China prepares to liberalise finance as hedge funds and estate agents salivate

Beijing is making prepartions to let its money off the leash, and the repercussions will be felt everywhere

It's a long way from Beijing to Belgravia but London's upmarket estate agents would be well advised to keep a close eye on developments in China over the next 10 days. The price of a mansion in London's more fashionable districts is rising fast. Cash buyers from overseas have snapped up houses with little or no regard of the cost, creating a property microclimate divorced from the rest of the market.

The Bank of England is keeping tabs on the boom, concerned that the flood of foreign cash pushing up the price of mansions could – if left unchecked – herald the start of the next bubble.

Well, you ain't seen nothing yet. The freeing up of China's economy over the past 35 years has been methodical. First it was agriculture. Then it was industry. Now, the next phase of liberalisation planned by the ruling cadre of the Communist party includes finance.

A host of possible reforms are being considered. These include offering higher interest rates for domestic savers backed up by deposit insurance for savings accounts and making China's currency, the renminbi, convertible.

Unfettered movement of capital out of China is not going to happen overnight, but it could happen within five to 10 years. That's why George Osborne was in China last month seeking to make London the global hub for dealings in the renminbi. That is why fund managers, hedge funds, private equity firms and property specialists in Britain are licking their lips.

China's leaders have encouraged speculation that radical change is afoot by talking about a "masterplan" for the economy. There have been signs that Beijing is prepared to sacrifice quantity for quality: accepting that growth needs to be slower but more sustainable.

Although living standards have risen sharply, China's economic model is investment-intensive. There has been a rapid expansion of industrial capacity to provide goods for export. Heavy debts have been incurred in the process, particularly by local government. The sluggish recovery in the global economy that followed the financial crisis of 2007-08 means that demand for China's manufactured products is growing less quickly than it once was. Hence the feeling that the economy needs more of a domestic focus and that capital should be used less wastefully.

The internal debates about the future of the economy will come to a head next weekend when the central committee of the Communist party meets in its third plenary session since it was elected for a five-year term in 2012.

Historically, the so-called third plenum has been the occasion for the party hierarchy to focus on the economy, followed by big shifts in policy. It was at the third plenum in 1978 that Deng Xiaoping announced the opening up of the Chinese economy: the move that triggered 35 years of stupendous growth.

Fifteen years later, Deng said the economy needed more investment and had to become more export-focused. Within a decade, the country's success in breaking into western markets was crowned by admission into the World Trade Organisation. WTO membership, together with a period in the early 2000s when the global economy was expanding at its fastest rate since the late 1960s and early 1970s, meant there was little pressure to reform China's economy. It was hard to argue with growth rates of 10% and record rates of poverty reduction. Now, though, expectations are high that President Xi Jinping and Premier Li Keqiang will act.

Analysts at Capital Economics say the third plenum will come up with a direction of travel rather than a detailed policy programme. But they expect the new leadership to address three key issues: the low share of national income going to average households; the dominant role of the state in much of the economy; and the inefficient use of capital.

Xi and Li are likely to proceed with caution. There will be strong opposition to reform from vested interests who like the status quo. What's more, China's fragile financial sector needs handling with care. The balance sheets of commercial banks and the shadow banking sector are bloated with loans to state-owned enterprises and real estate companies. Many of these loans are non-performing, and there are enough parallels between China today and the United States half a dozen years ago if Beijing wishes to observe the consequences of over-hasty or badly sequenced reforms.

Even so, the feeling seems to be that ducking the need for change will merely store up even bigger problems for the future. Deregulation, land reform and a strengthening of the social security system are on the agenda.

But it will be financial reform that will be of most interest to the outside world. There has been liberalisation in this sector but Capital Economics says this is set to accelerate by allowing the renminbi to operate in a wider trading band, allowing full private ownership of banks, facilitating the development of the corporate bond market and loosening curbs on cross-border capital flows.

In the US, there has been much agonising over the emergence of China as a rival economic superpower. America's trade deficit with China has been a particular cause of concern, with Beijing accused of manipulating the renminbi exchange rate to dump goods in the west. Fears have been expressed that America is vulnerable to a financial Pearl Harbor: a sudden decision by Beijing to stop buying US Treasury bills.

In the light of what is going to be discussed later this week, such fears look overblown. That's not just because such a move would be a pyrrhic victory for China, since it would destroy the value of its assets. It's also because bit by bit, China's economy – if not its political structure – is being reshaped along the lines sought by Wall Street and by American-owned transnational corporations.

