Shocks and Surprises, Week Ending October 29th

Whilst most attention has been directed towards policy development (or the lack of it) in the Eurozone, the most significant developments in policy over the last month have come from China. Over the last three weeks, China's authorities have moved swiftly over a broad policy front to identify and start to relieve the worst of the pressures points. Local authorities have been pressured into recollateralise projects and in return China's bank regulator is beginning to allow those debts coming due in the coming 18 months to be rolled. The Ministry of Finance has been prevailed upon to widen the scope of provincial/municipal bond issuance very slightly. Bank regulators have ushered in a number of policies incentivising banks to return to the SME lending market. And, of course, we've had that all-important acknowledgement that the population of those potentially-destabilizing private lenders are disproportionately comprised of precisely the local bureaucrats and SOE executives who are favoured by China's current system of credit rationing.

These moves are coherent and realistic, and represent a policy-response to China's difficulties far more nuanced than the China risk on/China risk off population of investors usually contemplates. Nonetheless, they do represent the key turning point in China's current cycle.

And the timing of that turning point is justified best not by data from China itself – where national data from this huge economy still describes an economy at the very apex of its inflationary cycle, but rather from its fringe. This week the big economic shocks came precisely from fringe China. Hong Kong trade data was truly dreadful, with exports falling 3% YoY on a sequential slowdown which broke the 2SD from seasonalized trends barrier, and which incorporated a 7% YoY fall in exports to China. Similarly, Taiwan's industrial output result for September – a rise of just 1.6% YoY – was off-the-map bad and the worst reading since early 2009. There is every sign the industrial slowdown is now spilling over too into Taiwan's money numbers – no one watches these, but they are deteriorating unexpectedly.

And this also found an echo in Japan, where industrial production contracted 4% MoM in September, leaving inventory/shipment ratios rising 4.2pps MoM and 9.6% YoY. But one has to set against that the fact that Japan's export numbers came in higher than expectations, at 2.4% YoY, with a pattern of demand which showed resilient demand from both Europe and China.

The moral of the story is, I think, that though China's government is now moving persuasively to address the problems which have been obsessing the markets all year, and which are therefore likely to close off the worst of the 'China hard landing' scenarios for now, those fringe economies leveraged to China flows have months of pain yet to endure.

Elsewhere in the world, the most important stuff we learned came from the US. There, we see developing a dangerous game of chicken between the household as consumer (where consumption is holding up far better than expected – 2.4% annualized in the 3Q GDP numbers, and personal spending, up 0.6% MoM in September) - whilst incomes are stagnating (up 0.1% MoM in July, down 0.1% in August, up 0.1% in September). What this means, of course, is that for now personal saving ratios are collapsing again, in September hitting just 3.6% of disposable income. That's the worst reading since December 2007, and in nominal terms, the lowest dollar amount of monthly savings made since August 2008. The willingness to keep spending whilst incomes stagnate is puzzling, not least because we have some dreadful readings of consumer confidence out there: the Conference Board Consumer Confidence Index gave its most wrist-slitting reading since March 09 this week. Yet even here the message is contradictory, for the US's other major measure of cosumer confidence - the University of Michigan reading – was this week revised upwards unexpectedly to give its most positive reading since July. The word I'm grasping for is 'unstable' .

Buying Time

A.S. Flu laid me in bed for the whole of the latest Euro-rescue. Never mind, I'll probably be better by the time the next one comes around. Meanwhile. . . . 
It is too obvious to bear much repetition, but the agreements reached by Eurozone governments this week – even if they put on both detail and actual financial muscle (here's looking at you Mr Jin Liqun) – are not exactly a rescue package. And that's because, once a heavily indebted country is set to swim with an unfeasibly heavy exchange rate strapped to its ankle, the only place it's going, even with encouragement from the sidelines, is down. No-one any more is even pretending that the 'rescue' package will allow Greece to grow in the long term. Rather, the ambitions of the package have been reduced simply to averting imminent financial breakdown within the Eurozone. Or, to be more specific, averting the imminent seizure of the Eurozone interbank markets.

The comparison usually made is between the situation in the Eurozone now, and the situation in US banking markets immediately prior to the collapse of Lehman Brothers in 2008. One of the key moments there was when it became clear that the interbank market was failing – specifically, that the price banks were charging to lend to each other was actually higher than banks were being obliged to pay directly from the money markets. As the chart below shows, in the US this collapse of interbank trust (or 'credit') arrived like a thunderbolt out of the blue in late September 2008, peaked at just under 200bps within three weeks, and – being intolerable – had been treated by extraordinary Fed action within a further two weeks. It was short, and extraordinarily painful.

