The first trading day after the Asia-wide three-day holiday, and following the weekend announcements of Lehman Brothers Chapter 11 filing and the buyout of Merrill Lynch, China’s stock markets dropped in tandem with Asian and world markets.

China Supertrends has been following the financial implications of the sub-prime crisis for a while now and will comment on this latest development and the state of China’s stock markets in a separate post. Today, Tuesday, September 16, was yet another blood-bath in the markets, but at a time like this it is worth remembering that China’s underlying economic fundamentals remain very strong.

In fact, China just came off yet another strong month of growth. If this is true, what causes the apparent contradiction of one of the world’s best performing economies having one of the worst-performing stock markets?

In brief answer to this complex question, let’s just say that the theory of decoupling - the idea that China and other developing countries are mature enough to continue to develop on their own during an economic decline in the US and elsewhere - is increasingly discredited.  We wrote as much in Supertrends: We are living in an inter-connected world, and nothing, not even neo-Mercantilist policies, a protected currency, nor the world’s largest foreign reserves, can resist the forces that are sweeping our world.  As John Donne famously said, no man is an island. This financial crisis calls to all governments to act.

China, with its strong economic performance in August and year-to-date, may appear to be in the eye of the storm, an island of calm and prosperity. Last week was the Mid-Autumn Festival, and the economists at China’s National Bureau of Statistics were producing new data faster than mooncakes at Wang Jia Sha. Virtually everything seems according to plan.

Starting with the drivers of the economy, consumption continued to show signs of strength, with retail sales maintaining a 23.2 percent pace of growth in August, only slightly lower than July’s 23.3 percent, the fastest rate since 1996, according to the Shanghai Daily.

The level of retail sales growth is far above the most recent inflation levels, meaning retail sales growth is not just about price increases, there is real growth there.  In fact, CPI - the consumer price index, or basic inflation - decreased to 4.9 percent in August, continuing the downward trend, but worrisome PPI - the prices producers are paying for raw materials and commodities - continued to climb, to 10.1 percent in August. PPI increases will, at some point, either result in decreased margins and profits as companies absorb the increases, or get passed on to consumers as price increases, so China is not out of inflationary woods yet.

Many were regarding the fight on inflation to be one of China’s core economic policies of 2008, but in a surprise move today the People’s Bank of China decided to cut interest rates by about a quarter percent, down from 7.47 percent to 7.2 percent and, in perhaps the most surprising move of all, cut the reserve ratio by a full one percent after having just increased it by one percent in June.  Now that the Olympics are over, micromanagement of the economy seems back in style.

But the message, that the economy is ready for a rate cut and wants to increase money supply, could be evidence that the PBOC overshot the mark and caused money supply to shrink too quickly, contributing to some of the summer’s abysmal stock and real estate performance.  Growth in M2, the money supply, decreased to 16 percent in August, down from 17.4 percent in June.  It is important to point out here that we are still talking about an increase of 16 percent, just that the rate of speed it was growing simply slowed down a little.

Is the PBOC acting wisely or foolishly? Time will tell if they are cutting too soon, a knee-jerk reaction to the latest sub-prime casualties, trying to prop up the falling stock and property markets, or if they are presciently avoiding a much harder crash in the wake of Fannie/Freddie/Lehman fallout and other factors yet to come.

While some of this data could be construed as negative, China had a lot of other positive economic results in August. For example, the trade surplus is up by 25.7 percent year-to-date, compared with Jan - Aug 2007 figures.

In August, with industrial output growth the lowest in 18 months, a mere 12.8 percent increase, exports decreased to 21.1 percent from 26.9 percent in July. Imports were down more dramatically, from 33.7 to 23.1 percent, mostly because of commodity import price decreases  (i.e. oil), so the trade surplus actually still got bigger. 

Though slowing its rate of increase slightly, clearly China’s export prowess is not affected significantly by the world-wide financial crises, and despite the 2008 increase in  the strength of the RMB exporters seem to have adapted. The sky, it woud seem, is not falling, though its perhaps a paler shade of grey. Ecnomists, analysts, and the Chinese media make a lot of dire proclamations about how the Chinese economy is in decline but this is better thought of as healthier, sustainable growth.

I could go on. FDI and other investments - still strong. Foreign reserve size- still troubling, but thanks to the Fannie Mae / Freddie Mac bailout, the 20 percent of reserves held in US mortgage debt appears safe.

So the question originally posed, why is there a contradiction? China’s strong economy (with all the usual provisos and assumptions about the data, of course) on the one hand, and its weak stock and property markets on the other. What gives?

Is this a sign that global markets cannot decouple and are doomed to falter together, or is it a sign that somebody needs to act more decisively?  Just as China became a stabilizing force in the Asian Financial Crisis of 1997, is there are way it could use its economic and financial strength to do so again?

No country is an island in our globalized world.  Everybody has a stake.  With the alarm bells sounding, can China passively wait for the U.S. to get through its bailouts, and hope that the world financial system remains intact?  Or does this bell ring for another?  Whom does the bell toll for?  China, it tolls for thee.

In Supertrends, we wrote about how increasingly-younger working professionals are coming to China, sometimes right after graduation from an MBA program or even undergraduate school. This is a certain trend. Shanghai can even be called the new New York for its growing fashion, club, restaurant, and shopping scenes. And, in the city’s business sector, to paraphrase the immortal Frank Sinatra, if you can make it there, you can make it anywhere.  But are halfpats the new expats?

