It's been over a month now since the unnerving market sell-off that was prompted by a mini-meltdown that hit the Shanghai market -- briefly. Now that global equity markets have essentially regained the ground lost during the those days, what are the odds that we could again get clocked by another bout of "Asian Contagion"?

Unfortunately, the odds are just as high (if not higher) now as in February. And it's due to the somewhat ironic fact that the Chinese economy is on a tear.

The Chinese economy is re-accelerating -- that's bad
The latest data emerging from People's Republic shows an economy that is definitely re-accelerating after a slight pause during the final quarter of 2006. Over the first two months of this year, export growth surged to 41.5% year-over-year – a dramatic acceleration from the still rapid 27% pace of 2006. As a result, the trade surplus ballooned to nearly $24 billion in February, about nine times the level hit a year earlier.

Fixed asset investment over the same period also showed no signs of slowing down, maintaining the strong 23% growth rate that it experienced throughout 2006. With the fixed asset sector now making up more than 45% of Chinese GDP, continued growth here is a major concern.

The fuel that's feeding the fixed asset investment fires continues to be easy credit. Despite the Chinese Central Bank's campaign of monetary tightening, which has included upping the reserve requirement six times and raising the bank rate twice since last June, bank lending growth re-accelerated to nearly 17% during the first two months of this year -- well above the 13% pace during 2006. Local currency loans during February alone were nearly three times the amount that had been extended in the same month a year earlier.

Beijing no longer appears to be in control
An accelerating economy is exactly what the Beijing policy makers had been hoping for. It now raises serious concerns that the economy is overheating, out of control and heading towards a crash in the near future. At the end of last month's National People's Congress, Premier Wen Jiabao described the economy as "unstable, unbalanced, uncoordinated and unsustainable". (To learn more, read The Greatest Market Crashes.)

While it's now clear that Beijing grasps the seriousness of the situation, the problem is that they may be loosing the ability to control it. The latest round of monetary tightening actions have been nothing more than dead stick maneuvers given their lack of impact. China's benchmark stock index, the Shanghai All Ordinaries hardly took any note of the latest reserve requirement hike as it broke to new highs, extending on the 130% gain it chalked up in 2006.

U.S tough trade could escalate into a trade war
If China's central planners can't put the brakes on, then who can? The U.S. government maybe, judging by the latest developments.

The first shot of what could turn out to be a trade war was fired by the U.S. Commerce Department last week when it decided to slap a preliminary 18% duty on Chinese glossy paper exports, which it argues are heavily subsidized. This was quickly followed by the United States filing two cases with the World Trade Organization aimed at stopping widespread piracy of U.S. movies, music and software; another move that should further escalate protectionist tensions.

Meanwhile, over on Capitol Hill, Congress could also be on the verge of taking a harder line toward China as protectionist sentiment appears to be gaining momentum. After two years of going nowhere, a Bill sponsored by two leading critics of China's trade practices, Sens. Charles Schumer and Lindsey Graham, now stands a decent chance of being passed into law this session. The Bill would impose an across the board 27.5% tariff on all Chinese imports into the United States unless China drastically raises the value of its currency, which some economists have argued is undervalued by as much as 40%. With the United States accounting for 21% of China's exports, such a move would deal a body blow to China's export dynamic, and possibly push the Chinese economy into a crisis.

If the only way to avert this prospect is for the Chinese to drastically upward re-value their currency, I doubt they'd opt for such a choice at this juncture. While a one-time meaningful revaluation move by the Chinese might have been possible earlier, it'll be a tough call now given the current overheated state of the Chinese economy. Things seem to have reached a point where there are no painless options left. And that raises the odds of another Chinese market meltdown.

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