China’s Next Generation
By John R. Taylor, Jr.
This year’s graduating class from Chinese universities totals around 7 million, and there are reports that these students are having a hard time finding jobs commensurate with their skills. In a population of 1.34 billion, that might not sound like too many new workers, but the Chinese economy is still dominated by manufacturing and capital development – basically construction of one type or another, businesses that have a very small need for university graduates. China is to be congratulated for rapidly expanding its university system and educating its people so well, but what are they going to do? Remember that these 7 million graduates are produced year after year and they need positions in an information-driven and innovative society, something that the Chinese say is their goal, but there are many hurdles to overcome before they can reach that point. Right now China is an export platform and a construction site, basically operating on a production schedule and a plan. As a Communist country with a command – or at least mostly-command – society, it has the centralized framework to carry out most of these top-down functions effectively. Assuming that the Party and its functionaries are competently organized and incentivized, they should be able to perform at a high standard, and they have done that for at least the past 20 years. The Chinese leadership has been first class and their success is history, but moving beyond this centralized model is another issue entirely.
The Soviet Union, the other Communist behemoth, failed much earlier in its economic development path because it did not follow the marketing lessons of the Western commercial giants. The Chinese became the handmaiden of these giants – companies like Walmart, Carrefour and Home Depot – producing the exact products, with the same standards and precision, on the equipment designed by the Westerners and then selling it to them. The Chinese export giant provided the labor, the land to build the factories, the power grid, and the transportation system to move the raw materials in and the finished products out. Product concepts and design, marketing, and customer service were all left to the Westerners. The Russians never got that far – they still can’t manufacture. However, the Soviets did not collapse on their failure to develop, but on their Communist Achilles heel – the lack of freedom of information. A popular anecdote says that the Soviet Union was defeated by the Xerox machine. In fact, the Czech revolution was greatly facilitated by Laterna Magika, an artistic group, which possessed the only machinery able to reproduce and communicate during the Communist overthrow in 1989. China’s battle with the internet, Twitter, and all their cousins will eventually be resolved, but only then will the country succeed as an innovative, market-oriented economy. Government reforms are necessary, but their
form is still unknown and the path to them will not be straight. In the end, all facets of society, not just the government-friendly ones, must have the free expression to develop a successful consumer-oriented system. These new 7 million graduates will be the most difficult faction of society. If they are frustrated, unable to recognize value for their hard-fought educational investment, the system could crumple. These young people will find work, but they don’t want to pour concrete. The old system is dead – the new one is not born. Watch this space.
As Brazilians Hit the Streets, the BRL Hits the Skids
By Jonathan Clark
Despite intervention by the Banco Central do Brasil (BCB), and removal of some of the taxes and capital controls implemented in 2010 to slow capital inflows, the real has entered a collapsing decline. Evidence shows that emerging market outflows are the largest in two years, and Brazil is particularly vulnerable to capital flight due to excess lending. Defaults are running at record levels. The commodity producing industries witnessed significant capital inflows in recent years but, with the end of the mining boom, inflows will continue to slow substantially. On Wednesday, Brazil
announced a bill to reform its mining code, doubling the government royalty rate and setting tighter restrictions on newly opened mines, which should appease current mine-owners and investors, but discourage future investment. The price at which Brazil sells its commodity exports (shown in inverse on chart) has been falling, and the pace of the downmove has accelerated since the start of the month. Despite below trend growth, inflation remains a problem where headline inflation is 6.5%, and core inflation is 6.0%, near the top end of the BCB’s 2.5% to 6.5% tolerance band. Adding to the country’s problems are the tens of thousands of Brazilians demonstrating in large cities protesting excessive spending on the 2014 World Cup and 2016 Olympics, plunging quality of life, and skyrocketing costs of living. Brazil is losing its appeal as an investment destination. To make matters worse, Brazil has seen the unraveling of carry trades that have helped to bolster the currency in recent years, which this has pulled the real down. Bernanke’s comments on yednesday indicating that the US Federal Reserve would begin tapering before the end of 2013, cutting global liquidity, should only amplify this flight from carry.
The 14% decline in the real since the middle of March is adding to the inflation, but the BCB will be reluctant to hike interest rates further. The yield on 10-year Brazilian government bonds has climbed to 11.45%, reflecting capital outflows, but this rate will only become truly attractive after the real stabilizes. The most likely action by the BCB is to sell dollars and buy real, supporting it, to tame inflation without slowing the economy, but recent intervention by Brazil has proven ineffective in the past few weeks. The cycles are not expecting a low before the end of July or early August. USD/BRL has exploded higher during the past several days and reached its highest level since April of 2009. The cycles argue that this overall strength should last for another six weeks before a significant peak is reached. The upmove has turned parabolic and this argues that it should continue to prove aggressive before ending in a spike top followed by a sharp reversal. Our target for the peak due during the week of July 20 or the following week is the 2.4000 area – approaching the 2008 dollar high. Following this high dollar/Brazil should turn lower and begin a sustained decline lasting into the end of the year. Only a close below 2.1200 would mean there is a risk that it has peaked ahead of schedule and is headed lower into November or December, but it is much more likely that the next downmove is postponed until we see a lot more upside fireworks.
