China's Tepid Economic Tightening

March data shows the Chinese economy growing rapidly, along with inflation. Lending for the month is up, and the share of alternative forms of financing has continued to grow after a swift rise in 2010. The data shows that whatever success authorities have had in tightening credit, banks and companies keep finding ways to circumvent controls. Contrary to official pronouncements, the recent data indicates there is little appetite for aggressively tackling inflation expectations in China.

Analysis

New economic statistics from China for the month of March show that the government’s tightening policy remains half-hearted. The economy grew at a 9.7 percent clip in the first quarter, though that number is down from 10.3 percent annual rate in 2010. Meanwhile, inflation hit 5.4 percent, the highest since July 2008. High inflation was expected, and the decision by the People’s Bank earlier this month to raise interest rates for a fourth time signaled its awareness of the rising pressures.

But interest rates do not determine credit conditions in China. Most important is the influx of credit, which shows no sign of significant slowing. True, new loans issued in the first quarter totaled 2.2 trillion yuan ($336 billion), down by about 14 percent from the same period last year, revealing a greater degree of control. But March lending rose to 679.4 billion yuan ($104 billion), considerably higher than 506.7 billion yuan in March 2010. This does not support claims by central authorities of more determined tightening.

Crucially, the share of alternative forms of financing (published now for the first time as part of “total social financing” or “national financing”) has continued to grow, after a rapid rise in 2010. This shows that despite any success authorities have had in tightening credit, banks and companies are finding ways to circumvent controls. Bank loans now make up only about half of total financing, and the government has much more difficulty controlling the off-balance sheet and underground lending. The national financing total was 4.19 trillion yuan ($641 billion), showing the massive proportions of the ongoing credit binge. If maintained at the same pace throughout 2011, the total would surpass 16 trillion yuan ($2.5 trillion), greater than the 14.27 trillion ($2.18 trillion) tallied in 2010 (though credit issued in the first quarter tends to be on the high side).

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The March data shows that, contrary to official pronouncements, there remains little appetite for aggressively tackling inflation expectations. The central government is ineffective in constraining prices and the monetary and credit forces that contribute to price growth, in part because of resistance from banks and corporations. The government is also wary of excessive tightening amid growing risks to growth. These include high commodity prices, the Japanese slowdown and global unrest.

The central government is still bickering with local governments that refuse to lower their real estate price-growth targets and has so far only threatened vague punishments for those that do not comply. Residential prices rose 6.6 percent on the official measure, while investment in real estate rose 34 percent in March year-on-year. This shows that attempts to curb these rises are meeting with little success, and has fueled fears of highly risky asset bubbles.

The National Development and Reform Commission continues to deny companies the right to raise prices, excepting necessary hikes on fuel and power that it seeks to delay and minimize. Direct price controls on food and consumer goods remain in place and will likely tighten. On April 14, 24 industrial associations announced, under pressure from Beijing, that they would not attempt to raise prices on key consumer goods. Exceptions will occur: the commission approved an electricity price increase in Shanxi and 10 other provinces because power companies were operating at a loss amid high coal prices. Corporations, especially energy companies and utilities, are demanding subsidies to offset the losses caused by purchasing inputs at international prices, then selling at domestically capped levels. This bickering will worsen as Beijing strives to shield the public from higher prices while companies resort to alternative or illegal ways to benefit themselves.

With growth surging, inflation remains the chief risk. The government will continue its marginal attempts to tighten policy in order to avoid losing control of the situation, while relying on price controls to alleviate the hardest hit areas. Economic conditions are pushing social dissatisfaction to new levels. Food inflation remained stubbornly high, at 11.7 percent, despite the government’s heavy hand in controlling grain and vegetable prices since late 2010. That 11.7 percent takes into account the statistical bureau’s attempt to downplay food prices by reducing their weight in the Consumer Price Index by 2.21 percent earlier this year. In any case, most Chinese people feel official statistics significantly understate the rise in food prices.

Still, there are sporadic indications of the government’s anti-inflationary measures achieving a degree of success. Inflation did fall slightly from the previous month. These measures pose a risk to growth. Smaller companies can have trouble obtaining enough financing to meet rising costs or, lacking political influence, cannot offset their losses with subsidies. Given the potential for social unrest, the government could be forced to take more drastic anti-inflationary measures. However, with extensive fears about growth and collapsing asset bubbles, Beijing seems prepared to maintain the high-growth status quo and use harsh security measures to suppress any unrest.

