FYI: I will be on CNBC’s Fast Money Monday from noon-1PM EAstern time to discuss the China growth news released this weekend. As you know, many people are worried about a hard landing for the Chinese economy. The March PMI, released today, should help them exhale. The National Bureau of Statistics said on Sunday China’s official Purchasing Managers’ Index (PMI) jumped to an 11-month high of 53.1 in March from 51 in February, beating analyst forecasts of 50.5. My take: China is slowing some, maybe from 9.2% last year to 8-8.5% this year, but don’t hold your breath for a crash. I expect more gains in dollar-based security markets, including China, for the remainder of this year as the tsunami of liquidity created by the Fed since 2007 beaks through to global asset prices.

Hope you can be there.

John

I did a spot today on CNBC’s FastMoney where the topic was reports of declining China growth. Here are the talking points I used to brief the anchors for the spot FYI.

China is slowing somewhat this year due to

-weak growth in Europe (China’s biggest trading partner and

-shrinking property market (residential property prices falling in all major markets)

-policy is also pushing fixed asset investment spending down, consumer spending up as a way of changing the structure of the economy over time

-Western observers are making too much of the slowdown. When they do, they sell China stocks. Slowdown will be modest, from 9% last year to 8-8.5% this year.

Reasons:

-income growth is strong in cities, even stronger in rural areas

-government finances are very strong (tax revenues growing 2x GDP)

-monetary policy is easing

-restrictions on owning property, mortgage loans, being eased

Investment ideas

-It’s not Kansas out there. Investing in China is still very risky

-rule of law still weak (property rights, courts, judges)

-transparency still lacking (audits, financial statements, insider dealing)

-so be careful investing directly into the Chinese market

Safer way to invest in the China growth story

-buy companies in safer places that make their money in China.

-China growth is driven by flows of resources.

-natural resources from south Asia (Australia, NZ, Indonesia)

-technology from north Asia (South Korea, Singapore, Taiwan)

-capital from Hong Kong, Singapore

-build a portfolio of stocks from these areas to mirror China growth

-Stocks in my portfolio today on this theme are down big today on the weak growth news. I will be buying more. They include:
-RIO, Rio Tinto, aluminum, copper, iron, energy
-BHP, BHP Billiton, coal, iron, aluminum
-FCX, Freeport-McMoran, copper, gold
-EWY, ETF for South Korea, (Samsung is 21% of the index), Chinese cell phones
-EPP, ETF for Pacific ex-Japan, i.e., Australia, NZ, Singapore, Hong Kong
-EWS, ETF for Singapore
-CAT, Caterpillar, (China infrastructure investment moves a lot of dirt)
-PTR, Petrochina, (Chinese stock, bet on rising oil consumption inside China)
-EMR, Emerson Electric, US capital goods exports to China
-YUM, Yum Brands, US company owns KFC franchises in China

JR

Dr. John Rutledge “Tuesday Lunch Series” 2-14-12 from CGU School of Politics & Economics on Vimeo.

 

I did a spot on CNBC Squawk Box this morning to discuss the impact of the recent unrest in China. Much of the news surrounds stories about migrant worker protests. As I wrote yesterday, the drivers for the protests making the news is not ideology–it is practical life issues like pay, jobs, work practices, discrimination, and corrupt local government officials. Wen Jiabao recently said that corrupt officials is China’s greatest crisis. Last year more than 146,000 corrupt officials were arrested in China; 97% of them were at the county, city, or village level.

Our discussion this morning turned on the impact on the US. The biggest US risk is supply chain interruptions, much like the Japanese earthquake. Just under half the manufacturing capacity in the world is in China. Much of it is in southern China, especially Guangdong, where the factories are operated by migrant workers from Sichuan, Hunan, and Xinjiang. Recent job losses in Guangdong caused by “hollowing out,” (businesses moving to cheaper locations in Vietnam and other Asian countries) are a real problem. Migrant workers are often the only source of income for their families in poor villages in western provinces. Rising food prices has also put the squeeze on migrant worker incomes, even though the incomes are rising at 10% per year.

All this is interesting, but what I care about are the people. It is easy to lump groups of people together and call them “migrant workers” if you have never met them. Not so easy when you know their names.