Halfpats are not an official job classification, just a collective term for people that go to another country to work on their own initiative, rather than being sent by their firms. They come as tourists or students, then stay as workers, sometimes for years. On the other hand, the classic expatriate, in China and elsewhere, is typically an older executive at the managerial level dispatched on a limited-term assignment from the headquarters to an office abroad.

Expats play an important role in bringing experience, trust, and corporate culture to a foreign office. For this, they are often handsomely rewarded with luxurious (compared to local standards) rent and food allowances, tax-differential subsidies, even hardship pay and medical evacuation insurance. A new article by Alan Paul in the Wall Street Journal ponders whether the traditional expat is the Neanderthal to the halfpat’s Homo sapien:

…these old school mainline expats may be endangered. There is another, growing group of expats in Beijing who are younger, more willing to move around and less expensive to employ.

All true.  But I disagree with the idea of halfpats significantly endangering the Neander.. sorry, expats.  Unlike their halfpat descendants, older expats have experience that callow youth simply cannot make up. Furthermore, the very thing that makes halfpats attractive - local presence, Mandarin-speaking, upwardly mobile skills - makes them into flight risks.  They have choices about where to work in China, and may not have a long-term commitment to the foreign firm.

A multinational company in China would be no more likely to hire a halfpat instead of an expat than it would to hire an inexperienced Chinese manager. Every survey I have seen still says there is a shortage of management talent in China, whether foreign or local. The key of course, is management talent.  A halfpat may be extremely competent but, for company politics if for no other reason, nobody is handing them the keys to a multimillion dollar China operation.  So the premise that Paul puts forward is - and I think he must get this, too - partly flawed.  Expats and halfpats are apples and oranges.

Full disclosure, I am a halfpat based in Shanghai.  And, like all halfpats, I sometimes lament the fact I am not an expat.  It is true, I have no luxury villa, no car with driver, nor tuition subsidy to send my kids to school.  I don’t even have kids!  But, like many other people coming to China without a work sponsorship, I gave up comfortable and higher-compensated jobs in other countries for the chance to be here. It was a chance worth taking. And, like that other Sinatra song, “…regrets, I’ve had a few, but then again too few to mention.”

Contrary to the implied conclusion of Paul’s article, that halfpats are going to be replacing expats, I believe that the demand for expats is as strong as ever, and halfpats are a mutually exclusive quantity which may also be increasing, for that matter.

Many foreign firms are still expanding in (or even just entering) the China market, requiring foreign management staff. A recent announcement showed that companies choosing Shanghai as their regional headquarters are still on the increase, now numbering 206, up from just 41 in 2003. While the current HR practice in China is to try to follow a local or local-plus (i.e. the aforementioned halfpats, such as haigui returnee Chinese, or foreigners already living in China) hiring policy, there are not yet enough qualified halfpat candidates available for top organizational positions.

We may also study the preferred habitats of expats to guesstimate their numbers. For example, expensive serviced apartments can be an indicator of expat populations. To make a generalization, halfpats get much lower salaries and little or no housing allowance, so few can afford the US$1500 - $15,000 monthly rents on a serviced apartment or villa in Shanghai. We can therefore take growing supply of luxury residences (as long as they are filled) to mean that the expat market size is increasing. Singapore’s Frasers Property, previously featured in our article on the redevelopment of Shanghai’s Wujiang Road, plans to open 20 new serviced apartment buildings in China by 2010, half of its global increase during that period.

Paul’s WSJ article also points to a barrier for new or returning halfpats:

Longer-term visas have become harder to obtain in China. Many of the visa brokers often employed by halfpats have been shut down and there are rampant stories about expats without full-time employment having to leave China, at least for a while.

But then he continues with the common expectation that visa restrictions will be lifted at the end of September or October after the Paralympics are over, once again swelling the ranks of halfpats. I’m personally not so sure. On the ground in Shanghai, my impression is that during this period of visa tummult, China-based businesses quickly adapted: For example, English schools put their best staff on permanent work visas, and other companies that depended on unlicensed foreign workers made the switch to locals.  There is only unofficial rumor to go on in regard to the government policy after September: While longer business visas are likely to return, the requirements may still be strict.  Young halfpats, however, are nothing if not flexible and creative.

So, while China still remains an extremely attractive place to work in the minds of many young foreign graduates, the job market for those workers is tight, and I don’t expect a big influx of halfpats to displace more-experienced expats anytime soon.

Attention big company managers: Rest easy on your imported beds and high thread count sheets this night, your jobs are not in danger from Mandarin-speaking Young Turks just yet.

Related Information:

Rich Brubaker at All Roads Lead to China has been following the halfpat story for some time, I recommend you check out a few of his posts on the topic here and here.

Can organic vegetables grow in China’s depleted soils? Won’t environmental pollution offset any gains from eating healthy? Aren’t vegetables here, produced by China’s 500 - 600 million farmers, already dirt-cheap? These are just some of the questions I had about a year ago, when a Chinese entrepreneur pitched me on an idea that seemed so ridiculous that I had to remind myself of one of the traditional entrepreneurial litmus tests: If you’ve got an idea so crazy that everybody thinks you’ve lost your marbles, on the contrary you just might be onto something.