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The Arrest of China's Ai Weiwei

Chinese artist Ai Weiwei was detained April 3 at the Beijing airport. He is among numerous lawyers and activists who have been detained since the Jasmine rallies began early February. The most important issue surrounding Ai’s detainment is not about the artist himself, who has received mixed responses within China, but the timing.

The timing of the arrest of Ai Weiwei, who has pushed a very mutable, non-transparent redline on numerous occasions, is very curious. It illustrates a change in government behavior and tolerance, not merely reflected by anything Ai said or did. Moreover, Ai’s crimes have not been formally announced; there’s been talk of him being charged on economic crimes, but there’s also been talk of subversion based on his art and political activities that openly disparage the Communist Party of China (CPC). In particular, a picture of him with a grass-mud horse, which, said in Chinese in different tones, is a harsh expletive aimed at the CPC.

Ironically, Ai’s arrest attracts more, not less, attention to the social uprisings the Chinese government has been aggressively trying to contain. Ultimately, when domestic security is threatened, the government’s priority is not on managing public perception — and especially not on managing international perception.

But why are they doing this now, when figures like Ai have pushed the boundaries on numerous occasions? There are three factors that have contributed to the growing sensitivities. The first is the fear generated by the uprisings in the Middle East. The second is rising social concerns, primarily centered on inflation. The third is the upcoming 2012 transition in China. Chinese President Hu Jintao does not want large-scale protests to develop and mar his legacy. The biggest question is how long they will be able to maintain this level of social control.

Finally, these arrests — Ai’s in particular — underline China’s growing scrutiny. Beijing believes these protests are foreign-generated, and there are many indications of these protests being originated outside of China, where many of Ai’s supporters are located. The lack of legal protocol or transparency highlighted in these arrests underlines the difficulty of operating in China.

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Why the Shi Lang (Varyag) will never see action

Chinese media is alight with the coming unveiling of China’s first aircraft carrier, Shi Lang (Varyag) and although it may send shivers of discontent through its regional adversaries one has to state, there’s no reason why China shouldn’t have a carrier.

After all, the US, UK, France, Russia, Japan, India, Brazil, Argentina, Canada, Italy, Spain, Australia, Netherlands and Thailand all have had one or more at sometime in history, so why not China now? The simple answer is that there’s no reason why China shouldn’t have one, it has maritime interests and is a burgeoning power and deserves to have an offshore navy.

However, like most things in the Chinese military these days it is set to burst onto the scene with enormous fanfare and hyperbole which unfortunately places it in the realms of ‘unreality’ before it even starts. It is a mistake by the CCP leadership to place the nation’s hopes on a converted, old, Soviet, rust-bucket. However this mistake is already in full swing, with Xinhua describing the ship as embodying “70 years of Chinese hopes".

The ship will be under incredible pressure to speed through the learning curve on how to run a modern day carrier. Add on to this the expectations of 1.2billion people and it is enough to sink any ship. I can’t begin to imagine the pressure the captain and his pilots will be under and that’s just in peacetime.

So, if war should break out, what might we expect from the Shi Lang (Varyag)?

Unfortunately in the annals of maritime history, fate is rarely kind to new-pretenders and their capital ships. One only needs to look at the fates of the Bismark, hunted down and destroyed by the nimbler, more experienced Royal Navy. Or the Yamato class super battleships, picked off by the US airforce, to grasp that capital ships often serve as good target practices and nothing else.

In reality though, I think the Shi Lang’s fate maybe far less heroic and share a fate similar to Veinticinco de Mayo.

For those of you who don’t know, the Veinticinco de Mayo was the Argentinean aircraft carrier that played no role in the Falklands War in 1982. After hearing that the British Task Force was sailing, the De Mayo was put to sea to intercept, but bad weather prevented any attack and it returned to port. Once in port it never left again for the duration of the war.

Why did it stay in port?

Because it knew for sure that it would be sunk by British subs. The British had thrown a 200mile exclusion zone around the Falkland Islands and another Argentinean capital ship, the General Belgrano had been sunk steaming away from the islands, killing 1,500 sailors and sending a clear message to the De Mayo that as soon as it entered deep water it would be hit. British subs had express orders to sink the De Mayo on sight, regardless of its destination.

So that was the end of the De Mayo, it sat out the war, useless, while the British brought in their two carriers Invincible and Hermes and quickly gained air superiority with their superior Sea Harrier jumpjets. 10,000miles from home, the Royal Navy was able to bring superior force to bear on the Argentineans who were just 400 miles away from the battle.

This is nothing to do with luck. It’s about experience, timing and utilization of kit, because having a carrier battle group requires a whole suite of ships to protect it. They’re not a beginners piece of kit. In a small navy, the amount of ships needed to protect a carrier puts huge pressures on the enitre navy. For the carrier to move into hostile territoy takes incredible amounts of coordination.

