Parallel to previous crises?
Several parallels have been made between China’s current situation and conditions leading up to previous crises, particularly focused on high debt levels and interest rates, as well as tightening credit. China has seen all three characteristics as the central bank had tried to suck excess capital from the economy.
But there’s at least one difference that makes China’s situation different: inflation. China is plagued with overcapacity. In February, year-over-year growth in producer price index, which has been stuck in negative territory, fell to 2.0%—a reflection of weakness in wholesale prices and ongoing excess capacity in the economy. Consumer inflation, measured by the year-over-year change in consumer price index, edged down to 2.0% as food inflation moderated.
Benefit to central bank
Moderate and low inflation means the central bank has the ability to loosen stimulus and engineer a soft landing, rather than a hard one. It also means the central bank can focus its energy tightening credit to deleverage shadow banking, pull money away from chasing risky investments, and remind investors that the days the government will bail out companies are gone, while simultaneously ensuring economic growth doesn’t fall.
Recent inflation figures are fairly below the government’s own target rate of 3.5%. As the economy slows, the risk of deflation rises. Deflation is negative because it has an effect on consumers of postponing purchases, leading to further deflation and slowdown in economic growth. If this occurs, investors could see more defaults, and the Guggenheim Shipping ETF (SEA), as well as several dry bulk shipping companies would not perform as well. These companies include DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), and Navios Maritime Holdings Inc. (NM).
In light of recent economic weakness, weak inflation figures, and people’s concern over default, the central bank could loosen monetary policy a little sometime down the road, which would be positive for SEA and dry bulk shippers. Look for cues as to whether the central bank would loosen its policy a little.
© 2013 Market Realist, Inc.