In a nutshell, this fellow had agricultural and academic connections to be parlayed into a network of greenhouses. They would be rented to foreigners who wanted to grow their own food. An integrated coffee shop and walking tour would allow people to hang around and watch their vegetables grow precariously from the ceilings. It was to be located in Shanghai’s picturesque and rural Fengxian district.

Although I knew something about the locavore and LOHAS (Lifestyle of Health and Sustainability) concepts, I still wondered if there were really enough green-thumb foreigners in the city to rent his greenhouses and farm their own produce.

“No problem!” he said, “We have people who do the actual farm work.” And what’s more, fresh ten kilogram baskets of the organically grown fruits and vegetables would be delivered to customers’ doors weekly. Ah, a garden without the work! Now he might be onto something.

I passed on the opportunity to invest but recommended the entrepreneur instead focus his marketing on the emerging middle/upper class of Chinese consumers who would be more than eager to eat up healthy vegetables at inflated prices. It turns out I was at least partly right. Before I get to that, let’s review a little Olympic context for organic foods in China.

In the wake of a poisonous dumpling scandal which rocked China-Japan relations in early 2008, China’s pre-Olympic food preparations suffered one indignity after another: The US planned to boycott the Olympic Village food altogether, Australia had to be banned from bringing its own food into the Village (including, it seems, copious quantities of Vegemite - Australia’s favorite spread), and the Olympic Village cafeteria itself would offer only 30 percent of the menu from China’s famous local cuisines. Then perhaps the ultimate loss of face for Chinese gourmands: Usain Bolt’s pre-world-record-setting meal? Chicken nuggets.

I mention the Olympics for its effect of kicking China’s organic foods production up a notch. In order to reassure Olympians - and the world - that China’s food chain was safe, no expense was spared. From RFID-encoded shipments to pigs having Mozart played on their final walk to the abattoir, safety was the number one priority. Number two was health.

In the run up to the Olympics, China has embraced organic foods extremely rapidly. Despite the fact that China has been a producer of organic foods for decades, just two years ago it was hard to find locally-available organic foods in even the foreign-owned hypermarts. Now, fresh, locally-grown organics are not only found in major grocery stores and served in top restaurants, they are even joining the ranks of DIY products.

Vegetable gardens put the commune back in China

Last week in the Shanghai Daily, a pair of organic food stories caught my eye, but this one about the People’s LOHAS Commune in Qingpu District was especially relevant given my experience with the farm/coffee shop/vegetable gallery I was told about last year:

The 33-hectare commune includes 27 hectares of farm land, and a 7-hectare eco-lagoon. The farm is divided into four parts - an orchard, a flower garden, an organic Chinese medicine farm and a vegetable farm.

For only 3,000 yuan (US$441) a year, you can have 3 hectares of land to grow any plant you like, even expensive ginseng.

In Supertrends of Future China, we discuss the growing trend in China of consumers seeking high-quality alternatives and upgrading their lifestyle, adopting activities such as LOHAS originally found in more affluent countries. We believe the trend is just getting started in China, although a number of incumbent businesses such as popular Shanghai eateries Element Fresh and Jujube Tree are already benefitting from the growing segment of health-conscious consumers. The Commune’s proprietor, Xie Lun, seems to share our optimism:

“The People’s LOHAS Commune welcomes everyone who loves nature as long as they observe two simple rules,” Xie says. “The first is no spitting and the second is that other people’s produce must not be taken without their permission. ”

So far more than 400 people, most white-collar workers, have applied to be members of the commune even though it will not officially open until next year.

Although China’s organic food industry is clearly only for affluent locals and foreign residents at this time, this is indeed a trend to watch and get positioned for. China’s own version of Whole Foods of Trader Joe’s may not be far behind.

In Supertrends of Future China, we discuss the need for localization of products and services when foreign companies come to China. We take it one step further, saying that products from the Chinese market are going to have a big influence on the lives of people outside of China as well. Think instant noodles or traditional Chinese medicine (TCM) as two early examples. China’s large market will encourage firms to create products suitable for local use, and some of the best will boomerang back. We call this Sinofication.

Back in October last year, Coca-Cola made news in China by establishing a research center specifically for products related to TCM ingredients. This announcement was important for two reasons. First, Coca-Cola showed how important China’s market was by increasing R&D spending there and, second, that the functional foods and beverages category (especially in Asia) is a growing trend.

While the kinds of beverages being developed are still kept secret, they could be standalone products (Coca-Cola makes teas, juices, and bottled water in addition to sodas) or a new variant on the original Coke recipe: Traditional (Chinese Medicine) Coca-Cola, anyone?

In fact the company is in a good position to benefit from a potential Coke-TCM concoction: Coca-Cola, originally containing cocaine from Coca leaves, was created as a tonic (”Coca-Cola Revives and Sustains” - 1905 slogan), and, in China, Coca-Cola is commonly given as a home remedy for some maladies by boiling it together with ginger and lemon, served hot to the patient (this is also a popular drink in many Hong Kong-style restaurants). Coke Adds Life? It may yet, if the TCM research bears fruit.

A recent article illuminated a few new details of Coca-Cola’s plan:

Cao Hongxin, the president of the China Academy of Chinese Medical Sciences, said that the center “has a few projects” with Coca-Cola.

