China & Russia oil deal

China just made a deal with Russian on $25bn oil purchase for over 20 years. That solves a chunk of China’s long term supply problem.

In return for its $25bn worth of loans, China will get a total of about 2.2bn barrels of oil over 20 years. Including interest at 5%, that equates to a price of $17.40 per barrel over the period, a bargain when the longest NYMEX futures contract, for December 2017, sells at $73.22.

The contract covers about 8% of China’s current oil imports, which are expected to increase sharply in coming years. The Chinese authorities regard long-term oil supplies as a key matter of national security, and are not prepared to rely more than modestly on the international spot market. Hence in recent years, Chinese oil companies have invested in a number of African countries to line up supplies, and have lengthy discussion with the other oil-rich countries.

Given its energy concerns, a 20-year contract with the erratically governed Russia could be regarded as only moderately risky. Russian oil companies may be less likely to default on a deal with China, which takes a strong stance in most international matters, than they would be on an equivalent obligation to the more passive EU, for example.

On the other hand, Russia gets the capital needed to upgrade its oil industry and established a long-term relationship with a large and growing customer. And even the low price of this contract probably represents a profit given Russia’s low extraction costs. It also provides guaranteed demand in the event of an oil glut.

This looks like a win-win deal for both sides.

China needs time to complete transition, if it will

Now the trade pattern for China is very interesting. With sharp decline in export and import, China’s trade surplus for January was a mind-blowing $39.1bn, just under November’s all-time high of $40.1bn. In comparison, in the first half of 2008 China’s average monthly trade surplus was an already high $16.7bn. In the second half it surged to $32.9bn.

The global economy is experiencing a sharp contraction in demand – which must be “shared” among all of the world’s producers. The decline in Chinese exports means that Chinese producers, of course, are absorbing part of that contraction; but the bigger decline in imports means that Chinese consumers are contributing a greater amount to the contraction in global demand.

What does it mean? It means the net result is non-Chinese producers must absorb more than 100 per cent of the contraction in demand from non-Chinese consumers. So no doubt we hear a lot of talks attacking the China trade and associated finance policies.

For China policymakers, they would nonetheless like nothing more than to see China increase consumption sharply. To that end they have unveiled a fiscal stimulus package and forced banks to expand lending at a pace so rapid – January’s new loans equaled one-third of all new loans in 2008 – it will almost certainly lead to a sharp rise in non-performing loans. However, the problem is that its weak consumer base make it very difficult for China’s fiscal stimulus to cause a rapid net increase in consumption. The most possible problem is that China will continue to export huge amounts of overcapacity into a world struggling with collapsing demand.

This can easily lead to worsening trade friction. Already Asian countries from India to Indonesia are squabbling fiercely over Chinese exports and western economies from France to the US are veering towards protection.

But trade war is not the solution. Threatening China with trade sanctions if it does not rapidly reduce the rising overcapacity it is forcing on to the rest of the world will not work. There is very little Chinese policymakers can do in the short run without causing a collapse in the export sector and a rise in unemployment so rapid that it could lead to social instability.

Again, my view is the world must recognize that China can adjust, but it cannot adjust immediately. It will take several years to do so, and will require significant changes in its financial system, in its political system and in its development model. To that end large economies need to work out a plan in which China is given a reasonable amount of time to make what will inevitably be a difficult transition. As part of the plan, the US, Europe and other big economies must assure open markets to Chinese exports.

The world, with US president Barack Obama in the lead, has a tremendous opportunity to help China through a difficult transition and, in so doing, create a new sustainable global balance of payments and a favorable institutional framework that will govern trade and capital relations for decades to come. If not, the advantages trade deficit countries receive from pushing the full burden of adjustment on to trade surplus countries will be overwhelmed by a global environment of deep mistrust and hostility.

This is not the time to attack China. China has a serious overcapacity problem that can best be worked out in global co-operation over years. To demand a quick resolution will bring nothing but trouble.