Now look at what's happening in the Eurozone currently. Euro-libor discounts to money market rates had been eroding steadily throughout 2010, and finally broke through to the distress-premium at the beginning of August.

However, since then the premium has neither spiked (a la Lehman), nor has it gone away. Rather, it continues to grind away, simply asserting as a fact that Eurozone banks now trust each other less than the market trusts them. Of course, this has the makings of an imminent crisis but, absolutely crucially, has not yet become one. What we have looks like chronic financial angina, rather than the full infarction.

Why? I can identify two reasons. The first is the one I pointed out weeks ago – namely that I think Eurozone banks have taken quite extraordinary steps to ensure that the US money markets cannot put them under irresistable pressure offshore. As I pointed out then, this has entailed those US-located branches keeping more cash than they have deposits, and also reversing their traditional funding patterns to become net fund-suppliers to US interbank markets.

The second relates to what is not happening in Credit Default Swap markets. Back in 2008, it was the realization that CDS market losses were potentially large enough to sink each and every financial institution, and that there was no way of actually knowing if or to what extent back-to-back offsetting CDS liabilities might or might not actually net off, that did the damage. When banks realized too late that if CDSs aren't fully fungible, then when the chips are down the 'offsetting' CDS just don't 'net out' to zero, then they stopped lending to each other.

This time, perhaps the greatest coup being pulled off by European negotiators has been to engineer (seemingly – time will tell) a situation where financial institutions are prepared to take a 50% write-down on holdings of Greek sovereign debt without triggering the default clauses in the CDS market.

One has to ask, if the 50% haircut on sovereign debt doesn't amount to a sovereign default, then what does?

Most specifically, one has to assume that as far as Eurozone sovereign debt is concerned (and bank debt too, to the extent that the banks are or will be nationalized), there is no point in buying credit default swaps on anything other than a pure non-deliverable forward basis – ie, it's strictly for the spread-bettors.

Well, it does if the market for Eurozone sovereign debt prices in the fact that its investors are now denied access to credit insurance, and have only a restricted ability to short. Surely as the terms deteriorate, so the the interest rate demanded on Eurozone sovereign paper must be expected to rise. Unless there are exceptions. It will, for example, be interesting to see what sort of terms China's sovereign wealth-fund will be offered – will CIC demand the ability to hedge fully and in whatever way it chooses?

What conclusion can one draw? In the short term, Eurozone banks have done a good job in insulating themselves financial in those financial markets its regulators cannot quash. Elsewhere, the bits of the market bringing bad news have been sidelined or shut down. Both give Eurozone banks a better short-term survivability than their US counterparts in 2008. This buys time. The danger – no, the likelihood – is that this time will have been bought very expensively, and will be wasted even more expensively. Why? Because, as so many countries discovered in the 1930s, if you hobble your economy with a vastly over-valued currency, your growth prospects are blighted until you change it.  

  

Shocks and Surprises, Week Ending October 22nd

The shocks and surprises which will matter this week are all political – and if things go wrong, with a whiplash on the financial. Economists, like everyone else, wait to learn their fate.

As we wait for Armageddon, it's quiet – too quiet. Eurozone data continues to chug along much as expected. This week, the list of economic data coming in as expected included: new car registrations (up 0.7%), construction output (up 2.5% YoY), consumer confidence, Germany's IFO business climate surveys, and French business confidence. Outside the Eurozone, however, the UK both surprised and shocked: retail sales surprised on the upside, rising 0.7% MoM, whilst consumer confidence shocked on the downside, reflecting a sharp deterioration in expectations.

Over in the the US, the major necessary adjustments to expectations have already been made, even up to the point of economists modestly revising up 3Q GDP forecasts, whilst cutting forecasts for 4Q11 to 2Q12. This week brought more confirmation of the likely 3Q surprise, with unexpectedly strong readings from the Philadelphia Fed survey (though this was offset by a surprisingly weak Empire State Manufacturing survey. The keys to the medium term trajectory of the economy remain housing and employment. Currently, housing market data is arriving modestly stronger than expectations – the NAHB Housing Market Index, and housing starts numbers both surprised this week, but sales of existing homes were no better than expected, and the number of building permits granted actually disappointed.