Back in the late 1990s, US multinationals demanded that China accept more stringent conditions than had been imposed on other developing countries in order to secure WTO membership. Beijing accepted. Now America wants two things: China's financial sector to be opened up to US banks and the country's savings to boost western capital markets. More than likely, Washington will get its way, perhaps not immediately but with profound effects.

Why? Well, consider this. America, the world's biggest economy, has savings of $2.8tn (£1.7tn); China has more than $4tn. As a result, the impact of financial liberalisation in China will make the flow of funds into the west from Russian oligarchs look inconsequential.

As Diana Choyleva of Lombard Street Research notes, China's elite already sends its children to Britain to be educated. The money is about to follow. Which is why the hedge-fund owners of Mayfair and the estate agents of Belgravia have every reason to be cheerful.

Article Source : http://www.guardian.co.uk
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Stock markets soar on positive world manufacturing surveys

UK order books and output grew at fastest pace in 20 years while China's year-long contraction ended

Stock markets soared on Monday as surveys of manufacturing output around the world gave the strongest indication yet that the richest countries are finally shaking off the after-effects of the financial crisis.

British manufacturing order books and output grew at their fastest in almost two decades while China, which has suffered a year-long contraction in manufacturing output, saw activity expand in August. Factory sectors in Spain and Italy returned to growth for the first time since 2011. Only France and India among the world's biggest economies experienced falls in production and Paris will be comforted by indications that some areas of manufacturing stabilised during the summer.

India, though, appeared to be heading into deeper trouble after a fall in the rupee failed to arrest the country's first contraction in manufacturing for more than four years.

The FTSE 100 jumped almost 100 points to 6507 with mining groups leading the charge. Rio Tinto and Anglo American saw a sharp rise in their values as investors bet on a more widespread use of iron, coal and nickel. The French Cac and German Dax also rose strongly.

George Osborne has taken comfort in recent months that the UK's long-awaited recovery in manufacturing is under way. The services sector has expanded for more than a year, but the economy was unable to push ahead while construction and manufacturing contracted. Since the beginning of the year those sectors have stopped being a drag on growth and in recent months have added momentum to the growth figures.

The monthly snapshot from the Chartered Institute of Purchasing and Supply/Markit said the return of confidence, a rosier outlook for exporters and demand for new products had all helped UK factories in August.

The purchasing managers index (PMI) rose from 54.8 in July to 57.2 last month – its highest level in two and a half years.

The PMI is made up of various measures of industrial activity including orders, output, employment, stock levels and inflationary pressure.

Rob Dobson, senior economist at survey compilers Markit, said orders and output were growing at their fastest since the summer of 1994, a period when the UK was recovering from recession.

He said: "The UK's factories are booming again. Orders and output are growing at the fastest rates for almost 20 years, as rising demand from domestic customers is being accompanied by a return to growth of our largest trading partner, the eurozone."

Meanwhile, Britain's high streets have performed well this year and the British Retail Consortium said the trend continued into August. Sales rose 3.6% on a year ago as shops expanded to cope with rising demand. The BRC said the figures augured well for the autumn because they were strong enough to show an improvement on last August, when the Olympics was at its height.

Strong manufacturing growth has been accompanied by an increase in price pressures, the Markit report said. Companies reported rising costs for fuel and raw materials, with its input prices index up by 10.4 points on the month – the second highest rise in the survey's history.

The potential for a rise in inflation, coupled with analysis showing that much of the boost to the economy has been based on consumer spending while investment remained on hold, has persuaded some analysts to conclude that the quickening recovery is unsustainable.

Trevor Greetham, a director at Fidelity Worldwide Investment, accused the government of "unleashing the beast" of cheap mortgages to foster a dash for growth before the 2015 election.

He said a large part of the current recovery could be traced back to the government's Funding for Lending Scheme, which offers cheap money to banks, and the housing market scheme Help to Buy, which have channelled money into mortgages at the expense of business lending.

The TUC said the benefits of the recovery were being swallowed up by business managers and shareholders, leaving workers worse off.

Speaking before the TUC's annual conference next week, general secretary Frances O'Grady pointed out that UK workers have suffered a huge squeeze on their incomes over the last five years, with average pay falling by 6.3% in real terms.

She said many have remained on frozen or low pay while inflation has jumped, leaving someone earning £26,000 a year more than £30 a week worse off in real terms.

The study, part of the TUC's Britain Needs a Pay Rise campaign, compared hourly pay rates in 2007 (at 2012 prices) with those in 2012, and "shows the extent of the pay squeeze being felt by families across the UK as incomes fail to keep pace with rising prices".

O'Grady said the north-west was the hardest hit region in the UK following a fall in average hourly pay from £11.43 in 2007 to £10.52 in 2012 – an 8% drop in real terms.

