Essence of a "Harmonious Society" is Lost in Translation

Every 5 years the CPC and Chinese Central Government devise a 5 year plan that will more or less direct the coming five years of development within China. It essentially serves as a road map defining the path the country should strive to travel over the next 5 years identifying areas of focus, specifying industries that should be built up, social issues that should be addressed, ect. The release of the 11th 5 Year Plan (2006-2010), was accompanied by the overall theme "to build a Harmonious Society."

This theme begs the questions, what exactly is meant by "build a harmonious society?" Answering this question is a bit subjective in nature. You'll get a different interpretation depending on who you as.

Below are a couple of interesting quotes from local media as to the meaning behind the theme. I'll leave it to you to draw your own conclusion:

"The resolution highlights the importance, guidelines and goals of building a socialist harmonious society. It puts forward the principles to be followed, the main objectives and tasks for building such a society by 2020, such as further improving the socialist democratic and legal system and narrowing the gap between urban and rural development and between different regions."

"The society in China now is generally harmonious. However, we do see disharmonies happening occasionally. This could be reflected in various gaps in development, between regions, between urban and rural areas, and between other areas. The increasing gaps are the problems we need to solve."

Building a harmonious society is not like building a bridge. How can you plan to have achieved that in 10 years or 15 years? How do you measure success of these efforts? Cultivating the mentalities and attitudes of people takes generations not 5 quarters. It isn't an infrastructure project. So what does this mean?

The best analogy I can think of is the scene in Bill Murray's "Lost in Translation" where he is sitting there shooting the whiskey commercial. There is a Japanese director instructing Bill Murray what to do, how to sit, ect. The problem is, the director is saying everything one hundred miles an hour in Japanese. Watching Bill Murray's facial expressions while the guy is yelling at him in Japanese is worth the price of admission. At the end of the director's 1 minute tirade, Bill's interpreter's say, "he said lower your head." Bill displays a very confused look on his face and responds with, "Is that everything? I mean, it seemed like he said quite a bit more than that." Bill's question is a reasonable one and one we should be asking regarding what exactly is meant by building a "harmonious society."

To many local Chinese, the government's aim with this theme is to try and solve fundamental problems within society, such as the blind pursuit of money. The government wants to cultivate a happy and peaceful culture and society in which people are content. But to me, the first questions that goes through my head is "is that everything? I mean, it seems like quite a bit more."

No one can question the progress of the Chinese economy over the past two decades. The growth and development has been nothing short of phenomenal and unprecedented in modern history. For that, the Chinese leadership should be commended. Having said that, many Chinese like to say "China is different." This statement comes up over and over again, regardless of the topic, when a Chinese person believes a foreigner isn't quite grasping what China is all about. I've stopped taking this personally because I've discovered, in some cases, Chinese people will say this to each other. If someone shows up in Shanghai from another province around China, local Shanghainese will be quick to say "you don't understand Shanghai" or something to that effect. This is a nice way of saying either "I don't know how to answer your question" or "you have no way of comprehending the answer to your questions, so I wouldn't bother wasting time giving you one." To me, every country in the world "is different" so I am not satisfied with this statement as an answer to everything.

To me, China isn't so different. It is much like many other countries in the world. The overreaching goals are to grow economically and provide people with a better life. China just happens to be bigger and have a longer history. Every time someone wants to engage me about the US, I could just as easily say, "you don't understand, the US is different" because it has a smaller more culturally diverse population and it is a younger country.

Regardless of how different China might me, laws of modern economics still apply. There has been lots of chatter both by onlookers abroad and economists/experts within China that China's economy is overheating and something needs to be done to slow growth. To me, this is the essence of the "build a harmonious society" theme for the 11th 5 Year Plan. The Chinese leadership is a sharp group. They realize the economy needs to be slowed down and have reverted to common economic tools to achieve this end such as raising interest rates 3 times in the past year, increasing the required reserve ratio for banks and even stating that many of the domestically listed companies lack the intrinsic value implied by their stock prices and in some cases should be delisted.

Despite these efforts to slow the economy, the China growth engine isn't listening as the economic growth is estimated to have accelerated to 11% in 1Q 2007 increasing from 10.4% growth in 1Q 2006, the local stock market is up over 30% during the 1Q 2007 following a sizzling 130% increase in the A-share market in 2006, a healthy pipeline of IPOs wait to list on the Shanghai Stock Exchange, exports experienced double-digit growth in 1Q, there are over $2 trillion in local savings that continue to be diverted into stock trading accounts to be invested in what is perceived to be a riskless market (oh contrar), the government has $1.2 trillion in foreign currency reserves, and fixed asset investment increased. What is not to like? The Chinese are a smart enterprising group that recognize opportunity when it presents itself.

To me, the translation for "build a harmonious society" is quite simple: slow down the growth by any means possible. Every approach using modern economic tools has been taken to slow growth to no avail. The fact that there are capital controls and a stock market that seems to only trend upwards at a 90 degree angle actually make these tools less effective rather than more effective. So, the approach to slowing growth is a softer one. The idea is to tell people not to focus so much on running after the all mighty dollar. As a result, people might stop focusing so much on making money and the economy might slowdown.

The logic behind the approach is understandable. People are probably listening and saying to themselves "yeah that is a good idea, other people should do that" as they scamper off to the local securities firm to make their next trade and continue ride the stock market tidal wave. Who can blame them? Where else, justified or not, can you get a 30% return in a week? I'd be doing the same if I could trade A-shares.