“Generally speaking, we want to create drinks that relieve fatigue and help the body fight off diseases,” he said. “(Coke executives) all hope to develop a Chinese-medicine-based beverage quickly.”

The director of the research center, Zhang Huaying, said of potential TCM-based beverages that “The aim is to be global but the source of the knowledge comes from China.”

We think this is a growing trend. Products influenced by their China localization or innovated from scratch in China will make greater inroads into global markets. Bubble tea, green tea extracts in just about everything from shampoo to anti-cancer preventative supplements, and China-influenced designer bags are just the start. Solar water heaters, solar-powered everything actually, invented elsewhere but perfected in China, are among the country’s next big exports. That, and TCM Coke.

Huge numbers capture the imagination, while some numbers merely surprise, and still other numbers only reaffirm or validate an expectation. China’s Internet users now top 253 million, the highest globally. This announcement by the China Internet Network Information Center (CNNIC) falls into that final category: After all it was only a matter of time before China’s Internet users surpassed those of the formerly-number-one (and birthplace of the net itself) United States, because China’s overall Internet usage rate even now stands at less than 20 percent, versus more than 70 percent in the US.

Since the time of the Great Wall and its first population estimates, China has been a nation of superlatives. Currently it has the longest bridge, the fastest train, the biggest shopping mall, and so on. We even covered this in Supertrends of Future China as the propensity to over-build infrastructure for

1. expected growth (Bejing’s new T3, the world’s biggest air terminal and building);
2. prestige or attention-getting (how about the once-planned 13-mile concrete dragon project);
3. and lack of financial restraints and stakeholder safeguards (easy lending terms, land grabs).

(In fact, a whole book was recently written about just the urbanization and infrastructure trends alone, the aptly-named Concrete Dragon)

Back to China’s Netizen population, I’m with ImageThief in believing the absolute numbers themselves are not as important the stories behind the data, the context. For example, what exactly are China’s estimated 253 million Internet users doing on the web?

A whole lot of blogging going on

China has more than 107 million blogs and spaces as of the end of June 2008, according to the latest CNNIC survey. This is up from 73 million last November, growing 46.5 percent. Active bloggers have increased to 70 million, up from 47 million last November, growing almost 50 percent in seven months. Who are the most popular bloggers?

Although QQ.com and 163.com are the recognized leaders in blog hosting in China, Sina.com hosts three of the top bloggers: Director/actress/writer/traveler Xu jinglei, singer/actor/writer/race car driver Han Han, writer/model/TV personality Acosta.

Each blogger has more than 170 million accumulated visits, with Xu Jinglei topping 180 million to be China’s (and by some measures, the world’s) most popular online personality.

Other rankings, such as BlogRank.cn, put Bill Gates’ personal blog as the 6th most popular, while a movie review blog written by a Chinese girl named duoduo is ranked number one, followed by another multi-talented actress/model/writer Yang Gongru.

It seems that China’s blogosphere rankings are ruled by the individual, unlike most US rankings, which tend to be dominated by gadget and gossip sites (e.g. Endagadget, Perez Hilton, Gawker) and collaborative works (e.g. The Huffington Post, BoingBoing), or the occasional celebrity blogger (e.g. Rosie O’Donnel).

China’s most popular blogs, on the other hand, retain a kind of casual atmosphere where down-to-earth celebrities write about what’s on their minds without slick product or site tie-ins. In China, monetization of blogger content (a la Google AdWords, or paid sponsorships) is only in its nascent stage and most popular bloggers elect to be site-hosted rather than self-hosted with their own URL. To be sure, some may be paid to post on those sites to draw in advertisers, but very few of the 70 million active bloggers would fall into that category.

Gawker recently lamented that too many people in the US blogged for free; in China, pretty much everyone blogs for free, and parlaying online popularity into real-life money or fame is a still seldom occurrence.

It’s clear to me that China’s blogosphere has much growth potential and opportunities yet to come.

(Come back for part two of this story on Monday.)

Last week in a major environmentally-themed speech in Washington, Al Gore called for complete elimination of carbon-based energy generation in the US within ten years. It was a bold statement, equivalent to Kennedy’s Man on the Moon address, and then some: Achieving his goal will not only require the full participation of the US government, but also that of every consumer in the United States, a far more ambitious effort than the manned moon landing. It’s an inspiring speech that I highly recommend:

Predictably some feel this is a long-shot, if not an impossibility. Yet perhaps that is the point: By aiming for the stars, at least we may reach the moon.

And I’ll go one step further to say that, if the US is to have any chance of success, China’s participation will be needed as well, to provide many of the products needed - the solar water heaters, the wind turbines, the batteries to store power in electric cars, among other things.

A growing number of Chinese firms listed domestically and abroad are positioned to profit from China’s own environmental woes by taking them as the newest business opportunities. We make this point in Supertrends of Future China (scheduled for release in about three weeks, just before the Olympics), where we devoted a full chapter to what we call the Greening Supertrend.

In brief, Greening is the intersection of China’s national environmental policy with the domestic and global trends towards clean energy and pollution reduction. A new generation of entrepreneurs in China is embracing this modern Green Revolution. By taking advantage of the domestic market size and manufacturing power, they will put China at the forefront of environmental technologies, first domestically and then, if present trends continue and Gore’s vision becomes a reality, globally.