France, India and Russia struggle

France's manufacturing sector is struggling to recover after a difficult year of redundancies at the state-backed car makers Renault and Peugeot Citroën and high-profile steel works closures.

While eurozone manufacturing activity expanded for a second successive month in August, in France the purchasing managers index was confirmed at 49.7, where a figure below 50 shows activity contracted. It was the only eurozone country where the measure of activity failed to improve.

However, output has fallen in France over the last four years far less than some other eurozone countries, and the slow rate of contraction was read by many analysts as a sign that the recession is bottoming out.

India also suffered a slowdown in manufacturing output in August, though much of the blame was heaped on the administration of prime minister Manmohan Singh, a former economics professor, who has run the country since 2004 and was re-elected in May.

The HSBC manufacturing purchasing managers' index fell to 48.5 after a drop in domestic and export orders. In the last two years GDP growth has more than halved to 4.4% and investment funds have flowed out of the country. The central bank has hiked interest rates, making it tougher for businesses and consumers to borrow.

India was not alone among the "Bric" countries to suffer a contraction in manufacturing. Russia's output also fell, largely because of government neglect and a high rouble. A drop in oil revenues exposed the weakness in manufacturing weakness, leading Vladimir Putin to suggest he may free several jailed business leaders to boost output and growth.

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GlaxoSmithKline China scandal: British man arrested

British embassy confirms arrest of risk consultant Peter Humphrey, who was detained with his wife, Yu Yingzeng, in July

A British risk consultant held in China since mid-July amid an investigation into the country's pharmaceutical industry has been arrested, the British embassy in Beijing and his family said on Wednesday.

Peter Humphrey and his wife, Yu Yingzeng, were detained in Shanghai on 10 July as police investigated bribery allegations against GlaxoSmithKline.

In China, an arrest typically means police believe they have enough evidence for a case to be brought to trial. Detentions can last for weeks and end in release without charges being filed.

It was not immediately clear if Humphrey's arrest was directly related to the investigation of GSK, which has been accused by China of funnelling up to 3bn yuan (£312m) to travel agencies to facilitate bribes to doctors and officials.

China has taken a tough stance on corruption and high prices in the pharmaceutical industry as it widens access to healthcare, bringing an estimated $1tn healthcare bill by 2020.

"We can confirm the arrest of a British national, Peter Humphrey, in Shanghai on Monday19 August. We are currently providing consular assistance," a British embassy spokeswoman, Hannah Oussedik, told Reuters by phone.

A Chinese employee walks into a GlaxoSmithKline office in Beijing. Peter Humphrey and Yu Yingzeng were detained as police investigated bribery allegations involving the companyOussedik declined to offer additional information about the reasons for Humphrey's arrest. The US embassy in Beijing could not be reached immediately to confirm whether Yu had also been arrested. The US consulate in Shanghai declined to comment.

Shanghai police did not respond to a request for comment.

A statement issued by a member of Humphrey's family said both Humphrey and Yu had been arrested.

A source close to the family said they had not yet been told which charges would be laid against Humphrey, or when, but the statement said lawyers had told the family that the couple were detained last month because they had broken a law related to buying private information.

Humphrey and Yu co-founded ChinaWhys, a business risk advisory firm that has done work with drug companies, including GSK, separate sources familiar with the matter have said.

Humphrey worked as a journalist for Reuters in the 1980s and 90s. The ChinaWhys website says he has been a risk management specialist and corporate detective for 14 years.

In March 2010, four executives from mining giant Rio Tinto were jailed for taking bribes and stealing commercial secrets. Three of those executives were Chinese while the fourth was a Chinese-born Australian.

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China accuses GlaxoSmithKline of paying £300m in bribes

British drugmaker under investigation by Chinese authorities for alleged bribery and price fixing

The British drugmaker GlaxoSmithKline used travel agencies and consultancies as vehicles to bribe officials and doctors and illegally boosted the sales prices of its drugs sold in China, police said on Monday.

Since 2007 the company had transferred as much as 3bn yuan (£323m) to more than 700 travel agencies and companies, Gao Feng, a police official in charge of the investigation into the company, told a news conference.

The investigation had found GlaxoSmithKline was chiefly responsible for the bribes, including instances of sexual bribery, Gao said. Four senior Chinese executives have been detained.

Police said they had taken no action against any British nationals, adding that no information had been received from GSK's UK headquarters.

GSK, which says it was only told of the grounds of the investigation in early July, has said it found no evidence of bribery or corruption in China, adding it would co-operate with the authorities.