The knee-jerk reaction to China's 3Q GDP (up 9.1%) was that it showed China's growth slowing. Which just goes to show that the headlines are written before even basic analysis is completed. Yes,  GDP growth did indeed slow, if you compare it to the 9.5% recorded in 2Q. However, when you adjust for movements in the trade surplus, which added 0.7pps to 2Q growth but stripped 0.2pps from 3Q growth, you find a snapshot of an economy at the apex of its inflationary cycle, and not yet quite over the hump. And this was confirmed by the monthly data for September released this week: industrial production accelerated to 13.8% YoY – although this seems like an acceleration from August's 13.5%, the truth is it was simply the reassertion of seasonal historic patterns. But the acceleration in retail sales growth, to 17.7% from the previous month's 16.9%, represented real sequential MoM acceleration.

We also had some trade data which was worth mentioning: Taiwan's export orders growth slowed to 2.7% in September from 5.3% in August, with the slowdown generated solely by a collapse in orders from Europe: demand from elsewhere in the world economy remained firm.

Inflation – Still Here

Finally, it is worth noticing that no section of the world economy seems to be tipping into deflation – rather, the last week has seen worse inflation numbers than expected in the US (PP1 rose 0.8% MoM), and the UK (CPI, which rose 0.6% MoM and 5.2% YoY). These are not the only unexpectedly strong readings on inflation we've seen in the last month: let's also remember that Eurozone CPI came in stronger than expected (3% YoY), Taiwan's WPI jumped to 5.1% YoY, and US import prices rose 0.3% MoM and 13.4% YoY. The only place where the inflation news is surprisingly good is now in China, where PPI slowed to 6.5% YoY in September, the lowest reading since Dec 2010, and confirmation that the PBOC's policies are finally beginning to find traction.

On reflection, the lack of deflationary pressure isn't surprising, since it's hard to point to overhangs of capacity or inventory anywhere in the world which might tend to trigger rapid price falls in the short term. In the US total business inventory/shipment ratios are at the low end of normal, with both retail and wholesale inventory ratios strikingly low, but offset by a rising inventory/shipment ratio in the manufacturing sector. In other words, whilst there is room for disappointment in manufacturers' situation, there is also room for a supply-chain squeeze afflicting wholesale and retail channels. I do not have comparable data for the Eurozone, but we do have capacity utilization data which shows that as of September, capacity utilization had recovered from 2009's lows of around 70% to around 81%. This remains only slightly lower (by around a 2 percentage points) from pre-crisis norms. In Japan inventory/shipment ratios are higher than normal, but this is plainly a reaction to the supply-chain disruptions following March 11th's catastrophes. It seems unlikely that corporate Japan would tolerate inventory/shipment ratios falling to pre-March 11 levels.

In other words, it's hard to find the ammunition for a deflationary shock in the short term. But, of course, a really shocking failure in the political sphere resulting in a second collapse of Western financial institutions could change all that in the longer term.  

Don't Drop the Vase!

I was lucky enough to attend a talk given by Dr Tim Summers, of Hong Kong-based XTE China Consulting, who delivered gave an excellent primer on the mechanics and personnel involved in China's transition to the fifth generation of leadership. His key message was a warning against seeing this changeover as just a fight between 'factions'. The two 'factions', or rather coalitions, commonly identified are: 

• the 'princeling' or 'elitist' coalition around Xi Jinping (almost certain to be the next leader of the CCP and President of China); and 
• the 'populist' or 'tuanpai' (youth league) coalition, supposedly  represented by Li Keqiang (probably, though not inevitably, the next Premier). 

Similarly, we should avoid identifying either as 'liberal reformers' or 'hardliners': what matters is the discovery of consensus and balance within the Party.

Fundamentally he's right. To interpret the changeover as some sort of Japan-style faction-fight seems more likely to obscure than enlighten. In their heyday factional politics in Japan was a mix of loyalty, discipline and interest-swapping which could and regularly did transcend the formal structures of Japan's governance. On one level they were trivial, on another level important. . . . . I guess.  In Western party politics, factional fights are much simpler: all parliamentary parties with a chance of gaining power are coalitions containing different streams of thought constantly vying for pre-eminence. 