Red Star Greening Over China

The central government has put green development as a prime objective of the 11^th Five Year Plan for China’s economy. The target is further outlined in the Five Year Plan for Environmental Protection. Many critics rightly point out that national policy is often ignored at the local levels, but last year’s promotion of the State Environmental Protection Agency (SEPA) to full ministry status is a sign of how seriously the central government is taking the issue.

Recently, the government has made some regulatory steps which are actually putting China in the lead of global environmental policy: For example, the plastic bag ban I discussed last week was announced, implemented, and accepted by the national population in just six months.

Replacing those bags with environmentally-sound reusable bags is just one of the new opportunities that China’s entrepreneurs have already jumped into. On a much larger scale, China’s wind and solar energy industries are taking center-stage.

The World Wind Energy Association currently ranks China as number five in a list of global wind users. China has approximately six thousand megawatts of generating capacity, about a quarter of world-leader Germany’s capacity, and not even one percent of China’s massive energy needs. Shi Pengfei, the vice-president of the Chinese Wind Energy Association, said that the National Development and Reform Commission had increased China’s target of wind-energy generation to 100,000 megawatts by 2020, five times as much as Germany’s present capacity.

Xinjiang Goldwind Science and Technology Company (SZ 02202), China’s leading wind turbine producer, went public on the Shenzhen stock exchange in 2007. Although large scale wind farms face many obstacles in China, such as an electric grid that is oriented towards cheaper coal-powered energy generation, on the strength of its domestic market growth, some analysts (additional link) believe Goldwind and other Chinese companies can rise in the next three years to challenge the world’s biggest turbine manufacturers including GE.

By 2020 the central government has pledged meeting 15 percent of China’s energy needs through renewable energy sources, including wind, biofuels, water, and solar. By 2050, the ratio is to be 30 percent including nuclear power. This means huge investments are required, but China is already a world leader in the use of at least one clean energy technology: Solar.

Star light, star bright

In many of China’s second, third or fourth tier cities, rooftops are covered by solar water heaters. The cheap, ubiquitous devices use the sun’s rays to heat water so that even rural workers can afford to take a hot shower after a long day’s work. In China, 200 million people have their water heated in this way, according to the NDRC. China has more than 50 percent of both the world’s production and use of solar water heaters, and other forms of solar energy are starting to grow as well.

Suntech Power (NYSE:STP) is the world’s third largest solar cell producer after Q-Cells of Germany and Sharp of Japan. It had US$1.4 billion in revenues in 2007. Revenues are expected to increase quickly as solar cell-generated electricity starts to approach price parity with carbon-based energy sources such as coal and currently high-priced oil.

The government is also active in solar energy policy, mandating that China should increase its current 100 million square meters of solar water heaters to 150 million by 2010, and 300 million by 2020.

With China set to take its place as the world’s largest economy by mid-century, its power needs will also dominate and, if it is not careful, the pollution problem will reach unprecedented levels. Green technologies promise to be among the best industries to be in during this challenging period of growth.  While China’s domestic market alone is a considerable prize for any green company, globally the potential is astronomical.  Gore’s call to action may help considerable to raise a green star over China.

Related Information:

A number of other commentators have written on China’s Green potential as a business opportunity. Here are a couple of articles that I recommend:

China: A Clean-tech gold rush

China’s Coming Environmental Renaissance

China’s Green Leap Forward

China’s Silver Lining

A possible Olympic legacy: A greener China

Sphere: Click here to see related content on other China blogs and news sites

]]> http://www.chinasupertrends.com/al-gore-ten-year-target-china-environmental-opportunity/feed/ http://www.chinasupertrends.com/g8-leaders-in-japan-pledge-to-halve-greenhouse-gases-china-cuts-more-free-plastic-bags/ http://www.chinasupertrends.com/g8-leaders-in-japan-pledge-to-halve-greenhouse-gases-china-cuts-more-free-plastic-bags/#comments Sat, 12 Jul 2008 11:10:51 +0000 Jason Inch http://www.chinasupertrends.com/?p=54

This week in Japan, the G8 leaders pledged to cut greenhouse gas emissions by 50 percent before 2050. In the same week, China announced it would immediately cut more free plastic bags. What is the main point of difference between these countries’ environmental policies? It could be summarized thus: More talk versus real action.

The G8’s move to cut greenhouse gases (primarily CO2) by 50% was immediately decried by some environmentalists and tagged as insufficient by the group of developing countries, including China, on the sidelines of the summit.

For example, the pledge didn’t even make clear whether the cut was to be from 1990 levels (as is the general practice of the UN and the Kyoto Protocol when measuring emissions reductions) or present levels, which would significantly decrease the impact of the pledge. The US in particular has increased carbon emissions in the subsequent 18 years by 20%. From a BBC report:

…the US has refused to set any interim targets for cutting emissions - and environmentalists have criticised the progress at talks as “pathetic”.

Five of the world’s biggest emerging economies said the G8 should increase its targets to more than 80% by 2050.

China, India, Mexico, Brazil and South Africa - who will join talks on Wednesday - also urged developed countries to commit to an interim target of a 25-40% cut below 1990 levels by 2020.

Meanwhile, in China, the Ministry of Commerce on July 11 announced changes to the plastic bag ban policy. Effective immediately, restaurants, bookstores, and clothing stores will also be required to eliminate free plastic bags, charging customers for each one issued. In fact, this was a clarification of the already-implemented plastic bag ban law, which came into effect on June 1 this year.