GlaxoSmithKline research centre in Shanghai. The company is under investigation over alleged briberyThe ministry of public security said on Thursday that GSK executives in China had confessed to bribery and tax violations during one of a string of investigations into foreign firms in the world's second-biggest economy.

The ministry said the case against Britain's biggest drug maker involved a large number of staff and a huge sum of money over an extended period of time, with bribes offered to Chinese government officials, medical associations, hospitals and doctors to boost sales and prices.

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China says GSK executives have confessed to bribing doctors

UK drugs maker GlaxoSmithKline under fire after executives in China confess to 'serious economic crimes' to boost revenue

Executives working for the UK drug maker GlaxoSmithKline in China have confessed to "serious" corruption and tax-related offences, China's security ministry said on Thursday, amid a wide-ranging series of investigations into foreign firms operating in the country.

The allegations, which the ministry classified as "serious economic crimes", include the bribing of doctors and officials in order to "open new sales channels and increase drug revenues". The employees are also claimed to have used fake receipts to violate tax regulations, according to a statement on the ministry's website. It did not reveal the employees' identities, how many were detained or when they were questioned.

"After initial questioning the suspects have admitted to the crimes, and the investigation is ongoing," the statement said, adding that police were carrying out investigations in Shanghai, Zhengzhou and Changsha, where GSK employees – whose identities have not been revealed – were detained two weeks ago on charges of fraud.

GlaxoSmithKline executives offered bribes to Chinese government officials, medical associations, hospitals and doctors to boost sales and pricesA spokesman for GSK rejected the charges, saying: "We take all allegations of bribery and corruption seriously. We continuously monitor our businesses to ensure they meet our strict compliance procedures. We have done this in China and found no evidence of bribery or corruption of doctors or government officials. However, if evidence of such activity is provided we will act swiftly on it."

He added: "We are willing to co-operate with the authorities in this inquiry. But this is the first official communication GSK has received from the PSB [public security bureau] in relation to the specific nature of its investigation."

A spokesman for the Foreign Office said: "We are aware of the Chinese investigation and we are in contact with GSK and the Chinese authorities."

The allegations follow similar claims that GSK sales staff in China showered doctors with money, dinners and all-expenses paid trips in promoting its Botox anti-wrinkle treatment.

The Botox allegations, reported in the Wall Street Journal following a tip-off from an anonymous source, centred on claims that GSK marketing staff in China had planned to pay doctors up to $490 (£325) for meeting prescription quotas between 2004-2010.

There is no evidence any payments were made and GSK's spokesman said the company had looked thoroughly at these allegations and had found nothing.

GSK's sales in China account for 3% of the group's turnover, but are expected to grow.

The allegations come as Beijing conducts a series of investigations into foreign companies across an array of industries. European and US-based companies Mead Johnson, Nestle and Danone have cut their infant milk formula prices in recent days amid a major government investigation into alleged price fixing. Earlier this year Chinese media targeted Apple and Volkswagon in scathing consumer rights investigations.

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Burberry beats forecasts after 'standout' spring/summer season

Growth strongest in Asia as British luxury group reports 18% first-quarter sales rise

Strong sales of men's clothing, large leather bags and coats during dismal spring weather in Europe helped British luxury brand Burberry to a better than expected performance in the first quarter of its financial year.

Angela Ahrendts, the chief executive, said: "Spring/summer 2013 was a standout season driven by innovative marketing, cohesive monthly fashion groups and exceptional execution."

The company, which recently signed actress Sienna Miller and her fiancé Tom Sturridge to front its advertising campaign, recorded an 18% rise in sales, at constant exchange rates, to £339m, well ahead of analysts' expectations.

When the impact of new store sales were stripped out, sales rose 13%, up from 8% growth in the previous three months.

The number of staff making Burberry's signature raincoat at its British factory in Castleford, West Yorkshire, has been doubled since 2011 amid high demand, with sales of outerwear and large leather goods such as its Blaze and Orchard bags accounting for half the brand's sales growth.

A Burberry store in Beijing – the brand saw double-digit underlying sales growth in ChinaMenswear sales rose 25% over the quarter as the label brought its men's catwalk show back to London this year. One customer was tennis ace Andy Murray who wore a Burberry suit for his visit to Downing Street after his Wimbledon triumph.

Menswear now accounts for nearly a quarter of the company's sales and Carol Fairweather, chief financial officer, said it was a "significant growth opportunity" for the future.

Growth was strongest in Asia with Burberry outperforming rivals in the all-important Chinese market by harnessing the power of social media to raise the profile of the brand and by opening more large and glamorous stores. It saw double-digit underlying sales growth in the country over the quarter.