Neither model seems to fit what's at stake in China. And yet, I am loathe to dismiss this identification of the 'princelings' and the 'tuanpai' groupings because I think they do represent something tangible and important. Struggling to put it into words, I found myself drawn back to the triptych of Ai Wei Wei dropping a Han dynasty urn.    

What is it about these photos which make them so powerful, so unforgettable? I think it's to do with all the questions to which we have no answers. Is the urn really a Han-dynasty urn? Does Ai Wei Wei mean to drop it?  How does he feel about dropping it? Is he destroying a work of art, or is he creating one? What could justify such vandalism?  How would his father Ai Qing (celebrated poet, joined Mao in Yan'an in 1941, persecuted in the 1950s anti-rightist campaign) view it? Is this an act of rejection of China's past, or a perverse assertion of its future? Is dropping the vase a tragedy or a triumph? Does it really matter if we have yes/no answers to these questions? 

Recognize that whatever else Ai Wei Wei is, he is a classic princeling, schooled and privileged by the Party, and also therefore perversely alive to its vulnerabilities and responsibilities as both it and he unavoidably and famously collide with modernity. His relationship to the Party, and to other princelings, is profoundly personal.  My guess is that every one of the 'princelings'  - Xi Jinping, Wang Qishan, Zhou Xiaochuan, Chen Yuan, Lou Jiwei, Liu Mingkang, Bo Xilai, Zhu Min etc - they'll all feel the power of these pictures, and this action. 

For what the princelings share is  personal 'ownership' of the problem: they have inherited both the Party and China from birth in a way which no-one who has worked his way up steadily through the Party hierarchy quite has. Their task is unavoidable and in many ways unenviable - what would it mean to shirk the duty? The vase is in their hands. . . . Creation or destruction?. . .  And how to tell the difference. . . .      

China's Root Problem is Export Competitiveness

Bear with me while I explain this, because the headline is not meant to be cute, but rather to draw your attention to a fundamental truth. Behind everything else, China's problem is its expensive and sustained failure in exporting to Western markets – a problem which was surfacing before the global financial crisis, but which has been greatly exacerbated by it, and which won't automatically be solved by the West’s recovery.

Though this problem is absolutely unseen in the West, and barely acknowledged in China itself, it is nonetheless demonstrably true: after overwhelming historic success China’s exogenous growth model is exhausted. It is this, as much as anything else, which makes a change in China’s fundamental growth model both inevitable and urgent. Left unchecked, the current model will eventually end in uncontainable financial stress (though not, so far as I can calculate, during the current cycle).

We’ll start with the numbers. We get hints of an underlying deterioration simply from looking at the rise and then stagnation in China's exports as a percentage of NE Asia's total exports. In the early 1990s, China accounted for barely 15% of NE Asia’s total exports (China, Japan, Korea Taiwan), rising to around 25% during 1998-2001. However, it was between 2001 and 2008 that China emerged as the modern-day exporting giant we take for granted. By 2008 China accounted for more than half of NE Asia’s total exports. Since then the proportion has stagnated, but of itself, this proves little, since one of NE Asia’s prime export markets has become. . . . China itself. And that’s one market China’s exporters can’t be recorded as triumphing in. So is this stagnation of China’s market share as trivial and inevitable.

No: there more to it than that. The seemingly inexorable rise in China’s export market share hasn’t just halted as a proportion of NE Asia’s total exports: China’s  share of NE Asia’s exports to Western markets (N America and Europe) has also stalled. Between 2000 and 2009, on average China’s market share of NE Asia’s exports to North America gained 3.9 percentage points a year; to Europe the gain averaged 4.1 pps a year, and by 2008 China was responsible for 54% of NE Asia’s exports to N America and 57% of the region’s exports to the EU.

However, it came to a grinding halt in2008/09, and in the 27 months between April  2009 and July 2011, China gained only 2.8pps of NE Asia’s exports to N America, and only 3.9pps of market share to Europe. And over a quarter of that was made in the months after Japan’s March 11 catastrophes, which temporarily eliminated Japan as a competitor.

Now, one response to this is: ‘Well, China’s still gaining market share – but just at a slower pace.’ But once again, this radically understates the problem. For the corollary to China’s rising share of NE Asia export trade is the build-up of capital stock which has accompanied the industrial relocation China’s rise.   This is something we can estimate, by tracking changes in the estimated size of capital stock in NE Asia’s economies. I do this simply by depreciating all (US$-denominated) gross fixed capital stock over 10 years.  What we discover is not immediately startling: whilst China’s share of NE Asia’s exports to Western markets was rising from 15.5% to 51.6% between 1996 and 2010, its share of NE Asia’s capital stock rose from 12.1% to 53.8%.