I thought I would just take a minute to inject a little humanity into the story by posting a few pictures of the kids I work with in the migrant worker schools in China. For several years, my partner Fred and I have organized teams of university students to work in primary schools in poor villages, often migrant worker schools. We have done projects in Tibet, Yunnan, northern China, and tried to do one in North Korea that failed to happen. In each case, we supply the students with books and materials to build libraries and kitchens, plant gardens, pay student fees, and give the children pencils and paper. The students spend a month or more in the schools teaching and working with the children.

Here are a few pictures from one of our recent projects in a migrant worker school in northern China.

The photo above is our team for a migrant worker school project. Fred (white t-shirt just in front of me) is my partner in all the projects we do. Ethan (black Rutledge capital shirt in front of me) was team leader for this project. The other team members are students at China Agriculture University.

Below are a few of the children, including an unforgettable kindergarten student showing me her very beautiful graduation dress.

This is a migrant worker school classroom. The classrooms have no doors and no heat in the winter–the students weal heavy coats in class to stay warm.

Finally, the picture below is a very special one for me. We were able to arrange for 15 of the students graduating from the migrant worker school to go to the official public school nearby, which will allow them to later go to university. They needed clothes, school supplies, and the like to fir into the new school. This is a picture we took on their first day of class. I keep this photo on my desk.

I hope you get to meet some of these wonderful children one day for yourself.

JR

I wrote an op-ed for the Christian Science Monitor a few days ago on US/China relations. You can read it by clicking here. It deals with the question of when China’s GDP will exceed US GDP. My point is that the answer depends on us.
Can we stay ahead of China? Yes!
But it will depend on America’s political will to fix its own problems, rather than blaming them on China.

I was approached by a man at the supermarket who penetrated my Southern California disguise of baggy shorts, T-shirt, and deck shoes with no socks and asked if I was me? (Yes); the one who talked about China on CNBC? (Yes); then the question I hear all the time, “Are the Chinese going to let us to stay rich?”

He is onto something. Whether we stay rich and powerful is hugely important. Economic, political, technology, and military power go hand in hand. But whether we stay rich is not up to China; it is up to us – determined by how fast we grow. We didn’t need China to get rich; we don’t need them to stay rich. But we do need to get our economic growth act together.

While the United States is the biggest, richest economy in the history of the world, it’s about to get passed by. China’s gross domestic product will exceed US GDP within the next decade – of this there is no question. At recent relative growth rates – 10 percent for China, 2 percent for the US – China’s GDP will exceed US GDP in 12 years. Adjusted for purchasing power, China’s GDP will exceed US GDP in just five years.

Being the second richest guy in the room, of course, isn’t the end of the world. But it’s not as good as being No. 1. Just ask the Europeans or the Japanese how they feel about US dominance in recent decades.

Of course, China has more than four times the number of people as America does. So in terms of annual income per person, Americans remain far ahead: $48,157 versus $4,399 (or $7,481, if measured in terms of purchasing power). At present rates of growth, it would take 30 years for the average Chinese to exceed American standards (25 years, if adjusted for purchasing power). This assumes that Chinese growth can keep outpacing America’s growth by the same rate, which becomes harder to do as China’s economy becomes larger and runs into more resource constraints on the availability of energy, commodities, and other resources.

So Americans have an opportunity to stay ahead in terms of income per person – and that won’t depend on China. China’s high growth rates are not the result of manipulating its currency or restricting trade: Manufacturing employment in China is falling, too. Instead, they are the result of huge saving and investment levels and intensely competitive Chinese markets. Private companies account for more than 70 percent of Chinese economic activity now and for essentially all new growth, jobs, and tax revenues.

Which brings us to the real question behind my supermarket pal’s query. Do we have the political will to stay No. 1?

To do that, we are going to have to tackle our real problems – the ones that put us in this spot. We are going to have to fix our schools so our kids can read, do math, and graduate. We are going to have to reform our tax system so people have incentives to work, save, and invest again. We are going to have to replace our so-called entitlement programs with ones we can afford so we can rein in unsustainable spending, runaway budget deficits, and the growth of government debt before it reaches the point where default or permanent 1970s inflation – with the attendant 20 percent interest rates – are inevitable. We have to restore the Fed’s political independence and commitment to price stability.