Fairweather said: "We've got a lot of self-help measures and quite a long way to go in China compared to some of our peers."

Two shops were opened in Shanghai during the quarter and another flagship store is planned to open in China later this year. The group has bounced back from a profit warning last September after sales in China had slowed.

The company said "soft" trading at its high street stores was offset by strong growth online, partly helped by the use of iPads by shopfloor staff to help customers order goods that were not immediately available.

Burberry is also experimenting with allowing shoppers to pick up goods ordered via the internet at flagship stores including outlets in London in Knightsbridge and Regent Street.

But Ahrendts, who topped the UK's pay league with a total package of £16.9m last year, almost £5m more than the next highest paid chief executive, warned that the macroeconomic outlook remained "uncertain" and that first half profits would fall below those of last year, partly because of the cost of bringing Burberry's fragrance and beauty business back in-house.

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GlaxoSmithKline executives in China 'confess to bribery and tax violations'

China's security ministry says GSK suspected of trying to bribe officials, hospitals and doctors to boost sales and prices

Executives of British drug maker GlaxoSmithKline in China have confessed to charges of bribery and tax law violations after initial questioning by Chinese police, according to the country's security ministry.

The company is suspected of offering bribes to government officials, medical associations, hospitals and doctors to boost sales and prices, China's security ministry said in a statement on its website on Thursday.

GSK is also suspected of using fake receipts in unspecified tax law violations, the ministry added.

"After initial questioning the suspects have admitted to the crimes, and the investigation is ongoing," the statement said.

The statement did not give details on the number of executives questioned, their identities or when the questioning took place.

A pharmacist checks stocks of medicine at a hospital in Hefei, central ChinaGSK said it would co-operate with the authorities but said Thursday's announcement was the first official communication it has received about the investigation.

"Corruption has no place in our business," said a company statement. "If evidence of such activity is provided we would of course act swiftly on it."

In recent months China has targeted foreign firms on multiple fronts including alleged price-fixing, quality controls and consumer rights, forcing companies to defend their reputations in a country where international brands often have a valuable edge over local competitors in terms of public trust.

Police in the south-central Chinese city of Changsha said last week they were investigating high-level Chinese staff at GSK on suspicion of unspecified economic crimes.

GSK said on Monday it was investigating new allegations that its staff had used improper tactics to market Botox in China, but had so far found no evidence of bribery or corruption.

GSK, Merck and other foreign and domestic drugmakers were also being investigated by China's top economic planning agency on cost and pricing issues.

China is an increasingly important market for international pharmaceutical companies, which are relying on growth in emerging markets to offset slower sales in western markets where many former blockbuster drugs have lost patent protection.

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Credit crunch confusion sends China's stock market on wild ride

Down 6% in the morning, up 6% in the afternoon. The wild ride in the Chinese stock market on Tuesday tells the tale of confusion about the depth of the China's credit crunch and the authorities' ability to control events.

China's lending almost doubled last year from the year before to 200% of economic output The trigger for the afternoon rebound was comments from the central bank that it would guide interest rates to "reasonable levels" and that cash in the financial system would be managed flexibly. In normal circumstances, such a statement would be regarded as woefully vague, almost meaningless. But the People's Bank of China traditionally runs its communications in a near-vacuum. Two statements in two days counts as an outbreak of verbosity. Investors took that as reassuring evidence that the authorities are at least aware of the risks as they attempt to defuse a credit boom.

Well, it's something to cling to. Confidence, however, looks fragile. The big problem is the scale of the ramp-up in credit in recent years. Fitch, the credit ratings agency, has calculated that the total lending in the $7.3tn (£4.7tn) Chinese economy reached almost 200% of economic output last year, up from 125% five years earlier. That rate of explosive growth can be dangerous. History is littered with example of economic blow-ups and banking crises that followed massive increases in lending – Japan in the late 1980s, most famously.

China's recent credit explosion started in 2009, when Beijing reacted to the west's banking bust and recession by ordering a massive programme of investment, principally in public infrastructure, offices and flats. That succeeded in restoring strong growth to the economy – and, indeed, helped to prevent a bigger global downturn. But, for the bears, the critical point is that the Chinese credit boom never slowed down: the skyscrapers and flats continued to be built before demand could catch up.

"The excess borrowing that occurred in 2009 has never been absorbed by the real economy and now more borrowing is being piled on top of this," said Wei Yao, an analyst at the Société Générale bank, earlier this month. She thinks "the debt snowball is getting bigger and bigger, without contributing to real activity" and suspects many borrowers are rolling over loans at punitive rates in a desperate struggle to stay in the game.

