Volume 62, Number 10
There is no denying that the February was another solid employment report, with 227,000 new jobs and 61,000 in upward revisions to already strong totals in December and January. The three month average for job gains now stands at 245,000, compared with just 157,000 in the three previous months. And therein lies the rub. You see, most of the improvement in job growth in the last three months (88,000 more jobs per month) has come in the manufacturing and temporaries categories (60,000 better on average). We add temporaries to manufacturing, because a majority of temporary employment is in light manufacturing positions. Moreover, other goods oriented employment areas (mining, construction, transportation, and wholesale trade) have risen 20,000 jobs a month faster in recent months. Meanwhile, the much larger services sector (ex transportation, wholesale trade and temporaries) has seen virtually no change in employment growth. We remain suspicious that it was very mild winter weather that boosted employment in these goods oriented sectors and that there will be a payback in March through July, when seasonal hiring would normally improve.
Two early warning signals are manufacturing ISM and initial claims for unemployment. ISM for manufacturing was lower in February, with a decline in the employment index. Last year in February-April when employment gains were averaging 261,000, the ISM factory employment index was north of 60, today it is at 53.2. The overall ISM for manufacturing averaged 59.7 during those months last year, while today it is just 52.4. Bottom line, last year looked like a real pick up in economic activity that was cut short by the Japanese quake and the ensuing supply chain disruptions. This year looks like weather pulling ahead activity with far less underlying strength. Meanwhile, the high frequency weekly data on jobs provided by initial claims for unemployment have stopped falling over the past several weeks – just as they did after April last year when employment data turned weak. We will continue monitoring the data closely for signs of continuing strength which can no longer be blamed on weather – but at present our best guess for the first quarter is still roughly 2.0% real GDP growth. Job growth so far this year has been too strong for such weak growth. After weak productivity and profits in the strong fourth quarter, we expect businesses — which have been playing it close to the vest so far this cycle — to tighten up on hiring this spring.
A Game Changer Out of China?
Two weeks ago, we spotted a story in the South China Morning Post that suggested China was about to allow hedge funds who register in Shanghai to raise Renminbi funds exclusively for investment outside the mainland. If true, this could be a win-win-win-win situation for the Chinese and a game changer for the world economy, as it makes hundreds of billions of dollars in wealth long trapped in inefficient investments on the mainland available to the credit/funding hungry world. First, we note that the Party often uses teases like this in the Hong Kong press to see if an idea floats or catches a lot of criticism – in which case it can quickly be denied as capitalist propaganda. The idea of property taxes in China was started in just this way several years ago, then discussed, then a pilot program was initiated in Shanghai and Chongqing, and now it appears it will be being rolled out across China.
If China were to open its capital controls even a bit – and remember, China controls who can qualify for hedge fund investments and so controls the flow – it would have several positive consequences. The wealthy in China have long desired diversification outside the Mainland, but the Party has also needed their money for sustained investment. Allowing some capital out would suggest the Party is dedicated to the long desired shift to a more consumer led – less investment led – economy. We see four major benefits for the Chinese (and the world) from a more open capital market. First, the wealthy are most likely to sell real estate in China to raise the funds to put in these hedge funds. The Party wants a reduction in real estate investment – and so do the wealthy if they had somewhere else to put funds. Second, the money flowing out of China would require selling of RMB putting downward pressure on the currency and creating a true two way trade among investors wanting to get in and out of the currency. We have long argued that a strong case could be made that the RMB was overvalued as funds are trapped inside (even funds earned by foreign investors) by capital controls. Third, by allowing capital outflows, the build up in China’s reserve fund would slow or end. China’s trade deficit has narrowed to about $150 billion for 2012, and that much capital could easily be let out resulting in a balanced capital account. The Chinese are sick of losing money in their $3.2 trillion in reserves, due to currency depreciation (as the yuan now appreciates against almost everything) and poor investment yields on sovereign debt, their off-tackle investment. By allowing China’s wealthy to invest abroad they would privatize such loses – yet the party would likely still control these wealthy investors. Finally, the investments that the hedge funds would make are unlikely to be in government debt. They would buy more stocks and other assets – like Brazilian or American farmland – that China’s government cannot. China’s state investment fund has been rebuked a number of times as it tried to diversify its portfolio. It will be much more difficult for countries to limit private investment – due to international treaties. Bottom line, we see a win- win-win-win situation for China. For the world, it is impossible to argue that relaxing capital controls and allowing more efficient allocation of resources is a negative – though surely not all existing investors will benefit or enjoy the new competition.
China may need a game changer soon. Data on January and February (which we cumulate due to the New Year’s Holiday which moved from January last year to February this year) have consistently come in weaker than expected. This week produced a deluge of Chinese data with retail sales, industrial production, new lending, and trade all on the low side of consensus. For us, this is a clear sign that the government is dedicated to structural reform and is willing to take slower growth – especially in real estate development – in order to achieve better balance. Sources indicate that President Wen Jiaobao’s announced reduction in growth targets to 7.5% for the next five years was a signal to provincial governments that not all growth is equal and that only growth which achieves the Party’s goals of income balance, more energy efficiency, and consumerism will be tolerated. With party elections and elevations underway, the central government has maximum leverage right now. Bottom line, China will be less of an engine of growth to the world in the near term – but we do not see more than moderate easing in coming months unless growth falters significantly below the new target. The Chinese government is more patient than Wall Street. By limiting peak growth to achieve other long term economic goals, China seems to be using its own form of Keynesianism.