“Over-consumption and a high reliance on credit is the cause of the U.S. financial crisis,” said Zhou Xiaochuan, governor of the Chinese central bank. “As the largest and most important economy in the world, the U.S. should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

This kind of lecture was a deviation from past meetings, which were dominated by U.S. calls for China to better manage its fiscal policies. However, the global financial turmoil that has emanated from the collapsing U.S. housing market has left the United States without a pulpit on which to stand.

“One result of the crisis is that the U.S. no longer holds the high ground to lecture China on financial or macroeconomic policies,” Eswar Prasad, a senior fellow at the Brookings Institution, told the Financial Times. “This may actually help turn their relationship into a more equal partnership with less posturing on both sides.”

Indeed, U.S. Treasury Secretary Henry Paulson, who in the past used summits like these to press Beijing to open its financial system and appreciate its currency, was noticeably more humble in representing the United States yesterday.

“International cooperation and coordination have been robust and we appreciate the responsible role China has played in the crisis,” he said.

Meanwhile, Wang Qishan, vice premier and leader of the Chinese delegation called on the United States to “take the necessary measures to stabilize the economy and financial markets as well as guarantee the safety of China’s assets and investments in the U.S.”

Wang’s remarks followed those of Lou Jiwei, chairman of China’s $200 billion sovereign wealth fund, China Investment Corp. (CIC), who said Wednesday that his firm lacks the confidence to invest in the United States, particularly U.S. financial institutions.

“Right now we don’t have the courage to invest in financial institutions because we don’t know what problems we will put ourselves into,” Lou said at a conference in Hong Kong. “My confidence should come from government policies. But if they are changing every week, how can you expect that to make me confident?”

CIC has lost about $6 billion of the $8 billion it invested in Morgan Stanley (MS) and The Blackstone Group LP (BX) last year. More importantly, however, China last month overtook Japan as the largest holder of U.S. government debt. And according to the Financial Times, officials have privately admitted that they are concerned about the value of the holdings.

Concerned with China’s overexposure to the United States, central bank governor Zhou said policymakers should no only address the country’s slowing economy, but “restructure the development model” and prepare “for a worst-case scenario,” the FT reported.

However, Chinese officials also say that any large-scale unwinding of U.S. holdings would be counterproductive, as the value of U.S. bonds and the dollar would subsequently plummet.

Source: China Blasts U.S. Economic Policy, Expresses Doubt in Financial System

“Resurgent inflation, everyone agrees, seems a global problem while a slowdown may be largely limited to the US with some spillover effect to Europe,” according to a report in India’s Financial Express newspaper.

China exported deflation for the last 15 years by stocking the shelves of retailers in the West with products made in their factories employing cheap labour and easy capital. Chinese imports constitute 7.5% of spending by Americans on consumer goods, but they make a higher share of categories such as toys, foot ware and clothing.

A closer look at drivers of Chinese inflation is in order to anticipate what to expect from the world’s factory in the coming years. The cost of manufacturing in China has been rising not only due to rising fuel and commodity prices, but also due to upward pressure on wages partly as a ripple effect of the new labour law and increasing cost of capital as a result of increase in interest rate by the Chinese central bank.

However, high food prices were the main driver of the steep rise in the country’s CPI.  China’s non-food prices in April were only up by 1.8% year-on-year.

“Last week,” says Peter D. Schiff in Money Morning, “several key Chinese officials, typically not known for their candor, conspicuously noted the need to both stimulate domestic consumer spending and to bring down roaring inflation.

“While at first blush these two goals might appear mutually exclusive, China’s leaders do have a “magic bullet” that can hit both targets at once.

“A stronger currency, commensurate with China’s increased economic strength, will simultaneously tamp down inflation and enable Chinese consumers to buy more goods and services. However, for reasons not entirely clear to me (or few others, for that matter), China’s leaders are resisting this simple-and-beneficial solution.

“By prodding China’s citizens to spend more, the country’s leaders say their goal is to decrease the nation’s dependence on exports. If China’s consumers, who currently save 50% of their incomes, saved less, more of the nation’s production output would be consumed domestically and China would be much less vulnerable to downturns in its overseas export markets.

“Without a vibrant domestic market, over-leveraged Americans will apparently remain China’s most important customers.”