SocGen's chart shows where the credit has come from – most of the extra lending is not being made by mainstream banks but by the so-called "shadow banking" system, which largely means small finance houses that have often funded speculative property projects.

Beijing has traditionally tolerated the shadow banks. They are viewed as an essential part of a financial system that is steadily liberalising, even if they have also become a way for state-backed banks themselves to bypass official lending caps. But it was these shadow lenders that the People's Bank of China seemed to want to punish last week.

Short-term lending rates between banks were allowed to soar – to 11% for one-week money. The official message seemed blunt: rein it in, apply discipline, and don't assume the state is always on hand to keep interest rates low. Having made its point, then central bank then managed rates back downwards, albeit not all the way down.

Beijing's mission seems reasonable enough – if there is excess credit in the Chinese economy, it's better to tackle the problem before a bigger bubble is blown. Mark Williams of thinktank Capital Economics comments: "The episode is arguably the strongest sign yet that the leadership is willing to suffer short-term economic pain if necessary to achieve more sustainable growth."

But Williams also calls the People's Bank's behaviour "extraordinarily reckless" since it offered no explanation for its initial inaction. Indeed. It's all very well to have a policy but surely it's better to communicate it. The risk is that confidence is damaged.

What's more, shock and awe tactics look ill-suited to the delicate task of finessing investment away from unprofitable property projects while simultaneously keeping the economy stable. Bank of America Merrill Lynch's analysts think the biggest risk lies in the central bank mishandling the situation. "In our view, dealing with banks in breach of regulations should be done by improving prudential regulations rather than engineering an interbank credit crunch which could potentially backfire should banks lose mutual trust," they said.

Viewed from outside, China's building boom also looks to rely on inherently shaky financial structures. The shadow banks attract cash in short-term products from middle-class savers keen to escape the low deposit rates on offer at state-sponsored banks. But then they lend to long-term illiquid building projects. In a full-brown credit crunch, they would be horribly exposed. We would also see the first test of how far Beijing is willing to go to protect the shadow banks.

"I would say the [Chinese] authorities have the situation well in hand," said incoming Bank of England governor Mark Carney. For now, that's the consensus view. While economists are busy trimming their forecasts of GDP growth – Goldman Sachs now expects the economy to grow 7.7% in 2014, not 8.4% – they are also praising China for acting early to prevent a bigger debt crisis.

The alternative view is that China has left it late to rein in the credit boom without risking a major slump. If Wei Yao at SocGen is right about the chronic problem of over-extended corporate borrowers, there are lots of bad debts that haven't been recognised. In the past, recapitalising banks has never a problem for China – but the economy's new reliance on shadow banks and hazy specialist financing vehicles makes events harder to predict. Given the size of the building boom, is it even possible to estimate accurately the accumulation of bad loans in the system?

China will also have to attempt the trick against an uncertain global backdrop. The US economy is growing but not everybody is convinced the recovery can withstand higher interest rates. In the meantime, recession rumbles on in the eurozone. But Beijing seems to have decided the country's credit pains have to be confronted anyway. After 12 years of boom, Chinese-style capitalism faces its biggest test – how to apply the brakes without crashing.

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Fed fears and China credit crunch concerns send jitters through markets

FTSE 100 falls to just above 6000 from all-time highs last month, while Dow Jones index opens 200 points down in New York

Fears that the Federal Reserve is preparing to remove its stimulus from the US economy coupled with anxiety that China is being gripped by its own credit crunch have sent jitters through global stock and bond markets.

The rout hit yields on UK government bonds which hit their highest level since October 2011 in what analysts said was one of the most rapid moves ever witnessed on the market. Yields, which move inversely to price, on 10-year gilts have now risen a full percentage point to edge towards 2.6% in just two months, a rapid pace of change in the potential cost of government borrowing that could in turn increase the price at which companies and households borrow.

The FTSE 100, which last month was testing all-time highs, lost another 70 points to sit just above 6000 – a key level it only moved through at the start of 2013 – while the Dow Jones Industrial Average in the US suffered a 200-point loss in the first half hour of trading. Commodity prices, such as copper, were also lower.

Yields on US government bonds, known as Treasuries, also hit two-year highs as investors digested recent remarks by the Fed chairman, Ben Bernanke, that he might begin to slow down the central bank's $85bn (£55.1bn) monthly purchases of bonds which are being used to simulate the economy.

Governments in the eurozone, particularly the fragile economies of Spain and Italy, also faced their highest borrowing costs since May as yields rose.