U.S. Banks Tightened Loan Terms

A majority of U.S. banks made it tougher for consumers and businesses to get credit in the past three months even as lenders received infusions of taxpayer funds. About 65 percent of domestic banks reported having tightened lending standards on commercial and industrial loans to large and middle-market firms. Large fractions of domestic banks continued to report a tightening of policies on both credit-card and other consumer loans.

It may underscore concern among Obama administration officials and some U.S. lawmakers that banks that have received more than $200 billion of taxpayer funds are failing to lend that on to customers.

The U.S. economy continues to be hampered by a financial system that lost more than $1 trillion on housing credits since the mortgage crisis began in 2007.

Treasury Secretary Timothy Geithner is supposed to soon announce a new strategy for reviving our financial system that gets credit flowing to businesses and families. Obama’s goals are to lower mortgage costs and extend loans to small businesses so they can create jobs.

A less favorable or more uncertain economic outlook was cited by all domestic banks as the cause for tighter standards on commercial loans, as well as lower risk tolerance and problems in specific industries.

By contrast, concern about strains on their capital levels were less of a reason for the tightening in lending standards in the period. Only about 25 percent of domestic respondents said a deterioration in their bank’s current or expected capital position had contributed to the change, in comparison with approximately 40 percent in the October survey.

This result maybe is due to distribution of more than $194 billion through Fed program of purchasing stakes in U.S. banks. It has also mounted rescues of Citigroup Inc. and Bank of America Corp., insuring a total of more than $400 billion of illiquid assets on their balance sheets.

Now, Obama’s team is discussing ways to overhaul the bailout fund, called the Troubled Asset Relief Program, in an effort to ensure banks step up lending. Possible strategies include insuring other banks’ hard-to-value investments, and setting up a so-called bad bank that would remove toxic assets from their balance sheets.

But the question is, who borrows? The decline in demand partly reflects the fact that nearly all banks continued to tighten their lending standards and boost the cost of the loans they did extend, making loans unavailable or less economical for many borrowers.

However, it also shows that the recessionary rot has moved deeper into the economy. Even if efforts to spur consumption are successful, businesses may not need to boost capacity or finance large inventories for some time. Other types of borrowers are in similar straits.

“Liquidity trap” is here, and it will keep Obama finger-crossed for a long time.

China has World-Beating Stocks in January

The world’s largest money managers say China’s steepest monthly stock gain in more than a year shows the fastest-growing major economy will avert a recession.

The Shanghai Composite Index, the broadest measure of shares traded on the mainland, rose to the highest in more than a month today after a weeklong Lunar New Year celebration. The gauge advanced 9.3 percent in January, the most among the world’s 10 biggest markets. The index fell 65 percent last year, the worst since at least 1996, data compiled by Bloomberg showed.

Chinese shares rebounded after the central bank lowered interest rates five times since September and the government announced a $584 billion stimulus plan. China’s economy is expected to grow near 8 percent this year even after expanding 6.8 percent in the fourth quarter, the slowest pace since December 2001.

China is going to do what it has to do to keep the economy humming, because of the deep pocket, it can enjoy faster growth than the rest of the world in 2009 and in 2010 as well. So far, China has pressured state-owned banks to increase lending, unveiled the 4 trillion yuan ($584 billion) stimulus package, reduced export taxes and agreed to provide support for 10 industries, through tax cuts and subsidies for steel and autos.

China is considering additional measures to help prevent a slump in economic growth, according to the Financial Times reported today, citing an interview with Premier Wen Jiabao.

Chinese stocks are trading at less than one-third of their peak valuation in January 2008. The Shanghai Composite Index is valued at 15.6 times reported earnings, down from a six-year high of 50 times a year ago. That’s still the highest among benchmark indexes in Asia.

2009 will be a difficult year for stocks. Government stimulus measures are unlikely to offset a contraction in private real estate investment and capital investment for export corporate. China stocks are most likely to be “range-bound” in 2009. Remember the government’s purpose is market stabilization, not market rebound back to the peak.