Source article in Chinese: 从“李克强看跌期权”到“榨菜指数”.
There are no consensus as to whether the Chinese economy is getting better or getting worse. The popular “Li Keqiang Put” indicated that the international investment banking sector expect the Chinese economy “to get better”; while the “Zha Cai index” brought forth by the National Development and Reform Commission (NDRC) signaled that the entity economy of China is irretrievably “getting worse”.
Trepidations behind “Li Keqiang Put”.
The so-called "Li Keqiang put” is an insurance Li Keqiang provides for the Chinese economy. A futures terminology, “put (options)” originally referred to the right of selling a certain amount of the subject matter in accordance with the exercise price that an option buyer has during the life of the options contract. It is a type of insurance that investors buy for themselves. Since some predicted that the Chinese economic growth this year may be lower than 7%, foreign investors have been on edge. To them, Li Keqiang's recent promise that the country's economic growth this year would not be lower than 7.5% is somewhat reassuring.
In June this year, Barclays Capital coined the term "Likonomics" and boiled down Li Keqiang's economic policies into three parts: no stimulus, deleveraging and structural reforms. The international investment banking sector took these three points as indicators that the Chinese government would bring change to the economy through financial reform.
I wrote in an article before that Likonomics lacks the institutional foundation it needs for implementation. And in less than two months, the international investment banking sector introduced something new, something less optimistic: “Li Keqiang put”.
The reason such a change took place within two months is that the Chinese economy has been releasing signals in various ways that it is in decline.
During the period the Chinese government meted out a series of heavy penalties to six major foreign milk-powder companies including Mead Johnson, Danone, and Fonterra for their anti-competition and price monopoly behaviors; due to bribery issues, several Western pharmaceutical enterprises like GlaxoSmithKline are being investigated by the Chinese authorities. The Financial Times called these actions as “foreign investors' China nightmare”.
Instead of seeing the experiences these foreign companies in China went through as signs that the Chinese government wants to fight corruption and straighten the market, it would be more accurate to take those as measures of the Chinese authorities seeking to protect the country's own national industries when its economic restructuring encounter great difficulties.
Rather than some readings of the actual state of Chinese economy by the international investment banking sector , both “Likonomics” and “Li Keqiang put” represented illusion about the Chinese economy that foreign investors created for themselves.
Why does the international investment banking sector wish the Chinese economy to remain strong? The reason is simple. Beginning in May 2013, international short-term capital withdrew from emerging markets, triggering devaluation in currencies and asset prices there. From May to mid-June, currencies of most of the emerging markets depreciated markedly against the US dollar. The South African Rand slumped by 9.2%; the Indian Rupee, the Brazilian Real, and the Filipino Peso fell by more than 5%. At the same time, emerging markets saw their stocks plummeted, their treasury bonds dumped, and their bond yields rising.
Managers of investment banks who placed huge quantity of capital in the Chinese market are worried that their performance would nose-dive. Therefore, they wish the Chinese economy could hold on.
The term "Li Keqiang put" manifested precisely this lack of confidence.
"Zha Cai index", whatever does it mean?
The so-called “Zha Cai index” is a product of China, coined recently by the NDRC. Officials of the NDRC Planning Division introduced the term, saying that they analyzed the movement direction of migrant workers by looking at the sales volume of Zha Cai (a kind of marinated mustard tuber), and they used that as the basis for devising appropriate welfare policy.
But to me, the messages this “Zha Cai index” conveys are richer than that. It doesn't just indicate the movement direction of migrant workers, it manifests also changes in the Chinese industrial structure and the faltering economy of the coastal regions of China.
Simply put, market-based competitive industries in the Yangtze River Delta and the Pearl River Delta are in decline, while government-funded projects in middle and western regions are booming. This shift of economic strength is what drives the migrant workers to change their direction of movement.
According to an article published on August 9 in the Economic Observer, the changes in sales volume of Zha Cai in various regions throughout the country reflected trends of population flow. Since Zha Cai is a low-quality consumable, its consumers are mostly the low-income migrant workers; the demand of this product from urban-dwellers with middle-income is stable (like salt, there is little elasticity in the demand of Zha Cai).