But look more carefully, and one can see that since 2005-2006, the slope for China’s proportion of capital stock has been rising rather faster than its market share of exports.  What this tells us is that as far as exports are concerned,  China’s capex effort –  which is, after all, the key to its exogenous growth model – has hit diminishing returns as far as export markets are concerned.

And we can measure this by expressing China’s change in share of NE Asian capital stock as a multiple (or fraction) of the change in its market share of NE Asia’s exports to the West. The chart below does exactly that.  What it shows is that between around 2000 and 2005, a one percentage point gain in share of NE Asia’s capital stock was regularly associated with a gain in China’s share of NE Asia’s exports to the West of around two percentage points.   However, by 2006 the gain had slipped merely to one: ie, China was no longer gaining export market share disproportionately to its capital inputs. This persisted into 2007 before collapsing completely in 2008, 2009 and 2010 (and – without doubt, in 2011 as well).   By 2010, a one percentage point gain in China’s share of NE Asia’s capital stock was associated with a gain of just 0.22 percentage points in China’s share of NE Asia’s exports to the West.

Quite simply, China’s exporters have never really recovered from the disasters of 2009. This is observable even in data for the first half of 2011,  when China’s market position was drastically enhanced by the March 11 catastrophes which enveloped Japan.

The problem is not that China can’t gain market share, but rather that to do so has become extravagantly expensive.  China can compete against the rest of NE Asia, but it’s an ever-more costly exercise.

(Incidentally, it's easy to misinterpret the chart as saying that for every dollar of China's capital investment buys less than a dollar worth of exports to the West. But of course, the proportion of investment spending in China (48.7% of GDP) is almost double the proportion of export-earnings (28.5% of GDP), so it is nearer the truth to say that two dollars of capital spending no longer buys one dollar of export-earnings from the West. Or, since 2008, that four dollars' worth of capex no longer buys a single extra dollar of export-earnings from the West.)

What we see is that China’s response to a deterioration in its underlying labour cost advantage and an ever-deteriorating terms of trade has been ever-increasing capital investment of diminishing returns. In the end, this can, must, will, and is leading to a steady erosion of net cash flow from the corporate sector, and a deterioration of net cashflow into the banking system. It’s a slow retreat from a position of great advantage, and with China’s private sector savings surplus having diminished from double digits in 2007/08 to around 4.6% now, it’s not one which is likely to turn critical in the next year or 18 months.  But unless there’s a fundamental change in China’s growth strategies, it will happen.

And in the meantime, the bills for that over-investment are piling up everywhere. So to repeat: China’s root problem is one of export competitiveness, and its economic response to losing it.

Shocks and Surprises, Week Ending Oct 15th

This was a curious week, in that the shock which dominated markets all week only arrived officially on Friday, but had been foreshadowed the previous week. The previous week, China's press had announced that deposits at the Big Four state-owned commercial banks had fallen by around 420bn yuan during the first 15 days of September. For China-watchers this was a massive flashing red light, because twice in China's recent financial history the unwillingness to allow formal interest rates to rise has ended up destabilising the bank deposit base, and forcing a policy change in order to sort out the underlying problems of the financial industry.

By Monday, Chinese policymakers were in action. The most obvious move was the announced arrival in the market of Central Huijin (the domestic arm of China's sovereign wealth fund), buying up stocks of the Big Four. Less obviously, but just as important, the recent focus on the financial complications of Wenzhou – the most active of China's private-lending markets – crystallized into action. China's press reported previously undisclosed details of the role which local officials were playing in the market, and by midweek, Beijing had dispatched 11 teams to the city to mediate a clean-up between the debtors, the SMEs, the 'private lenders', the officials who fund them, and the banks who fund the officials. The very next day, Wenzhou was applying for pilot status as the example-project around which China's next round of financial-system reform could be structured.

Markets in China and Asia rapidly recognized this series of events as a signal that the Chinese authorities, having for much of last year watched, analysed and sized-up the multiple and interconnected problems developing around inflation, local government debts, SMEs, the property market, and China's kerb-market interest rates, had developed a plan and had now concluded it was time to act. I think this is not the signal for a crude reflation, but rather the next stage of the long-running overhaul of China's financial sector. 