To do all these things we must talk with voters about our problems like adults, not blame our troubles on others. If we face up to these problems we can do more than stay rich, we can continue to lead the world.

But make no mistake about it. In that world, there are going to be two big elephants in the room, the US and China. There will be plenty of legitimate issues – energy supplies, environment, and terrorism – to solve. Playing the blame game runs the risk of bringing these two elephants into conflict, with unthinkable consequences.

I am convinced that the security and welfare of my children will depend more upon the quality of US-China relations than any other single issue. We simply must get to know each other to find common ground to work together for mutual security and prosperity. And the US must get back to the economic growth that allowed us to earn the No. 1 spot in the first place.

JR

I did a spot with Larry Kudlow tonight to discuss today’s retail sales reports that seems to have been a major impetus behind today’s huge stock market increase. Great to work with my old friend again. Not many know this, but Larry and I have been working together since 1976 when he was Chief Economist at Paine Webber and I was a professor at Claremont Men’s College (known as Claremont McKenna College today).

The US Advance Advance Monthly Sales for Retail and Food Services Report for was down -0.2% for May (+0.3% excluding motor vehicles), and +7.7% over year ago levels (+8.2% excluding motor vehicles.) Analysts focused on the numbers excluding motor vehicles because the supply chain interruptions caused by the Japan earthquake made a significant dent in assembly and sales. The stock market interpreted this number as “no double dip recession”. Nice.

The Chinese retail sales number was even better. May retail sales were +16.9% over year earlier levels and a big jump over April. This was important because US investors have been hyper-ventilating over the idea that China’s growth was about to end. (They did this about once every 6 months. I don’t know why.) The truth is retail sales in China are doing fine, signaling continued strong growth.

The interesting stuff, as usual, is in the details. Among the components of the retail sales index sales of oil products were +42% above year ago levels, jewelry sales were +43%, and grain and edible oil sales were +24%, revealing the effects of rising oil prices, gold prices, and food prices. But middle class luxury items were up big too including  cosmetics (+20%), personal care goods (23%) and garments (22%). Government policy is trying to increase the consumption share of GDP relative to the investment share, which should keep retail sales strong in coming years. (If you want to watch a company in this sector, Haier Group makes washing machines and water heaters and is a powerful brand in China. Haier’s revenues should grow 20% next year producing 25% earnings growth–the stock sells for 15x 1011 earnings and 8x 2011 EBITDA in the Hong Kong stock market.

Other supporting growth news this week include:

• +13.5% industrial production growth in May.
• +34.6% real estate investment growth January-May
• +33% Real estate sales growth January-May
• +25.8% fixed asset investment growth January-May.

Less positive news:

• +15% M@ growth in May is a little slower
• +5.5% CPI inflation in May is a big number

China’s central bank raised reserve requirements today again for the 6th time this year (after 6 times last year) to 21.5%. They are doing this to show the government’s concern about inflation, which means rising food and gasoline prices to the man on the street. These tightening moves are not as tough as they would be here in the US–banks are not nearly loaned up anyways. But if they keep beating on this horse long enough it will surely have an impact.

Larry made a point during the show that I think is worth remembering. From our perspective, a little slowing in China and a little lessening of inflation pressures are not necessarily bad things. Slower growth and lower inflation would be easier to maintain.

China’s stock market was up big today after being driven more than 12% lower since April by falling growth worries. I think that market is pretty cheap today, as are the stocks of US companies who sell retail products in China. That’s where I am putting my money.

JR

(June 14, 2011) Will do an early morning spot on CNBC Squawk Box tomorrow (Wed. 6/15/11) 8:40AM Eastern time (5:40AM hit for me here in California–argh!). Hope you can dial us in.

The topic will be the recent unrest in China that was the subject of the Wall Street Journal front page story today. There have been a series of public protests in recent weeks in Inner Mongolia, Lichuan, and Zengcheng, including bombs set off in Fuzhou and Tianjin a few days ago. Individually, the events are hard to connect: a Mongolian sheep herder accidentally killed by a Chinese truck driver; protests against corrupt local officials and property seizures; rough treatment of a migrant street vendor by police. Together, they reveal the stresses on a population struggling to deal with rapid change, corrupt local officials, rising food prices, and especially for migrant workers, uncertain paychecks.