Unfortunately for the Shi Lang (Varyag) , it will ply its trade in seas infested with the subs of the world’s two most formidable fleets, the US and the Japanese. The Japanese navy cut its teeth on 60 years of Cold War, tracking the best of the Soviet fleet in the seas off Japan, China’s backyard, and the US navy needs no introduction. So, with just an infant anti-submarine fleet the Chinese Southern navy will be easily found wanting, leaving the Shi Lang with little protection, making it highly unlikely that it will ever be able to be brought to the fight.

One may add that the Chinese navy has the largest submarine fleet in the region, with over 60 boats. Surely these will be the counter weight to protect the Shi Lang? But this fleet too, is untested, with only a few boats being truly world class, and don’t forget, in WW2, the German Wolf-packs had more than 300 U-boats, yet they still weren’t able to win the Battle for the Atlantic.

On top of this, the Age of the Carrier is over. We are in the twighlight of the Carrier Strike Group’s power. America knows this and is slowly but surely moving away from them. Long-Range-Unmanned Strike is the future of warfare. Just like the Yamato Class Battleships of WW2 came at the end of the Age of the Battleship, so Shi Lang (Varyag) joins the party too late to make a difference.

I know that I may seem like a party-pooper, but I wager that the Shi Lang (Varyag) wont venture out of port if a serious conflict breaks out within the next 10 years, as the CCP wont want to risk losing it. That’s the price you have to pay when you place the hopes of an entire nation on one ship. China certainly deserves to have a carrier, but it is a mistake to pin the national interest upon a ship that is outdated before the first plane has even taken off.

Xinhua scrapping the barrel to make a tired old arguement…

As I wrote in my post To Fly Or Not To Fly, China would have a tough time vetoing any No Fly Zone over Libya as it would considerably jeopardize its investments, which are currently estimated into the billions of RMB. (See here for one estimation of the cost)

Although, the No fly Zone doesn’t guarantee the lost investments, it would have looked really bad if China were seen as a deliberate block in any attempt to protect the people of Eastern Libya. Especially as a sizable chunk of their investments are in eastern Libya.

So, China abstained. It had no other choice, and this was the right thing to do. China could show that it respected the humanitarian side of the No Fly Zone, without compromising its own ideal of non-state intervention by other states.

What it should have done from then, is well…. Nothing. But instead it has once again fallen into an “Anti-American” stance, questioning the credibility of the No Fly Zone and it’s legitimacy, even relating it to imperialism.... again!

Turning the situation into another opportunity to flog a tired old argument about the US being a global bully that is happy to attack weaker countries.

On March 22 Xinhua reported

“Some countries Monday blasted the ongoing West-led military operation against Libya government forces, saying the air raids went beyond the UN resolution and must be scrapped immediately.

Further investigation reveals that one of the principle quotes for this story comes from Robert Mugabe, no less.

What is Xinhua doing? Why, if it wants to present China as a global leader is it still associating itself with these kinds of people? Does Robert Mugabe represent the aspirations of the Chinese people? I think not. Does what Mugabe think on the world matter to any reasonable nation that values its citizens?

Other notable countries joining this “global slamming” of the No Fly Zone being the political heavy-weights of Ecuador and Bolivia.

It is really beyond me why China’s propaganda machine thinks it is doing itself a favour by scrapping the barrel like this and flaming up anti-Americanism by associating with these kind of regimes and countries.

The CCP should realize that its current actions to present an “alternative” consensus on the UN sanctioned No Fly Zone actually alienates it more from the world it so desperately wants to be respected in.

If China wants to lead the world, then it should act like a global leader and garner the respect of the international community rather than wasting its time consensus building with minnows or pariah states, trying to prove a tired old point about western imperialism or US hegemony.

General Luo Yuan is back!

After a couple of months hiatus – which strangely started on 25^th Jan, General Lou is back in the news, and this time singing from Deng Xiao Ping’s hymn sheet.

No longer is he the cutting edge of the PLA’s more assertive stance, as he was in 2010. This time, he’s the poster-boy for the modest Deng policy of hiding one’s capabilities and not drawing attention to one’s self. This old strategic chestnut is now en vogue again in CCP circles, so as to detract from the ever-increasing demands for real political change that is sweeping the world in the form of the Jasmine Revolutions.