Everyone Please Remain Calm-It Was Just a Correction

If last week taught us anything, it is that many of the world's most liquid mature equity markets have started taking cues from China, be it justified or not. Previously, the vast majority of people agreed that, given China's unquenchable hunger for resources, China was a significant player in determining world commodity prices (i.e. steel, oil). People also largely agreed that China was in many ways responsible for holding US interest rates down due to their feverish purchasing of US Treasury Bills. Yes, those of you in the US that took advantage of the low interest rates and refinanced your homes in the past few years, you have China to thank whether you want to admit it or not. China's buying of US T-bills has less to do with their attractive investment returns and more to do with keeping their own currency weak relative to the US dollar enabling their export engine to keep running. Keeping US interest rates low is in China's interest, because it keeps US consumers purchasing goods that China exports. Continued export customers keeps China's factories humming and employment up, something critically important in a country that must maintain over 7% economic growth annually to create enough jobs for new people entering the work force annually.

There has been chatter that China, in addition to many other nations (i.e. cash rich Middle-Eastern countries-->price of oil per barrel is denominated in US$), are looking to diversify their FX holdings into other currencies and/or gold. Currently, China holds over $1 trillion in US T-bills. No, that is not a typo. If I'm a market speculator, I'm definitely betting that gold is going up. The economics just make sense. If these countries do indeed choose to dump a percentage of their USD holdings in favor of other currency's or gold, expect US interest rates to jump and money not to come quite so cheap in the US. Adios, to the low financing of the new car.

The events of this past week warrant some consideration. We must ask ourselves, how does an 8% drop in a stock market (China's A-share market) that was among the world's worst performers in 2004 and 2005 and is coming off a year during which it increased 130% send such shock waves throughout the world? The following day, the Dow was driven down almost 4% and other indicies around the world took it on the chin as well for no real reason at all. After a 100+% rise in the China A-share market over 12 months, isn't a slight pull back justifiable, even expected?

Before 2006, the rest of the world didn't care what was happening on China's stock market. It was what many considered to be a casino. Maybe this is what was necessary for people to finally take notice or acknowledge that they already knew subconsicously. Officials have openly stated this year that over 70% of the listed stocks on China's A-share market are worthless and should be delisted. Granted, things are getting better, regulations are beginning to be enforced and more quality companies are starting to list in mainland China, but China's financial infrastructure has a long way to go. A country might be able to build highways and bridges in 20 years, but instilling the concepts of intrinsic value, corporate governance and regulatory enforcement take time no only to implement but to educate people as to why they are necessary for a well-functioning market.

My guess is, this won't be the last "pullback" China's market experiences. I believe there were actually people in China breathing a sigh of relief as the government has been working very hard to find ways to cool the already overheated market. The question is, how will the world react when it happens again, and believe me, it will. That is the nature of an emerging market.

I think we should stop pondering whether or not there is a connection between China's equity markets and the rest of the world or if the aftershocks are justified. Rather, it would be better to accept the fact there is a perception of a connection ingrained in peoples' minds. As one of my coworkers accurately stated, "fear and greed" drive the market. In the end, I think most people think there shouldn't really be a correlation between what happens on China's markets and the rest of the world, however, they "fear" there just might be, and that is enough to cause a panic.

Chinese Stock Market "Smashes" Records Two Days in a Row

2007 is shaping up to be an interesting ride for local Chinese Exchanges.

The Shanghai Composite Index, which tracks domestic Chinese RMB-denominated A-shares and foreign currency denominated B-shares, jumped 1.4% on Monday to close at 3040. This was the highest close since the bourse was launched in 1990. Three of China's largest steel companies lead the charge as Baoshan Steel, Angang Steel and Wuhan Iron and Steel jumped 8 percent, 8 percent and 6.5 percent respectively. Mainland banks China Merchants Bank, China Minsheng Bank and The Industrial and Commercial Bank, which had been responsible for much of last year's rally, fell 5.6 percent, 4.1 percent and 0.8 percent respectively in response to the central government ordering lenders to increase reserve-ratio requirements from 9.5 percent to 10 percent.

On Tuesday, the Shanghai Composite Index fell 8.84% to close at 2771.79, again "smashing" records as institutions locked in profits and individuals sold in response. This was the largest single-day fall since 1997 when the market dipped 8.91 percent following the death of former Communist Party leader Deng Xiaoping. A few listed stocks, including Chan Vanke Co (the nation's largest property developer) and China United Telecommunications Corp (China's second largest mobile carrier), fell 10 percent, the single day limit for individual stocks. Trading volume hit record levels soaring to 131.6 billion yuan (US $16.57 billion), a 42 percent increase over the volume during yesterday's rise. One market participant noted, "selling sentiment might continue for some time if there is no strong policy stimulus from the government." Someone should let this guy know the government is probably very relieved by the pull-back as they have been trying to figure ways to cool the red-hot local stock market that rose over 130% last year and was already up 15% for 2007.

Smart market players will see yesterday's pullback as a buying opportunity and look to jump back in. Liquidity continues to slosh around the markets as China launched a new US $1.29 billion mutual fund (the first new fund in 4 months) yesterday that sold out within 2 hours. Shanghai is also reportedly preparing to allow H-shares, Hong-Kong listed mainland companies, to start trading on local exchanges "soon" in an attempt to continue to increase the size and quality of the domestic market. These will be referred to as CDRs, Chinese depositary receipts. China Mobile and PetroChina are rumored to be among the first Hong-Kong listed mainland companies to sell CDRs. Hold on to your hats, because 2007 should be a wild ride.