So between Monday and Thursday, Shanghai's index rose 4.3%, and the Hang Seng rose nearly 6%, and 5yr CDS rates China Development Bank and Bank of China retreated by 43 basis points. The assurance that the Chinese authorities seemed to know what they are doing of course contrasted with the continued dithering of European politicians.

When China's monetary data finally arrived on Friday, it was just about as bad as one might expect. M1 growth slowed to 8.9% YoY in September, the slowest since January 2009. Worse, it fell 2.2% on the month, which was a sequential disappointment more than two standard deviations below seasonal historic patterns. M2 growth slowed to 13%, which was the slowest growth since January 2002, and a sequential slowdown which also passed the 1SD mark. Not only did the absolute growth of monetary aggregates stall, but together they also signalled the collapse of liquidity preference (M1/M2) of 1.5 SDs below seasonal historic trends, suggesting a rapid retreat of inflationary expectations.

And this found an echo also in China's inflation data. Although there was no surprise in the CPI number (6.1% - as expected), there was in the PPI number, which came in at 6.5%, below the range of analyst expectations, with the retreat showing across all sectors.

Elsewhere in the world, economists are recovering their range in the US, with only modest positive surprises coming from retail sales (up 1.1% MoM), and labour markets (again). What analysts will be looking for in the coming months is, of course, the 'danger' of a 'growth shock' which could reignite both commodity prices and the debate over US monetary policy.

In Europe there were also more positive than negative surprises this week, particularly from the industrial economy. Industrial output rose 1.2% MoM, which was massively better than the consensus had expected, with both France and the UK particularly surprising on the upside. In addition, German trade data came in much stronger than expected, with exports rising 3.5% MoM – economists had expected a rise of only 1.1%.

The obvious thing is to dismiss this better-than-expected European industrial data as irrelevant in the face of the potentially catastrophic problems of the financial sector, and the seeming unwillingness/inability of European politicians to deal with them. And indeed, that is the safer bet. Nonetheless, over the last three weeks, we appear first to have had fairly decisive evidence that the US is not headed for a double-dip recession, and now to have a reasonable assurance that China's policymakers are well aware of the potential frailties of China's position, and are moving across a broad field to deal with them. If the world economy is a tripod, two legs standing is very materially better than none.  The gale is no longer howling in the face of a European solution - rather, it has swung very gently behind them. 

Wenzhou - China Reaches Turning Point

When I'm not doing other things, I sometimes lend Hugh Peyman a hand at his Shanghai-based ResearchWorks. I want to introduce you to what we wrote yesterday. I'm re-running it here today partly because its message is validated by the news today that Wenzhou has applied to be  an official 'pilot' city in sorting out China's financial system and the malign legacies of the 2009/10 credit splurge. And secondly, I think this is one of those once-in-a-decade turning points in China's economic history, and I don't want you to miss it. The fix is in: it should be changing your view on how the world is going to look over the next year, five years, and ten years.

How They Do It In Wenzhou

For the last 12-18 months, nothing has worried Chinese markets so much as the build-up of local government debt which financed the countercyclical 2008/09 infrastructure spending, and the stock of npls that lending must inevitably breed.

And so to today’s developments in Wenzhou. Over the last couple of months, focus has been trained on this city in eastern Zhejiang because it is a famously entrepreneurial town, home to both a swarm of financially suffering SMEs, and also to China’s most prominent collection of private grey-market lending syndicates. Most particularly, reports from the town have told how businessmen have fled the city to escape the vast debts they owe to private financiers.

Over the last couple of days, the story has moved on dramatically, in a way which illustrates how China’s leadership is likely to deal with the wider debt issues. It is probably not a coincidence that this is emerging only a week after a visit by Premier Wen Jiabao. One can follow the ‘fix’ that’s emerging from various Chinese press outlets, from both the ‘alternative-official-policy’ instrument ofCaixin, to the ‘Voice of the Party’ Global Times.

The poster boy for Wenzhou’s problems is Wang Xiaodong, a businessman who fled town a few weeks ago, owing up to Rmb 1.2bn to private lenders. The first bit of news, reported by Caixin, is that Wang is back in Wenzhou, and apparently offering repayment with a 30% haircut.  But more interestingly still, he has also produced a list of lenders, which prominently features 'government workers who routinely conducted financial deals on the side’ by recycling, and repricing, the privileged access to bank credit that government and bank workers enjoy. ‘Wang kept a list of private lenders, and a large proportion of the names on that list were civil servants.' Also ‘the higher the administrator is in the ranks, the greater the amount of bank loans.' His list is leverage for him over his creditors, for the central authorities over Wenzhou powerbrokers; and for Beijing’s market reformers vs the status quo.