Is Red China Becoming Green?

One law eliminating free plastic bags does not a green country make, but I believe that China’s environmental policy is frequently unfairly derided by critics as unenforced. In fact, such a broad generalization is inaccurate: Here in Shanghai, it’s true that not every store has implemented the policy at present, and it seems many of the aforementioned clothing, restaurant and bookstores presumed the law was meant to apply to groceries only, but this loophole has now been closed. In hypermarts, supermarkets, and convenience stores, it is already impossible to get free plastic bags, so I expect the new revision will take effect quickly in restaurants and other venues.

In our new book Supertrends of Future China, we cover the plastic bag ban law as an example of China’s new environmental movement and the central government’s willingness to put its words into action. The G8 really should pay more attention instead of just making more hollow promises.

Related information:

For more details on the plastic-bag ban update, the resourceful China Environmetal Law blog has a post on the matter, describing the hitherto unknown-to-me existence of ‘produce department hooligans.’

Shanghai residents and visitors both may recall some of the lively pedestrian malls in the city, the most famous being Nanjing East Road going all the way to the scenic Bund. Shanghai’s Wujiang Road is also famous in the city for serving such delicacies as Shengjian (friend dumplings, most unhealthy but oh so delicious) and fermented tofu (usually served fried) known locally as ’stinky tofu.’ One half of Wujiang Road has undergone a facelift that is indicative of the changing consumer landscape in China.

Retail in China can be a mixed bag: French-retailer Carrefour may be having problems, but China’s Lianhua is doing well, and foreign firms such as Staples and UPS are expanding, even as Bertlesmann China closes its retail outlets.

There are clearly winners and losers, but retail consumption overall is the most important driver of growth in the Chinese economy. The picture is bright, according to a report by AT Kearney that ranks China as the fourth most attractive retail market (h/t to China Law Blog).

Here is my article from the June 30 edition of the Shanghai Star Business Journal, with some before and after pictures for your enjoyment.

__________________

As world energy prices begin to affect transportation costs, the appreciating yuan results in a decreased demand for Chinese exports, and a tighter monetary policy starts to reign in inflation, the question now is how China will avoid a dramatic economic slowdown. If Shanghai’s Wujiang Road area is any indication, retail may be the answer to China’s excess supply, with China’s newly-affluent middle-class consumers increasingly demanding more.

People who have been living in Shanghai for longer than three years will have distinctive memories of the old Wujiang Road, the bustling restaurant street running parallel to Nanjing West Road near the subway station and intersection of Shimen No. 1 Road.

The area directly behind the station used to have Chinese eateries and snack stands, push-cart vendors and colorful events such as a weekly English corner. Now, in much the same way the Huangpu River separates Puxi from Pudong, old from new, Wujiang Road stands divided: East of Shimen No. 1 Road, the street remains much as it has always been, while the western half has recently taken on a new look: Redesigned by Singapore’s Frasers Property and rebranded as InPoint, part of the Jing’An Four Seasons mixed-use residential and retail development, western Wujiang Road is home to a newly-renovated shopping arcade.

The loss of yet another part of Shanghai’s historic past aside, it is hard to deny the new layout and selection is vastly improved.

Where once were about twenty small restaurants and shops now stands a mall with space for more than ninety. Hole-in-the-wall bubble-tea stands have been replaced by four coffee chains including the ubiquitous Starbucks. What once was a Chinese snack vendor selling meihuagao (a rare and delicious baked rice cake with red bean paste inside and topped with dried fruit) is now an Iceason. If you don’t like their ice cream, you can go to one of three other frozen dessert shops, such as a DQ and Cold Stone Creamery, or try Honeymoon Dessert, one of the many Hong Kong and Taiwanese-style snack shops.

Much like the Wujiang Road of old, there are sit-down restaurants galore, but now with a corporate-branded flavor. And that’s not even mentioning the shops: Retailers Levi’s, Tissot, and ONLY, and other sellers of everything from stuffed animals and puzzles to jewelry and baubles.

All this stands in stark contrast to the eastern side of Wujiang Road, with its low-priced stinky tofu vendors, fried dumpling shops, and outdoor crawfish restaurants.

In fact, the transformation of Wujiang Road is not unique, and is merely symbolic of how retail is quickly maturing in China. Shanghai has dozens of revitalized or new shopping areas taking shape, and it seems there is now an international-style mall on every major street to replace what once was a local- or state-owned retailer.

Nationwide, China is home to four of the world’s fifteen largest shopping malls, but many of them, including the world’s biggest in Dongguan, Guangdong Province, are having trouble filling up the space. This begs the retail supply question: If you build it, will they come?

Retail spending has been growing rapidly in China. In 2008, urban retail spending is up 22.3 percent in May year on year, with an average rate of 21.1 percent this year so far compared to the same period last year, according to China’s National Bureau of Statistics. This growth seems likely to exceed 2007’s 17 percent overall increase in retail spending, but this is partly expected due to the increased inflation rate compared to 2007. However, by taking inflation out of the calculation, real retail spending has still grown 13 percent in the first quarter of 2008, according to the World Bank’s most recent China Quarterly Update.