Here’s in latest interview from China.org.cn

China is no threat to the U.S.: General

The state of Sino-U.S. ties will be decided by the U.S., because China has always maintained a constructive attitude and is committed to preserving a positive, cooperative and comprehensive relationship in the 21st century, Major General Luo Yuan told China.org.cn on during the CPPCC session.

China will not change its policy towards the U.S. as its national power grows, said Luo, who is deputy secretary general of the China Society of Military Science and a member of the Chinese People's Political Consultative Conference. China's traditional culture and national character emphasize modesty and prudence, and China will neither seek hegemony, nor pose a threat to the United States, he added.

"We are very clear about our realities," said Luo. "I have visited former revolutionary base areas in remote and border areas and found that people there are still living in poverty." He said that as a visiting scholar abroad he saw quite clearly that China still lags far behind western countries. Those who see China as a threat to the United States and believe that China is competing for world leadership with the U.S. should go to western China and have a close look at how people live there, Luo said.

Well-informed Americans understand that China is not capable of posing a threat to the United States, Luo said. "Those who say China is a threat to the U.S. are just playing the ‘China card' to achieve other goals, such as increased military spending, shifting the public's attention from domestic issues and avoiding blame at home, or forming alliances with other counties."

According to the Major General, there is no country in the world capable of constituting a military threat to the United States. "China has never sent surveillance aircraft and ships to the U.S. East Coast or West Coast, but the U.S. regularly carries out surveillance activities in the South China Sea and East China Sea." Those who know China understand that China neither wants to nor has the power to pose a threat to the U.S., Luo added. "The China threat theory is utterly absurd."

But Americans who know little about China see China as a monster because China is a socialist country led by a communist party, said Luo. They believe there is a structural conflict between China and U.S. Moreover, they don't believe China can develop peacefully without seeking hegemony, because there is no precedent. Previously all big powers achieved their goals through waging wars or pillaging.

When asked how to enhance mutual trust between China and the U.S., Luo said China should address American doubts and explain its military strategy to the world, as well as demonstrating by its actions that it is pursuing peaceful development.

Is the U.S. encircling China?

During her visit to the Asia Pacific last October, U.S. Secretary of State Hillary Clinton claimed that the U.S. was not seeking to contain China.

But the U.S. has strengthened its military cooperation with Taiwan; it has also enhanced ties with its five military allies in the Asia-Pacific region, and its alliances with Japan, S. Korea and Philippines cover both the South China Sea and the East China Sea. It has gained access to military bases in many South Asian countries and has built a strategic partnership with India; it has also built a dozen military bases in Central Asia under the pretext of fighting terrorism. The U.S. has also tried to woo Mongolia, Luo said.

Is the U.S. encircling China? Please take a look around China, Luo said. "The U.S. constantly urges China to increase transparency in its military strategy. We would also like them to explain to us their military intentions."

Americans believe that their values are best and they are determined to spread them across the world and maintain their dominant position in the world. Because China's social system, ideology and cultural traditions differ from theirs, they are unwilling to allow China to fully integrate into the international community, but they cannot ignore 5000 years of Chinese civilization, Luo said.

Three barriers to Sino-U.S. military ties

Major General Luo said that China has made great efforts to develop sound and stable military ties with the United States: China publishes a defense white paper every two years and has participated in the UN Military Budget Transparency Mechanism and the Conventional Weapons Registration System. China has also invited many U.S. high ranking military officials to visit China, including Robert Gates, who visited the Second Artillery Force of the Chinese People's Liberation Army (PLA) during his recent China tour.

But three issues still hamper Sino-U.S. military relations: arms sales to Taiwan; frequent reconnaissance missions by U.S. ships and aircraft in China's waters and airspace; and U.S. legislative limits on military exchanges with China, Major General Luo said. The National Defense Authorization Act (NDAA) for Fiscal Year 2010 and the Delay Amendment set restrictions on military exchanges with China in 12 areas.

Sino-U.S. relations in 2011

Luo said Sino-U.S. relationship should improve and develop smoothly this year as the U.S. has just held mid-term elections and the general elections are some time off. But accidental factors could not be avoided, such as the Taiwan issue and the Korean Peninsula issue, Major General Luo said. "If the U.S. sells F-16 CD fighter aircraft to Taiwan, it will definitely harm Sino-U.S. relations."

China and the Middle East

The Chinese have deployed a vice foreign minister to the Middle East, North Africa and West Africa to assess the security of Chinese energy assets there. Beijing is growing increasingly concerned by the unrest sweeping through the Middle East and the potential impact that will have — not only on oil prices but potentially on Chinese social stability.