Meanwhile, over in the 21st Century Business Herald, it is reported (without attribution) that China’s bank regulator (CBRC) has increased a loan quota for Wenzhou by Rmb 100bn. In addition, Zhejiang is seeking Rmb 60bn yuan in one-year bailout funds from the central bank. (Guangzhou Daily, incidentally, directly queries 'rumours' of a 60bn yuan facility.)

Bottom line: Wenzhou’s financial markets will get most of their money back but only in return for a highly embarrassing admission that private banking markets depend on illicit collusion between banks and officials. What will Beijing do with this?

A commentary in today’s Global Times on private banking gives us a clue. It reads: 'The interest rate policy of the Chinese central bank has twisted the domestic financial markets and kept money out of the banking sector, redirecting it to private lending, which has in turn further shrunk bank lending. As such, the govt should not clamp down on private lending directly, but instead accelerate reform of the interest rate policy, while also encouraging the establishment of more private banks to promote healthy competition.’

Conclusion: This very public fix of Wenzhou's problems suggests that China is now confident about dealing with its wider debt problem, and that the end-game has begun, and that it may involve significant bank market reforms and liberalization. This should generate confidence that solutions are underway that will put questions about bank stability behind us. More positive views should flow in the following weeks and months.

Shocks and Surprises, Week Ending October 8th

The thing that changed this week is that for the first time since around April, it's easier to believe that the US recovery can coexist even as the household sector deleverages, than that the recovery has run out of steam. The dataflow has been quietly urging this change in assumption for the last three weeks, with positive surprises quietly outnumbering negative shocks.

The key development this week was that the repeated hints of slightly better-than-expected news from the labour market were confirmed. First, for the second week in a row the jobless data came in better than expected, with the continuing claims number printing the lowest since July – a number to match the previous week's positive surprise on initial jobless claims.

There remain questions about the impact of the seasonal adjustment process on both these numbers. However, the surprise from the weekly data was buttressed by two sets of monthly data: first, the ADP tally of monthly employment change, which came in right at the top end of expectations, and then the full monthly labour market data, in which non-farm payrolls and private-sector payrolls not only broke through the top end of expectations, but also carried with it a major upward revision (to 57k) for the previous month – you remember, the one in which the preliminary result showed no net job growth at all!

That preliminary report was, in terms of the market impact it made, probably the biggest shock of the last month. It was also, it now turns out, significantly inaccurate.

Both the perception and the reality of US job-growth matter. There's no mystery why the reality matters – it's the very stuff of economic growth. But in a recovery circumscribed by household debt-deleveraging, the perception also matters, because a household which is worried about its employment prospects is a household with an added incentive to pay down debt whilst the going remains good. As I wrote here, on at least three crucial measures, US household balance sheets have already been rectified to states which have previously been accepted and stable. The medium-term question for the US is whether those levels can remain accepted and stable in the face of the threat of severe financial turbulence. And in this, the labour market data is absolutely crucial.

Not only is the labour market delivering positive surprises, but so too was manufacturing (the ISM surpassed expectations) and construction (a rise of 1.4% MoM in August offsetting the 1.3% MoM fall recorded in July, with the numbers jostled by the impact of the near-shutdown of government contracts towards the end of July). Elsewhere, factory orders and wholesale inventories data neither surprised nor shocked.

Most probably, global markets have yet to react to the change in rational expectations about the US economy, since they remain focussed on the Euro-drama. And there, markets remain avid for a reason to believe that Euro-policymakers will or can act constructively. Perhaps this week genuinely brought some hope, in the form of a break-up of the Franco-Belgian bank Dexia. This may have allowed enough reality to intrude on European state-rooms that sensible conversations can finally be possible. Thus, the week ended with a fairly open row between the French and German governments about who is to pick up the tab for French banks' bad assets.

Arguably, the inability to articulate this core impasse, this core conflict of financial interests (let alone surmount or resolve it), has inhibited European politicians from thinking clearly about the real issues they face.

