Boeckh:  China’s Great Reflation Experience – August 11, 2009

By all appearances, China’s success in stimulating its way out of the global recession has been wildly successful. GDP growth was 8% annualized last quarter despite ongoing export weakness. The stimulus package, consisting mainly of a combination of infrastructure spending (U.S. $590 b) and state-directed expansion of business lending ($1,084 b), is by far the largest as a share of GDP of any nation. Tax rebates and other incentives have increased domestic consumption dramatically. For the first time, more cars were sold in China than in the U.S. in the first half of this year.

This success masks a growing set of imbalances. GDP growth has increasinglybeen driven by capital investment, as exports and profits have both declined over the last two years. At a time when most businesses outside of China are retrenching by reducing leverage and cost cutting, large Chinese corporations are doing just the opposite. Capacity expansion with weak exports will lead to a growing output gap that will further reduce profitability. Due to state control of the banking system a financial crisis is unlikely. However, investors should be concerned particularly given the high valuations of most Chinese equities (P/E ratio averages 38 for stocks in the Shanghai composite index).

Volume 1.9 – China’s Reflation Experiment_Aug.11.2009

Boeckh:  The Great Reflation Experiment – July 23, 2009

The Crash of 2008/9 should be seen as yet another consequence of long-term, persistent U.S. inflationary policies. Inflation doesn’t stand still. It tends to establish a self-reinforcing cycle that accelerates until the excesses in money and credit become so extreme that a correction is triggered. The bigger the inflation, the bigger the correction. Once a dependency on credit expansion is well established, correcting the underlying imbalances becomes extremely difficult. Reflation has occurred after each major correction and this one is proving no exception. Return to discipline in the current environment would be too painful and dangerous. Once on the financial roller coaster, it is very hard to get off. Moreover, the oscillations between peaks and valleys become increasingly large and unstable.

Volume 1.8 the Great Reflation Experiment Jul 23 2009