Another important indicator is that in 2007, China’s consumption growth - the portion of GDP growth that covers all the goods and services consumed by households - exceeded the growth due to trade or investment to become the top driver of China’s economy, albeit by a slim margin.

Of course, retail spending is only a part of total consumption, but it is a growing part in China as disposable incomes go up. In 2007, average urban salaries increased 18.7 percent, according to NBS figures, nearly four times the 4.8 percent pace of inflation in 2007, and minimum wage levels were increased in many of China’s largest cities. This excess income will drive new retail spending.

Short-term economic statistics aside, where will the long-term support for retail growth come from? There are three major population segments that will keep retail spending high in China’s cities: The white-collar youth, newly-urbanized migrant populations, and the nouveau riche who are spending on big ticket items in the automotive, housing, and luxury markets.

One study by MasterCard estimates that China will have more than 117 million young people with a yearly income greater than US$60,000 by 2016. A recent survey by website zhaopin.com of 6000 urban Shanghainese white-collar workers found that 80 percent had credit cards, and more than half of them already considered themselves in hock to their cards as monthly “card slaves.” The spending power of more than one hundred million high-income consumers who are comfortable with credit card debt, many of whom will live at home until marriage, will be of growing significance to retail sales.

Second, the urbanization trend in China shows no sign of slowing down. The McKinsey Global Institute estimates China will almost double its urban population to 926 million by 2025, with 219 cities of more than a million inhabitants. Each of these cities will have their own Wujiang Road-style pedestrian malls to stimulate consumers’ taste buds and empty their wallets.

Finally, China’s most affluent people, those who can afford their own cars and homes, are literally driving new trends to support their high-end consumption habits. Cars and homes create much related-goods spending, allowing auto-accessories stores such as Japan’s Autobacs, and home-furnishers such as Ikea, to prosper.

As well, the World Luxury Association reported that in 2007 China became the world’s second largest market for luxury goods such as watches, bags, and jewelry, and will top world leader Japan by 2015.

One only needs to look in a three block radius of the new Wujiang Road to see a healthy microcosm of China’s retail environment: Eastern Wujiang Road for the traditionally-minded, the new InPoint shopping street for young consumers, and Nanjing West Road’s high-end fashion and luxury retailers for the affluent. Some may miss the old meihuagao vendor, but China’s economy is not looking back.

Who wants to be a multi-trillionaire?

Based on the apparent pace of growth in China’s foreign reserves, the State Administration of Foreign Exchange may need to answer this question in a mere three months. Its answer should be an emphatic “Not China.”

In fact, SAFE’s next quarterly announcement of foreign reserves is not due until July but unconfirmed reports have been flying through state and foreign media (covering an unofficial number in China Business News interestingly) that China’s foreign exchange reserves increased by US$74.5 billion in the month of April alone, to reach US$1.76 trillion.

As a point of comparison, the world’s second largest foreign reserves are held by Japan, and in March 2008 they increased by one tenth of China’s apparent April gains - just US$7.6 billion. Incidentally, it was only in February that Japan’s foreign reserves surpassed one trillion for the first time, and they have since fallen back below the trillion mark, once again leaving China the lone member of the trillionaire’s club.

China first hit the one trillion mark way back in November 2006 but, unlike Japan, its foreign reserve increases are usually measured in double-digit billions. If later confirmed by SAFE, April’s increase of US$74.5 billion will be the biggest ever increase, anywhere.

If this pace continues, China’s foreign reserves could reach two trillion as early as August this year.

This is perhaps not the message China’s government wants to send to the world during the Beijing Olympics (”All your money are belong to us”), so there is intense discussion at the highest levels of China’s government over two issues: How to reduce the foreign exchange reserve, and how to use the existing foreign reserves more efficiently.

Reducing China’s Foreign Exchange Reserves

At one time, having enough money on hand to pay for imports might have been a prime consideration, but this has not been the case in China for years. Its current amount of reserves may cover monthly imports 15 times over, or more. What about another main reason countries keep a large foreign exchange reserve on hand, to defend the currency from speculative attack?

China does not allow convertibility of the yuan, which curtails the possibility of a run on the currency, but as well, China, together with the ASEAN countries plus Korea and Japan (the so-called ASEAN + 3), recently pushed forward the Chiang Mai Initiative, a US$80 billion foreign reserve pool that could be swapped to any member country experiencing speculative pressure. In theory, from 2009 this could reduce the need of Asian countries to hold such large foreign reserves. Until then, Asian central banks may feel better safe than sorry and decide to keep more reserves on hand, but China really doesn’t need to do this in the first place, so it needs to more aggressively reduce the size of its foreign currency holdings.

One way to reduce the size of the foreign reserve is to encourage foreign currency outflow. At present, the yuan’s continued and still expected appreciation has actually increased inflows, both as FDI and as hot money, to record levels.

In the first four months of 2008, FDI was up almost 60 percent over the same period last year, while the total number of company registrations actually decreased by 23 percent, according to the Ministry of Commerce. One likely explanation for this is that foreign firms inflated their average investment size so as to benefit from the future yuan appreciation. In fact, for hedge funds and other investors, this is one of the only methods they have to skirt Beijing’s capital controls, sneaking money in as legitimate-seeming FDI. The exact amount of hot money is unclear but can be inferred from known inflows (e.g. announced FDI), the estimated trade surplus, and other data.