Although the fifth-largest oil producer in the world, the Chinese are a major importer of oil as well, consuming more than twice as much as they produce themselves. In 2010, the percent of Chinese oil consumption that they had to import from abroad grew by an additional 50 percent. A large quantity of this oil comes from North Africa and the Middle East and from countries that are considered politically unstable. China currently gets about 3-3.5 percent of its oil from Libya. It’s increased its investment more than 25 percent in 2010 and, as we’ve seen, the Chinese have placed a lot of interest in the future of Libya as a supplier. The Chinese have had to work out the evacuation of more than 30,00 Chinese from the country.

What Beijing is trying to do is to determine both how long energy prices are going to stay high due to the unrest in the Middle East and whether there’s going to be a lasting impact on places that China has been able to sync their own investments in — gain access to more resources themselves.

One of the major issues for Beijing now is that, as energy prices rise, it has a compounding impact on the inflation problem that’s already raging in China. Chinese inflation in 2010 came in at about 3.3 percent. For this year, it’s estimated — prior to these crises — at reaching 4 or 5 percent. Those are the official figures — by many accounts, those figures are far below reality. The real number should be 6-7 percentage points higher. Inflation has long a problem for the Chinese and during periods of extreme inflationary jumps, China has faced significant social challenges as well.

Since the economic opening in 1979, China has had three major spikes in inflation: one in 1985, one in 1988-89 and one between 1993 and 1996. In 1985, inflation ran around 10 percent and the Chinese managed to hold things together socially. In 1988-89, the rising inflation contributed to what ultimately became the Tiananmen Square incident. In 1993-96, Chinese inflation was rapidly rising on the back of the rest of expansion in East Asia and the Chinese really were saved by the collapse of the rest of Asia where Beijing could rein in, it could hold things down domestically and then it could start to grab the export share that had fallen away from many of the Asian economic tigers.

As China watches the unrest and North Africa, they’re also looking cautiously at the so-called “Jasmine” revolution that’s just in its early stages in China. Thus far we haven’t seen very large numbers of demonstrators, but the Chinese security apparatus response suggests that they may be even more concerned about this than perhaps what people see from the outside.

For Beijing, several things come together right now that make this a particularly difficult period. One, you have the higher energy prices coming on top of inflation that already exists. Two, you have this attempt at public demonstrations that spread not only geographically but across socio-economic classes. Three, you have a change in communication strategies where information is able to move faster, its finding ways to circumvent Chinese censorship and it’s drying out people who have very different grievances. The fourth is that China is in a very different stage of its development right now. There really has become a growing middle class, there has been higher expectations given to the Chinese over the past few years — the government to deal with the economic crisis has tried to push domestic consumption, has done so by subsidizing, by giving rebates, by funding, and people are coming to expect more and expect more. These factors are combining at a time where Beijing is also focusing very heavily on the transfer of leadership from Hu Jintao to his successor.

At times like these, social stability becomes a top priority for the government. They want things to hold steady so they can carry out the political transition without any significant problems or impact. STRATFOR is watching very closely how the Chinese manage these different issues as they come at them very quickly. The Chinese government is not known for being able to move very rapidly, particularly at a time like this when they are undergoing a political transition and they’re working up a balance between the various political factions.

STRATFOR.com

Perfect Storm for Taiwan Contingency

It may sound callous, but now may be the “Perfect Storm” of conditions that would make it a favourable time for the PLA to retake Taiwan by force.

China’s major competitor in the region is devastated by the earthquake and the proceeding tsunamis. The US Navy’s 7^th and 3^rd Fleets will be mobilized for the huge recovery effort, as well as being logistically affected due to the earthquake.

In Europe, NATO is all fingers and no thumbs over the No-Fly Zone in Libya, which despite it being a long way off will still be taking up many of the assets allocated to the 5^th and 6^th fleets.

Meanwhile, the U.S still has two wars going on in Iraq and Afghanistan.

From a military point of view, the U.S navy may never be so stretched again - having so many pressing and urgent military and humanitarian needs.

Right now, Carriers Ronald Reagan, George Washington and Essex will be being reconfigured for urgent mission to help the 100,000s of Japanese refugees - the U.S's principle partner in the region. It would be a logistical nightmare and almost a step too far to reconfigure them back into a war fighting stance for a Taiwan contingency. Plus, Obama just isn't up to it!

While there may be those in the PLA that may see the opportunity - Nothing will happen.

Why? Because I believe it’s not the in the nature of the CCP to be so bold even when presented with the Perfect Storm of events.

Even though the PLA actively writes about taking the initiative militarily and striking while the enemy is weak and over stretched, this is hard for them to materialize into practice – blame Confucius!