An overheating China would be bad news for Australia: Kohler

The decision by China and America to postpone their trade war is good news: one less thing to worry about.

It might still go badly of course, but last week’s feet-on-the-desk phone call between Presidents Obama and Hu ahead of Hu’s visit to Washington next week, followed by the weekend announcement by Treasury Secretary Timothy Geithner that he was delaying the formal April 15 decision about whether China is a currency manipulator, all suggest that the heat is coming out of the exchange-rate tensions.

Yesterday a senior Chinese government economist, Ba Shusong, held a press conference in Beijing to suggest that the renminbi’s trading band may be widened, and that its gradual appreciation would soon be allowed to resume.

Stephen Green, an economist with Standard Chartered Bank in Shanghai told the Financial Times that it seemed a “grand bargain”, between the US and China was in the works, “or may have already been struck”.

So – what’s left to worry about with China? Answer: the property bubble and consumer price inflation.

Actually Chinese real estate may not be the looming danger many believe. One of the best China economy watchers, Arthur Kroeber of Dragonomics, calls the Chinese property market “sustainable madness”. He says: “There is no question that much of it is irrational, but we tend to think the irrationality can last a fair bit longer than outside observers usually think.

“To boil it down to its essence, China’s housing market is supported by the capitalisation of inner-city land values. So long as inner-city land can reasonably be capitalised, and a portion of the financial proceeds transferred to residents to subsidise their purchases of newer flats farther from the city centre, the apparent madness of house prices 10 times average household income can continue. This process is not infinitely extendable but we tend to think it can run for another three or four years.”

The other comforting fact, says Kroeber, is that personal leverage in China is very low, so that if there were a property price collapse it would not have the devastating effect on household balance sheets and confidence that the same thing in the US did in 2007-08.

That leaves inflation and the risk of overheating in general, which look real, and worrying.

Michael Lewis, the head of global commodity research at Deutsche Bank, says the main event risk in world commodity markets now is the prospect of a Chinese clamp on lending and infrastructure spending.

According to the London Telegraph, Lewis expects the Chinese authorities to slash growth in infrastructure spending from 120 per cent last year to 7 per cent this year, to cut loan quotas by a quarter, raise interest rates and demand that local authorities curb the property boom.

Royal Bank of Scotland analysts agree, suggesting that the degree of leverage that base metals have to China’s infrastructure and building cycle means there is likely to be a “general price lapse for the commodity complex over the next six months – not a major price collapse, more of a hiatus.”

In yesterday’s monetary policy statement from the Reserve Bank, accompanying its 0.25 per cent rate hike, the bank specifically referred to rising terms of trade and the build-up in investment in the resources sector.

If both Chinese and Australian authorities simultaneously tighten monetary policy, will that produce a double-whammy for the Australian economy, in which higher rates coincide with a decline in commodity prices and therefore the terms of trade? If Michael Lewis of Deutsche Bank is right, that could happen.

This article first appeared on Business Spectator.