Dull Chinese gold futures’ trading has come as a bit of a disappointment. On day one the Shanghai contract surged to a premium of nearly $100 over the international spot gold price. It almost touched $1,000, a new record high at that point. The Chinese seem to prefer the real thing to paper – but watch this space!

The Exchange went to a lot of trouble to avoid the tricky issues regarding futures trading in China that would have brought censure from the authorities. It did its best to deter private punters. The size of the contract was upped from the originally planned 300 grams to 1,000 grams – a hefty 32.15 ounces. They may have been overcautious in this; the measures were too effective.

The Chinese regulators are now relenting. A notice has just been published in the China Banking Regulatory Commission website loosening controls on futures trading. From now the nation’s commercial banks (and hence their millions of customers) will be allowed access to gold futures on the domestic market. More details are promised soon.

This is also seen as a move to help the Chinese banks improve their profitability and compete against overseas banks. The Chinese Central Bank has obviously noticed the profits generated from futures by banks abroad. Non-interest income can account for up to 80% of bank revenues, while Chinese banks make much of their money from the margins between interest rates on deposits and loans.

Commercial banks now interested

China’s commercial banks are huge. As a story in the official state news agency, Xinhua, says, they can certainly provide more liquidity and stability to Shanghai’s gold futures. It quotes an expert at Beijing Technology and Business University, Hu Yuyue, as saying it was “great news for the gold futures market, which is not operating that well.”

Meanwhile, physical gold trading is booming. The Shanghai Gold Exchange has two major new international members – Standard Chartered and HSBC. Even without them, business has been brisk on the back of local punters.

Shen Xiangrong, chairman of Shanghai Gold Exchange, expects the number of individual investors to triple this year. Last year around 94,000 investors traded. In 2008 more commercial banks are launching individual gold trading services. The Exchange is hoping they will now also promote its derivatives contracts.

Continues below

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Further proof that the Chinese prefer to have their gold in hand can be seen in jewellery sales. Chinese love of gold jewellery surpassed the US as the world’s second-biggest retail gold market, after India, last year. Total consumer demand on the Chinese mainland, Hong Kong and Taiwan reached 363.3 tons, 23.5% up on a the previous year, according to the World Gold Council. Demand grew even in the fourth quarter – up 20% – while gold demand elsewhere dropped.

Nor are the Chinese slouches when it comes to production. Chinese miners are expected to increase their output by over 10% in 2008, reaching 300 tonnes. That would see the country overtake South Africa as the world’s largest gold producer.

Some say it was the largest producer in 2007. Dispute arose because of a clash in the experts’ statistics. Gold Fields Mineral Services put production at 276 tonnes, China Goldfields Association counted 270 tonnes.

Mining companies were the first target…

Mining companies were the main target of Shanghai’s futures contracts. The aim was to provide the facility for the gold miners to hedge production. The first deal showed the way – it was between China National Gold Group and Jiangxi Copper.

China Daily quoted the explanation of the rational given by Jiangxi vice president, Wang Chiwei. Time taken to for his company to refine gold from copper concentrates was four months, yet the fee was only $5 an ounce. Even a small gold price movement would wipe it out.

Yet locking out the punters has reduced the depth and scale of the gold futures market. The exchange has not been able to keep up with booming gold production at home and soaring world gold prices.

….now it is the $1.8 trillion savers’ market

At the same time, the commercial banks have wanted to market gold-linked products into the booming retail banking market. The Chinese are famous savers – over a quarter of Chinese hold bank accounts, and they typically put aside 25% of their income. Last year that came to $1.8 trillion!

Competition to manage that money is fierce. Sophisticated international banks offer services that enable them to pick off the wealthiest individuals (the number of Chinese with investable assets of $100,000 or more now exceeds 4.5 million households). Domestic banks are telling their regulator, as gold’s new high price levels win the headlines, that gold products will do very nicely, thank you!

Shanghai is really going for it in 2008. The hundreds of local gold miners, refiners and fabricators are begging for more volume, and the investment market is there to oblige. The exchange has approved 65 new companies as futures members.

Trading gold futures in China may have started off modestly, but so did it in the US in the 1970s and Japan in the 1980s. Now China seems all set to build up force! Another driver for gold to hit $1,500!

Keep buying!

Erin and Isabel

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