Chinese stock markets dropped more than 5%, the biggest fall in three years to reach their lowest close in more than four years, after the People's Bank of China (PBoC) – the central bank – appeared to suggest it would not step in to prevent a rise in the rates at which banks borrow from each other.

Analysts at Nomura said that "investors remain concerned over tight liquidity conditions in the banking system" in China after the PBoC said it would "contain financial risks with more solid actions" and "fine-tune policy when necessary".

The rates which banks borrow from each other in China have jumped to close to 10% and to as much as 25% for some banks – from just 3% a month ago – raising concerns about the impact of lending by non-banks in China, known as shadow banks.

Traders on the floor of the New York Stock Exchange

Michael Hewson, senior market analyst at CMC Markets, said: "Fears of a continued cash squeeze in the Chinese banking system has seen European markets continue their soft tone on fears that a dislocation in the banking system will cause further downward revisions in forward expectations for growth over the coming months".

Hewson noted that the warning at the weekend by the Bank for International Settlements, the international central bank organisation, that more stimulus could actually harm fragile economies had also ratted markets. Stephen Cecchetti, head of the BIS monetary and economic department, warned on Sunday: "Unfortunately, central banks cannot do more without compounding the risks they have already created. Monetary stimulus alone cannot put economies on a path to robust, self-sustaining growth, because the roots of the problem preventing such growth are not monetary."

But a senior US central banker attempted to fight back against the market reaction saying that the Fed could not be broken in its resolve in easing back from monetary stimulus in the way that the UK had been forced out of the exchange rate mechanism in 1992 by speculative attacks by George Soros. "But I do believe that big money does organise itself somewhat like feral hogs. If they detect a weakness or a bad scent, they'll go after it," Richard Fisher, president of the Dallas Fed, told the Financial Times. The Fed had not even started to cut back its purchases of bonds, Fisher said. "I don't want to go from Wild Turkey to 'Cold Turkey' overnight," said Fisher.

John Higgins, chief markets economist at Capital Economics, said the potential removal for stimulus by the Fed was the main cause of the upheaval in bond markets but said, though, that a "bloodbath" should be averted. Even if US Treasury bond yields rose to 3.5% by the end of the year – from around 2.5% now – it would be low by historical standards, Higgins said.

In China, concerns about a rapid expansion in lending have dogged Beijing's economic management as consumers seek to maintain their living standards by borrowing cash from these local finance companies rather than main stream banks, although much of the lending can ultimately be traced back to the banking sector. Deutsche Bank has estimated that the among credit extended by non-banks could account for as much as 40% of Chinese GDP.

Capital Economics' China analyst, Mark Williams, said investors were factoring in lower growth as the credit squeeze takes effect while the Nomura analysts said the liquidity squeeze was the first real test for China's new leaders, in office for just three months.

"If the new leaders maintain their current approach, we believe it will add downside risk to growth in 2013 but in our opinion this would help reduce systemic financial risks, supporting long-term sustainable growth," the Nomura analysts said.

China's economy has already slowed in recent months: manufacturing contracted and property construction weakened in May, leading most analysts to say that hopes earlier this year of a bounce in growth have proved misplaced.

Article Source : http://www.guardian.co.uk

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Was jittery Thursday a foretaste of another global economic crash?

The sharp slide in share prices was either a blip in the road to recovery or a sign that the unwinding of quantitative easing will lead to disaster. Our writers argue it out

Central banks may be pumping billions of dollars into the world's financial markets through quantitative easing, but by artificially inflating the prices of stocks and bonds they're just storing up an almighty crash for the future.

That's the argument of City bears, who warn that while last week's slide may be reversed in the days ahead, the sharp fall in share prices that spread from Tokyo to Wall Street and London was a foretaste of the reckoning that will inevitably come, once QE starts to be unwound. "This is a liquidity-fuelled rally in stock prices. It's clear that the world economy has not been performing as well as stock prices say it has," said Neil Mellor of BNY Mellon.

Pessimists cite several reasons to be nervous about whether the rally that took share prices in the US to record highs before the blip can be sustained.

The first is China: a weak reading on the purchasing managers' index survey for the country – a barometer of its manufacturing sector – was one of the factors that fed Thursday's decline.

Growth in the world's second-largest economy has long been expected to slow from the double-digit pace that was the norm before the world recession of 2008-09. But there are serious concerns about the health of China's banks, which are thought to be sitting on a growing pile of bad loans. "It's clear that a lot of banks are in an awful lot of trouble," said Mellor.

Demand from China is critical for a number of major economies, including Japan, for which China is a huge export market, and Australia, which is heavily reliant on its natural resources. Any sign that the Chinese economy was slowing sharply, or worse still, facing a financial meltdown, would have knock-on effects right across the world's financial markets.