By John R. Taylor, Jr.
This year’s graduating class from Chinese universities totals around 7 million, and there are reports that these students are having a hard time finding jobs commensurate with their skills. In a population of 1.34 billion, that might not sound like too many new workers, but the Chinese economy is still dominated by manufacturing and capital development – basically construction of one type or another, businesses that have a very small need for university graduates. China is to be congratulated for rapidly expanding its university system and educating its people so well, but what are they going to do? Remember that these 7 million graduates are produced year after year and they need positions in an information-driven and innovative society, something that the Chinese say is their goal, but there are many hurdles to overcome before they can reach that point. Right now China is an export platform and a construction site, basically operating on a production schedule and a plan. As a Communist country with a command – or at least mostly-command – society, it has the centralized framework to carry out most of these top-down functions effectively. Assuming that the Party and its functionaries are competently organized and incentivized, they should be able to perform at a high standard, and they have done that for at least the past 20 years. The Chinese leadership has been first class and their success is history, but moving beyond this centralized model is another issue entirely.
The Soviet Union, the other Communist behemoth, failed much earlier in its economic development path because it did not follow the marketing lessons of the Western commercial giants. The Chinese became the handmaiden of these giants – companies like Walmart, Carrefour and Home Depot – producing the exact products, with the same standards and precision, on the equipment designed by the Westerners and then selling it to them. The Chinese export giant provided the labor, the land to build the factories, the power grid, and the transportation system to move the raw materials in and the finished products out. Product concepts and design, marketing, and customer service were all left to the Westerners. The Russians never got that far – they still can’t manufacture. However, the Soviets did not collapse on their failure to develop, but on their Communist Achilles heel – the lack of freedom of information. A popular anecdote says that the Soviet Union was defeated by the Xerox machine. In fact, the Czech revolution was greatly facilitated by Laterna Magika, an artistic group, which possessed the only machinery able to reproduce and communicate during the Communist overthrow in 1989. China’s battle with the internet, Twitter, and all their cousins will eventually be resolved, but only then will the country succeed as an innovative, market-oriented economy. Government reforms are necessary, but their
form is still unknown and the path to them will not be straight. In the end, all facets of society, not just the government-friendly ones, must have the free expression to develop a successful consumer-oriented system. These new 7 million graduates will be the most difficult faction of society. If they are frustrated, unable to recognize value for their hard-fought educational investment, the system could crumple. These young people will find work, but they don’t want to pour concrete. The old system is dead – the new one is not born. Watch this space.
As Brazilians Hit the Streets, the BRL Hits the Skids
By Jonathan Clark
Despite intervention by the Banco Central do Brasil (BCB), and removal of some of the taxes and capital controls implemented in 2010 to slow capital inflows, the real has entered a collapsing decline. Evidence shows that emerging market outflows are the largest in two years, and Brazil is particularly vulnerable to capital flight due to excess lending. Defaults are running at record levels. The commodity producing industries witnessed significant capital inflows in recent years but, with the end of the mining boom, inflows will continue to slow substantially. On Wednesday, Brazil
announced a bill to reform its mining code, doubling the government royalty rate and setting tighter restrictions on newly opened mines, which should appease current mine-owners and investors, but discourage future investment. The price at which Brazil sells its commodity exports (shown in inverse on chart) has been falling, and the pace of the downmove has accelerated since the start of the month. Despite below trend growth, inflation remains a problem where headline inflation is 6.5%, and core inflation is 6.0%, near the top end of the BCB’s 2.5% to 6.5% tolerance band. Adding to the country’s problems are the tens of thousands of Brazilians demonstrating in large cities protesting excessive spending on the 2014 World Cup and 2016 Olympics, plunging quality of life, and skyrocketing costs of living. Brazil is losing its appeal as an investment destination. To make matters worse, Brazil has seen the unraveling of carry trades that have helped to bolster the currency in recent years, which this has pulled the real down. Bernanke’s comments on yednesday indicating that the US Federal Reserve would begin tapering before the end of 2013, cutting global liquidity, should only amplify this flight from carry.
The 14% decline in the real since the middle of March is adding to the inflation, but the BCB will be reluctant to hike interest rates further. The yield on 10-year Brazilian government bonds has climbed to 11.45%, reflecting capital outflows, but this rate will only become truly attractive after the real stabilizes. The most likely action by the BCB is to sell dollars and buy real, supporting it, to tame inflation without slowing the economy, but recent intervention by Brazil has proven ineffective in the past few weeks. The cycles are not expecting a low before the end of July or early August. USD/BRL has exploded higher during the past several days and reached its highest level since April of 2009. The cycles argue that this overall strength should last for another six weeks before a significant peak is reached. The upmove has turned parabolic and this argues that it should continue to prove aggressive before ending in a spike top followed by a sharp reversal. Our target for the peak due during the week of July 20 or the following week is the 2.4000 area – approaching the 2008 dollar high. Following this high dollar/Brazil should turn lower and begin a sustained decline lasting into the end of the year. Only a close below 2.1200 would mean there is a risk that it has peaked ahead of schedule and is headed lower into November or December, but it is much more likely that the next downmove is postponed until we see a lot more upside fireworks.
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