As I have written many times before, every policy discussion with a Chinese leader focuses on a single goal–social, economic, political stability. Cynics say that is because the government wants to continue in power. Optimists say it is because the government knows they must keep China growing for a long time to catch up to the rest of the world’s living standards. China has grown by an incredible 10% per year since it was opened up 33 years ago. That growth has increased per capital GDP by a factor of 23 times from roughly $200 per year when Deng Xiao Ping opened China to market reforms in 1978 to roughly $4800 today ($8200 if measured adjusted for purchasing power.) But US per capital GDP is about ten times that high at roughly $50,000 per year. It will take decades for Chinese incomes to rise to US or European levels even if growth remains at 10%, which gets harder to do as incomes rise.

I don’t think the pressures than are making people angry are going to disappear overnight. That means we are going to see more protests, and more policy responses that are equal parts harsh security measures and accommodative economic policies designed to keep maintain high rates of steady economic growth. As an example, China’s huge stimulus program during the recent financial crisis was heavily weighted toward infrastructure and construction to keep the 100+ million migrant construction workers in China’s cities employed so they can continue to send money to their families in poor villages in western China.

The one think I can say about the protests in China is they are not ideological. They are often about very practical, local issues like food prices or a land grab by a city official. That means we should be careful not to make sweeping generalizations about them. In China, as in the US, the interesting stories are in the detail. These stories are heartbreaking. As you may know, I work with migrant workers’ children in China, building libraries and kitchens in grade schools and providing scholarships so kids can go to school. They don’t need life to be tougher than it already is.

Tune into our discussion on Squawk Box tomorrow. I will try to come up with something clever and insightful to say about all this by then but don’t recommend you hold your breath until I do.

JR

China CPI – February 2010

(The charts below are courtesy of Andy Rothman at CLSA. Andy is by far the most knowledgeable person I know on Chinese inflation issues.)

The worry that rising inflation in China will provoke the government to tighten sharply, which would slow growth and push commodity prices lower is unfounded.

China’s February CPI was up +2.7% from a year earlier after showing deflation for most of 2009. As the chart below shows, however, it’s all food prices. 2.06% of the 2.7% headline number came from food. Another .44% came from residence expenses, which were pushed up by a one-time increase in utility costs last year. Other goods and services accounted for only 0.2% of the 2.7% increase–about one-fourteenth of the total increase in consumer prices.

Food prices make up a much larger share of the CPI basket than they do in the U.S. or Europe. Food prices in February were +6.2% higher than a year earlier. Most of the increase was due to the 25.5% increase in fresh vegetable prices and +19% increase in fresh fruit prices, as shown in the chart below. Both were caused by severe weather and the New year holiday, which fell in February this year. Together, fruit and vegetable prices accounted for about one-third of the total CPI increase in February.

Rising incomes in China make the CPI increase negligible, as shown in the chart below. In fact, rising food prices drive higher income growth for China’s farmers. This is exactly the kind of relative price/wage pattern we expect in a country with fixed exchange rates and sharply rising productivity. Traded goods prices are constrained by global competition and rising productivity. But wages grow strongly to reflect rising output levels. It is important in this situation not to confuse rising wages with inflation when setting overall economic policy.

Internationally traded industrial input prices, however, are rising sharply to reflect the strong China growth and strong construction activity following last year’s stimulus program, as shown below. With input prices rising and end-user prices (CPI) constrained by intense competition and overcapacity the worry is not inflation, it is the profit margins of the industrial companies that make up a large part of China’s stock market.

Bottom line: China is not going to tighten policy aggressively to try to control cabbage prices. The exit from China’s stimulus program will continue in a gradual and orderly way over the next year.

JR

I don’t often write about government policies that I like. It’s not that I’m crabby; it’s because they are so scarce. But today I will make an exception. Today, the Fed and the Treasury, along with several other financial regulators, correctly identified the cause of the small business lending problem–themselves–and took steps to fix it. It’s about time.

Today the financial regulators passed the grown man test by “manning up” to what we have known all along; banks have been effectively redlining loans to small businesses due to fears of regulatory reprisal. You can read the statement by clicking here.

They have made a start at addressing the problem by instructing banks to look at the health of the borrower, rather than computer models, when assessing loans. And they have gone on record that banks who do their homework and make loans to healthy small businesses will not be subject to criticism from the regulators.

