessments of consumption) data in both the US and
China, the
CONTRIBUTION to global growth is much closer. US retail sales rose by
3.2pct in
July, contributing 0.7pct to global growth. Chinese retail sales of
16.4pct,
contributed around 0.6pct, close to the US amount on it's own. The
other
three
BRIC economies, Brazil, India and Russia showed retail sales growth of
10.5,
14.7 and 12.8pct from their latest reported releases (not as up to
date). Adding
them to China, the four BRICs are currently contributing nearly 1.5pct
to
global growth, more than double that of the US.
The gloomsters need to think differently.
It is clear that global growth has slowed, and is probably slowing
more.
Our GLI
for July suggests some further waning momentum, and if the world was
growing
closer to 5pct for much of 2003-06, it is now probably centering on
something
close to 4pct, perhaps, not clear but perhaps a touch below. So, the US
centric
-credit problem is a problem for the US, a challenge for others, but it
is
important to keep it all in context.
3.Chinese Growth and Policy
Retail sales rose by 16.4pct, and as discussed in a note yesterday by
Hong Liang
they have been trending higher. On a qoq basis annualized, this latest
increase
is close to 20pct. While retail sales volumes are closer to 11pct,
there is
hope that the stronger trend can persist. Many other coincident and
leading
indicators show signs of strength. Our proprietary leading indicator is
strong,
and accelerating, monetary growth is accelerating, and even export
growth
remains robust, if not quite at the absolute strongest year over year
gains of
recent months. (China's PMI did slow in July to 53.2 from 55.0).
This morning, industrial production was reported at 18pct year over
year
for
July, down from 19.4pct. We suspect IP growth actually remains stronger
based on
other indicators such as electricity production.
As is often the case with China, while many can only imagine that
growth
can
slow, there are no real signs of that happening. Indeed, without a
mechanism for
slowing growth, how can growth slow? Chinese financial conditions
remain
extremely easy (our index eased from 107.4 to 106.7 from June to July)
and with
the very recent stability of the CNY, there is no sign of any
tightening
of
financial conditions. Until markets can believe that the CNY will not
definitively rise in future value, it is very hard for the PBOC to
actually
tighten monetary policy effectively. As we have discussed for a long
time,
allowing a much stronger value of the CNY is the only effective way of
sustainably tightening monetary policy. Raising interest rates
tentatively or
changing reserve requirements does little, and at times adds to the
problem by
attracting more capital inflows.
The strength of growth recently, and more importantly, the sharp rise
in

headline inflation (July to 5.6pct) has led some people to anticipate a
much
more dramatic tightening phase ahead from Chinese policymakers, and
indeed, Hong
and her team have some concerns. However, two things need to be borne
in mind.
Firstly, there are no signs of anything much on the currency front,
indeed, the
signs of accelerating appreciation from early July have been reversed.
As we
discussed, this is the most effective form of tightening. Secondly,
excluding
food prices, Chinese CPI is currently around 0.9pct close to where it
has been
for some months. If monetary policy is to tighten in a draconian manner
to stop
food prices rising, then it will be a risky thing to do, and probably
unlikely.
As we argued in the Global Economics Weekly on July 4th, "What will the
next
recession look like", whenever it happens, it will probably be because
of
something going wrong in China. Luckily it looks to be still some
considerable
time off.
4. Keeping the Current Jitters in Some Perspective
Hopefully, the above discussion goes some way to putting the current
challenges
facing the world economy in some perspective. The US economy is the
biggest
economy in the world, and the housing market, and now more broadly sub
prime
related credit challenges appear to raise the likelihood of sustained
below
trend growth in the US. Other countries that are reliant on exports,
and
used to
exporting to the US are indeed likely to be also more challenged
therefore,
(and of course, additional challenges may be rising due to the credit
problems
in various places). Yesterday's US trade report demonstrated much of
this quite
clearly, exports rose 11.1pct while imports were up just 3.8pct.
The rise of China and the BRICs is changing many dynamics including
those for
the biggest and best exporters, which includes countries such as
Germany
and
Japan (and the US). So long as China continues to show strong growth,
and if
anything, it might get stronger, before slower, then much of the
world's

prospects remain bright despite ongoing financial market jitters.
We continue to believe that most, if not all of the world's best
investment
opportunities relate directly and indirectly to the BRICs economies,
whether
they be commodity, equity or otherwise.
5. Current Trading Views
Markets remain extremely jittery as evidenced by Monday's large
recovery
in
European stocks only for yesterday's fresh declines. On the foreign
exchanges,
there are growing signs of an unwind of the "carry trade" phenomena
with
further
strong declines in the New Zealand Dollar overnight and a further
recovery of
the Yen. The Yen's strength caused us to be stopped out of our long
EUR/JPY
trade at last nights close, however we remain short NZ$/Yen.