To lessen the inward flow of hot money, China could either reduce interest rates to make passive funds less profitable in China, or could revalue the yuan exchange rate in a one-off revaluation similar to 2005 when the original dollar peg was removed. The former is likely to exacerbate China’s current inflation problem, while the latter would shock the country’s exporters. On balance, allowing the yuan to appreciate faster seems the lesser of two evils for the government.

An appreciation will cause outflows for several reasons. Some of the hot money will repatriate, while the stronger Chinese currency will encourage more consumption and imports from abroad. If the trade balance can reverse the current trend of annual surpluses, foreign reserves will dwindle rapidly.

Using the Foreign Reserves more Effectively

The second issue on China’s leaders’ minds is how to use existing reserves more efficiently. Some may even wonder why large foreign reserves are a problem at all. A rich country is a strong country, as this argument goes.

But the foreign reserves are, in effect, sitting in the central bank earning meager returns and keeping the yuan under-valued. Each unit of foreign currency that enters China is bought up by SAFE and yuan notes are issued by the central bank.

China does not actually hold wads and wads of cash, like a high-roller hitting Macau’s new casinos. Most of its funds, especially those denominated in US dollars, are in the form of US Treasury bills and other long term securities. T-bills have a notoriously low interest rate because they are seen as the safest investment available.

With China holding an estimated US$466 billion in T-bills alone according to the US Treasury, earning interest in the low single digits, this means China is literally leaving billions in potential investment income on the table.

Couple this opportunity cost with the depreciation of the US dollar against major world currencies and China’s US dollar holdings are looking even less attractive. Given a common estimate that China’s total foreign reserves are comprised of about 70 percent dollar-denominated securities and cash, and that the depreciation in the US dollar over the last year has been about 10 percent against the yen and 13.5 against the Euro, that is like saying those Chinese reserves in US dollar terms have lost about US$100- 150 billion in spending power.

Of course, China’s Euro and Yen holdings have increased buying power in terms of US dollars, but they only represent about 20 percent and less than 10 percent respectively of China’s foreign reserves. With such low interest returns and the passive depreciation of its US dollar holdings, China is anxious to look for other ways to spend its growing fortune.

In the last six months, SAFE has made a number of portfolio investments abroad in an attempt to diversify and increase returns, while China created the China Investment Corporation, a US$200 billion sovereign wealth fund, in 2007 to place funds in higher-growth areas. [ED: I covered the uses of China's foreign reserves by both SAFE and CIC in an earlier post, The New Gold Mountain.]

At the time of writing, the yuan appreciation has reached 20% against the dollar since that fateful day in 2005 when the peg was finally removed. It has taken three years to get here, and if it takes three more for the next 20%, I worry about the effect this will have on inflation in China as the foreign reserve will continue to surge.

There’s no easy solution to China’s growing problems of inflation and low rate of return on its reserves, but letting the yuan appreciate more quickly is probably the best place to start, for the sake of the Chinese economy, and maybe even the global economy, as a whole.

[UPDATE: June 25 - Two notes which just came to my attention: In regard to how some foreign media have not covered the April 2008 rise of US$75 billion as alarming or even sufficiently surprising, Yves Smith of Naked Capitalism commented yesterday on the apparent nonchalance, and overnight Brad Setser added some data on changes in China's portfolio investments and overall foreign asset growth. On the point of western media attention: I don't think the lack of in-depth coverage on the ramifications is indicative of disinterest. As I pointed out above, the April foreign reserve figure of US$74.5 billion hasn't been officially confirmed and will not be until July, most likely. I held off reporting on this figure in my newspaper column until June 23 expecting a repudiation by SAFE or the PBOC, but their combined silence on this issue has been deafening.]

Two months ago I discussed in this post the effects of regulation on the stock markets in China. My theory: After the precedent China’s regulators set in April by offering two investor-friendly policies timed to pump up the markets, China’s investors would now get in the habit of looking to the government for a bailout whenever the markets were in trouble.

At the time, I predicted that the existing market fundamentals affecting China (high inflation, decreasing exports, high oil price etc) would eventually re-register with investors, and we might see another dead cat bounce. Well, the cat is back:

The above chart shows China’s CSI 300 Index, the measure of both the Shanghai and Shenzhen stock exchanges.

Two periods to take note of: First, April 20 to 24, when the two regulatory actions were announced, a clear jump in the markets was evident. Overjoyed would be an apt description of investors when their stamp duty was reduced.

Second, May 12 to 19, the week following the Sichuan earthquake, there was market confusion until May 20. Thereafter indexes began their slide over uncertain earnings growth and worries about the 8.5 percent April inflation figure, announced just before the earthquake, started to sink in.

So, what now?

The China Securities Regulatory Commission faces a dilemma: Does it toss the market a bone, perhaps by offering investors margin trading as some are predicting? Or will it finally let modern investors learn a hard lesson in stock market bubbles? As of June 11, the markets are setting new 2008 lows and volumes are dramatically down as investors start waiting for the bailout.

While I am in favor of China’s use of industrial policy to grow the economy, my admiration doesn’t extend to such shallow tactics as propping up the stock markets. Margin trading, suddenly thurst upon the investing public at such an uncertain ecomomic time, would be an unmitigated disaster in my opinion. China’s development needs to be sustainable, so supporting the pusuit of easy money is not one of the solutions China’s leaders should be considering.