A second reason to worry is the eurozone. While the mood has been quieter since the Cyprus bailout was agreed in March and a rate cut from the European Central Bank boosted confidence, the crisis is far from over.

The eurozone economy remains deep in recession, and there is a long list of countries, from Slovenia to Spain, with unresolved problems that could spiral rapidly into a major crisis.

Third, Japan: markets have been supercharged in recent weeks by the radical policy of "Abenomics", named after new prime minister Shinzo Abe, which involves deregulation and a boost to public spending as well as the "shock and awe" quantitative easing announced last month.

Even if the policy works well, however, it is unlikely to be the overwhelming success that would be required to validate the 25% jump in share prices seen since the end of last year.

The final reason to be nervous is a more general one: as central bankers themselves have warned, extended periods of cheap money tend to create market distortions, as investors take the money and use it to fish around for better returns, in a "search for yield".

In the bond markets, for example, countries that would usually find it impossible to attract foreign lenders are finding investors falling over themselves to buy their bonds. Rwanda's $400m (£265m) bond issue in April was more than seven times oversubscribed, while middle-income countries such as Turkey, Mexico and Brazil have seen their borrowing costs slide. That's great news for the governments in question, but smacks of what Fed chairman Ben Bernanke recently referred to as "excessive risk-taking".

Whatever the outlook, "jittery Thursday", as analysts at City consultancy Fathom called it, underlined the fact that investors should brace themselves for a period of increased volatility.

"This bout of market jitters has laid bare the twin distortions imposed by a combination of near-zero interest rates and unconventional monetary policy, namely an excess sensitivity to small changes in the data and an unhealthy addiction to doveish central banks," they said.

People who buy shares are by nature optimistic. They make a profit when the stock market goes up, so they want it to go up forever.

Until last summer – after two years of crisis in the eurozone about the single currency – European investors were wary about the prospects for the global economy. The 2008 banking crash had been a disaster, as shares lost almost half their value on the big European exchanges. Then governments soaked up bank debt and themselves grew vulnerable.

But then European Central Bank chief Mario Draghi said he'd do "whatever it takes" to save the euro. That pledge, plus the renewed money-printing from the US Federal Reserve and the Bank of England, was a message that delighted investors. Since June 2012, the German Dax index has soared from around 6000 to almost 8400, before dropping back a little last week. The same story is told by the other major European exchanges, including the FTSE 100, which jumped from 5260 to a peak of 6723 earlier this week – a 28% gain in less than a year.

Japanese stocks fell sharply last week after an unexpected drop in a Chinese business confidence index

 Some economists argue that stock exchanges are riding for a fall. They say fundamental building blocks of growth are missing. In the major economies, investment remains low and consumer confidence is lacklustre, especially while high unemployment is rising and wages are frozen in real terms.

However, there are three good reasons why stock markets, a few blips aside, will continue to grow for some time: central banks are scared; there is lots of money waiting to be invested; and returns on all other assets are low.

Many analysts blamed the sharp falls in stock market values last week on a hamfisted performance by Federal Reserve chairman Ben Bernanke, who initially gave little hint that the Fed's QE measures might be scaled down only to say later that several members of his committee thought the time might be ripe in the next few months.

The Fed has injected more than $3tn of freshly minted money into financial markets and is supposed to be increasing the total by $85bn a month until unemployment comes down to 6.5%. It is 7.5% at the moment. The hint that Fed funds would stop early sent markets into a spin, but it was not new. Bernanke had said the same in January.

And the Fed must stay the course because households and businesses across the US and Europe are still paying back debt from the boom years. Only central bank funds are keeping economies afloat. The Bank of England remains steadfast and the Bank of Japan is ramping up its QE programme. Bernanke will stick with his original plan.

Stock markets are also being buoyed by the huge reserve of funds sitting in the Middle East, in Asia, and in western pension funds. Fund managers want to bet the trillions they are keeping on the sidelines on the stock market, should it feel safe. Central banks will continue to make it feel safe.

The third driver comes from the low returns elsewhere. Sovereign wealth funds and pension funds have used large amounts of their spare money as loans to governments and big companies. But buying bonds earns them only a small return. Lending to the German government is such a privilege that investors lose money on the deal.

Strapped to these three rockets, the market can still soar. Of course, Spain could yet go bust or China grind to a halt. There could be a natural disaster, an act of terrorism or war. History tells us a bust is waiting down the track, but while the world economy recovers and governments and central banks maintain their pledge to keep printing money, we should expect prices to rise.

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Article source : http://www.guardian.co.uk