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China, the Silk Road and the ‘slowdown’

Shanghai
  • China deregulating markets at breakneck speed
  • New Silk Road represent’s Beijing’s growth strategy
  • RMB to supplant GDP as third-most-traded currency

Shanghai
Crowds on the Nanjing Road: Things move fast in China, and macro trends
(and their underlying policy moves) are no exception. Photo: iStock

Change is in the air in China, where there are now more than 5,000 hedge funds, the IPO market is red hot and the stock market has recently been up more than 100%… but that’s not the full story.

Outsiders and pundits are busy foretelling the story of a China in slowdown mode, in financial trouble and with bubble-like equity markets. The main take-away from my trip to China, however, was the following…

Firstly, financial deregulation is happening faster than anyone ever thought and the internationalisation of the RMB is the real fuel for the Silk Road project.

The financial deregulation does not only take the form of things like the Shanghai-Hong Kong link, or Shenzhen-Hong Kong and the qualified investor programme. It also can be seen in the gradual easing of regulation, the Shanghai Financial Zone (or, more correctly, the Liujiazui financial and trade zone) and the firm belief in opening markets.

Meeting officials in Shanghai, I got the sense that even they are surprised at how the « open market » evolves faster and faster, an observation confirmed by increased volumes not only in the stock market but in a bigger and deeper bond market, as well as the domestic FX market.

This brings me to the second major observation: the internationalisation of the RMB. When I first wrote about the Silk Road in March after my visit to Hong Kong, I didn’t realise how important this is.

The internationalisation of the RMB will get a kick start in September/October when RMB is added to the basket of SDR.

There is already great demand for RMB clearing, and several central banks and sovereign wealth funds are looking to increase their exposure, probably at the expense of the USD.
The fast-growing IPO market can also be seen as building a deeper capital market, with the raising of capital occurring away from the government-supported banks and the liberalisation of the financial markets.

Shanghai
Morning on the Shanghai Bund: Chinese capital markets are expanding
as the country makes moves to liberalise its economy. Photo: iStock

The steep price of these IPOs, of course, doesn’t make it a bad deal for either the government or for shareholders…

Yes, the 100% rise reminds us old « gents of the market » of NASDAQ and the IT bubble in 1999/2000…

Yes, I think the Shanghai Composite will sell off to 3.000 from the lofty 5.200-ish seen earlier this year…

Finally, yes I do think China will have a hard time living up to the promise of 7%-ish growth this and maybe next year, but… China has a plan.

You can agree or disagree with it, but they do have a plan and it’s the Silk Road.

Making one trip per year on average to China doesn’t make me an expert, but it does remind me that China and its interpretation can’t be done traditionally, or from a chair in London, New York or Copenhagen.

China is likely to see some improvement over the balance of 2015. The aggressive monetary easing will act as the « bridge » to the time when the Silk Road is implemented and the flow of funds from China start coming in earnest.

What we need to learn as investors and as observers of macro trends is this:

It’s far more important what China does with its foreign exchange reserves (USD 3 or 4 trillion) than when and if the Federal Reserve hikes rates.

Both the monetary easing and the initiation of the Silk Road project means China needs to reduce its reserves. Each 100 basis point cut of the country’s Reserve Requirement Ratio equals China selling $260 bn worth of bonds.

(China is a closed economy, hence they need to unsterilize, or put money into the economy each time they reduce rates).

Similarly, when the Silk Road needs to be financed it will be from the same source – the selling of US bonds. Maybe that’s why the cost of money, rates, has already risen this year… not because the Fed has moved, but because China has.

This new world order is something we need to get used to; in a world where everyone is over-leveraged and under-financed, the people and countries with excess savings dictate the terms.

In my view, the RMB will overtake the GBP as the number three currency (in FX volume) in less than three years. China will dictate the cost of money, but China will also be engineering a global restart of growth exactly as they did in 2008, but this time the plan is more grand and ambitious.

Yes, there is change in the air in China, but it will spread to the rest of the world over the next two years as China makes a move to create one big trading zone across Asia .

At least China has a plan.

Silk Road

China’s New Silk Road will revolutionise global trade. Photo: iStock

— Edited by Michael McKenna

Steen Jakobsen is chief economist at Saxo Bank

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