The purpose of the directive is “to ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small business borrowers.”

As you can see from the chart above showing bank lending to business borrowers. it would have been helpful if they had started ensuring that this wouldn’t happen 15 months ago when banks slammed their doors shut for business borrowers. But let’s not quibble. I’m happy they are taking action now.

Longtime readers will know that I believe non-price credit rationing to be the principal trigger for downturns in employment. It happens when regulators get over-zealous and lay their heavy hands on lending standards. I called it a credit crunch in a series of articles I wrote for the Wall Street Journal in the early 1990′s and again in 2001, which prompted a vicious response from the then Comptroller of the Currency, who denied it ever happens. The fact is, business customers don’t decide how much money to borrow based upon the interest rate; it’s the availability of credit that matters.

This time around, non-price credit rationing has fallen especially hard on small businesses–the source of almost all new jobs. In the dotcom bust, only 15% of the drop in loans hit small businesses. This time it is almost half.

The facts are simple. Employment can’t increase until small businesses can borrow the money to meet payroll. Today’s step just might be a nudge to make that happen.

Bravo to the regulators for taking steps to fix the problem they created in the first place. Now it’s time for banks, large and small, to respond to this statement by giving small business owners the loans they need to do what they always do best–make more jobs for people who want to work.

JR

This week is jobs week. Not Steve Jobs–last week was his, with blowout Apple earnings and the announcement of the slick new iPad. Real jobs–remember those? Where people actually get to go to work and earn a paycheck.

This week’s data include the ADP report, today’s initial unemployment claims number and Friday’s payroll employment report along with several other reports (ISM manufacturing, ISM non-manufacturing, and factory orders) that give further color on the subject. Add them all together and what do you get? Blah! Positive but crappy growth–not enough to meaningfully increase employment. That will still have to wait for the banks to start lending to small businesses. And no, they haven’t started yet.

The ADP National Employment report, released yesterday, estimates that January nonfarm private employment fell by 22K jobs, the smallest drop since January, 2008. 19K of the 22K lost jobs were at large firms; small ones did better (-3K). Goods producers lost jobs (-60K); service companies added jobs (+38K). Manufacturing lost 25K jobs, the smallest in two years. Take this with a grain of salt, however. ADP reports have overstated the Labor Department’s estimate of private payroll job losses by 500K in last six months of 2009.

Friday’s employment report is likely to show no loss, or even a small gain of 10K jobs or so. That’s better than getting poked in the eye with a sharp stick but don’t expect any parades. That’s because on Friday the Labor Department is also going to release one of their strange revisions for the year from April 2008 to March 2009. It’s going to be a whopper. They will report that March 2009 employment was actually 824K lower than they had previously reported.

The culprit is the faulty business birth/death model the Labor Dept. uses to correct for a bias in their data collection method. They collect establishment employment data by calling a list of known businesses. That list shrinks over time by attrition, however, as some companies die from natural causes. Others came into business too, of course, but they didn’t get the phone call because the Labor Dept. doesn’t know who they are, which would tend to make the job numbers shrink even if employment didn’t. So they “correct” the data by assuming that, more or less, the births offset the deaths causing them to add a fudge factor (+55K jobs/month from April 2008 to March 2009) to the data to make up for the missing new company jobs.

Unfortunately, it doesn’t always go that way. Shockingly, more companies die during recessions that are born (duh). So they are going to take all those fudge factors out in tomorrow’s number. Hence, the -824K revision. But wait, as they say on the infomercials, there’s more. This revision only takes us up to last March. The Labor Dept. gurus added another +900K in fudge factors in the months since then.

Confused yet? (I certainly am.) Bloomberg has a very elegant and easy to understand graphical explanation of this on their website. The real issue, of course, is how many people will understand all this when the number is released at 8:30AM EST tomorrow morning. My guess is not all of them will, which is not good news for tomorrow’s stock prices.

Take all this together and you get a picture of an economy that is growing, but not by enough to light the job market on fire. As this week’s ISM Manufacturing and ISM Non-Manfacturing reports show, the strong recovery in manufacturing has not yet shown up in the service sector. I don’t think that can happen until the banks are open for business again later this year.

JR