Meanwhile, the economic newsflow from Europe this week was, on balance, better than the market had expected. From within the Eurozone, manufacturing PMIs for Germany and Italy came out surprisingly better than the flash estimates, and the French trade deficit improved unexpectedly, thanks to a surge in exports of transport goods. Outside the Eurozone, Britain had a surprisingly strong week, with PMI for both manufacturing and services confounding expectations, as did service industry activity. Yes, there were negative shocks too (German and French services PMI, UK construction), but it's been a couple of months now since the good news outweighed the bad.

It was a quiet week for Asian data, mainly because Chinese markets were closed for the National Day Holiday week. Probably the most important piece of data came from Japan, where although the quarterly Tankan indexes of business conditions held no major surprises, the accompanying survey of investment intentions did, with the planned capex growth of 3% by large companies this FY coming in significantly below expectations.  

Shocks and Surprises, Week Ending October 1

With most of the week spent travelling back and forth to Istanbul, this week's shocks and surprises will be lighter than usual. (Also, I fear this will be slightly longer than usual. Oscar Wilde got it right, when he wrote: 'I'm very pressed for time, so this will be a long letter. . . . ') However, four strands stand out – one for each major economic geography - two of which (for the US and Japan)  suggests that consensus expectations will need to be adjusted.

First, in the US, we've entered that phase of expectations adjustment where positive surprises are now comfortably outweighing negative shocks, and are coming in about as frequently as data which reflects the consensus. This week I was looking for modest positive surprises from the housing market. We did get one – pending home sales were up 13.1% YoY, which was just over double the YoY the market expected. However, actual new home sales were a disappointment because although the 2.3% MoM fall was well within the range of expectations, the data came larded with a 8.7% MoM fall in the mean and median prices achieved. If this is not revised away, then the stabilization of volumes is being achieved only by slashing prices – ie, the market is not yet clearing.

Rather, most of the positive surprises came from the industrial and 'real' economy: the Chicago PMI and the Kansas City Fed Manufacturing Activity Index both came in far higher than the range of market expectations, both featuring jumps in output, new orders and (importantly) employment indicators. We also had a very strong weekly initial unemployment claims report, with new claims falling to the lowest readings since March this year. There's a claim that the strength of this report is owing to a 'slight mis-timing' of the seasonal adjustment process – but whether this mistiming means the past was better than it looked, or the future will be weaker than it appears, is not yet clear.

The second obvious story-strand this week was the broadening of the evidence that Japan's recovery is stalling, most probably in response to the belated J-curve impact of the strong yen. We'd noticed this last week in Japan's trade data, and we got confirmation this week from data on industrial production (up just 0.8%, vs a consensus of 1.5%), and the Markit/JMMA Manufacturing PMI which came in below 50 for the first time since April as export orders fell for the seventh month in succession. Moreover, retail sales also fell 2.6% MoM, which was far worse than the 0.8% MoM fall expected. We should expect targets for Japan's recovery for the rest of this year and early 2012 to be lowered in the coming days/weeks.

The third story-strand is the achievement of a consensus in and around China which is only mildly miserable. This has been a heavy week for second-string China data, and data from closely-associated economies in NE Asia – but a week which has yielded very few shocks or surprises. In China itself, there was no surprise from industrial profits data, from its Leading Index, from its own Manufacturing PMI, from the HSBC/Markit manufacturing PMI, or from the MNI Business Conditions survey. Outside China, Taiwan's clutch of leading and coincident indicators came in much as expected, as did its monetary data. Over in Hong Kong and South Korea, trade data barely deflected the dial. All these data confirm a softening which remains surprisingly unthreatening. We even got two semi-surprises in the form of better-than-expected industrial production numbers from Singapore and Korea. In both cases, circumstances suggest we don't take them too seriously.

The fourth strand, of course, is Europe. And, quite strangely, we're in a period where the consensus is alternately too cautious, then too optimistic. It is a land, in other words, where the economists are all over the shop. This week, economists proved themselves unrealistically optimistic when it came to French consumer spending and German retail sales, and almost all pan-European confidence indicators reflected a pessimism far deeper than economists had expected. And yet, within this darkness there were also unexpected shafts of light: German unemployment data remains far stronger than expected; Eurozone broad money is growing faster than anyone expected (as is inflation, which, at 3% is the highest since pre-crisis 2008), and even UK consumer confidence appears to have recovered its equilibrium from August's shocks rather sooner than expected.