Officials of the NDRC Planning Division discovered that the share of sales of Zha Cai in South China region has been falling each year. From 49% in 2007, it dropped to 29.99% in 2011, while the share of sales in other regions rose by over 25%. Between 2009 and 2012, the share of sales of Zha Cai in central China jumped from 2.6% to 10.57%; in Henan and adjacent areas, the share of sales increased from 8.02% to 10.1%; and in north-western region, the share of sales rose from 9.38% to 11.91%.
Although Chinese statistics are habitually falsified, Zha Cai manufacturers and distributors do not need to do so with the sales volume, and it could be a telling index in observing changes in the Chinese economy.
To observe the situation of China's economy, the Pearl River Delta and the Yangtze River Delta are indeed two important windows. Since the 1840s, the economy of these two places boomed ahead of other places and they fell into decline later than elsewhere. If these two leading economic regions find themselves in trouble, then other parts of the country might be in an even bigger trouble.
Originally the main workshop of China the world's factory, the Pearl River Delta now faces not only a decline in the processing industry, but it also sees the “strategic industry” of manufacture and assembly of automotive (predominantly of Japanese brands) suffering tremendous impacts and is struggling.
Having been among the handful of provinces that turned over huge amount of tax in the past three decades, Guangdong now finds its sources of tax revenue depleted. Apart from finding ways to collect more tax more enterprises, the local government also seeks to reduce the amount of revenue it is required to turn over to the Central government.
Recently, when chief executives of other provinces went to the Ministry of Finance in Beijing to ask for help, the Governor of Guangdong, who was always ostentatious in the past, actually lowered his head and joined the rank of others to “plead poverty”.
Situated in the Yangtze River Delta region, Wenzhou, Zhejiang, has always been seen as a model for the development of private economy. Today, the Wenzhou model, which backbone has been labor-intensive light industry, nears its end. Such industries as the manufacture of footwear, clothing, leather, glasses, pen and lighters are in recession. Between January and May this year, the number of SME exporters in Zhejiang reduced by 1500.
The two once wealthy cities of Wenzhou and Guangzhou are now both included in a Chinese media list of cities with industrial decline.
The labor-intensive industries in the Pearl River Delta and the Yangtze River Delta have long been the powerhouses for providing migrant workers with jobs. That migrant workers are now departing from these areas and are heading to central and north-western regions does not bode well for the Chinese economy because this movement shows that migrant workers are either going home or are finding jobs in areas closer to their home. Most of these workers are getting a job from government-funded projects, such as building infrastructure facilities and real estate construction that the “new urbanization scheme” requires.
According to government data, the new urbanization scheme has already become the driving force for economic growth in central China. Places in north-west China like Shaanxi unveiled a new urbanization plan for redrawing administrative areas under its jurisdiction, a plan to be completed in ten years; and cities in central China, such as Changsha and Wuhan, are working on plans to expand to new districts and create new business circles.
The majority of all these government-funded investment projects, unlikely to translate into meaningful market demand and lack stamina and effectiveness, is tantamount to creating a new “ghost town economy” under the shadow of the old one.
These are not all of the bad news.
At the moment, China is facing the largest industrial restructuring over the past three decades. The nine industries that have once played a major role in the Chinese economy such as the photovoltaic industry, shipbuilding, steel, LED lighting, and small and medium real estate companies are facing bankruptcy; the numbers resource-depleted cities and cities with industrial decline are rising.
It could be said that China is now caught in a predicament of a double decline in both the virtual and the entity economy. The international investment banking sector is aware of the plight that the Chinese virtual economy is in, and they knew that Chinese government debt and the shadow banking system are the two risk areas prone to trigger an economic and a financial crisis in China, as indicated by the impending bankruptcy of trust companies that flourished in the past three years and the claim that 600 third-party finance companies would close down within this year.
And with this, “Li Keqiang put” became a reassurance that the investment banking sector created for themselves. As for the “Zha Cai index”, instead of seeing it as a basis for the NDRC to formulate its welfare policy, it is more to the point to regard it as a presage of the Chinese entity economy slipping into recession.
