China factory growth suggests contraction

I found this story through Americablog, with the source story coming from CNBC.Com:

China factories expanded in June at their slowest pace in 11 months while price pressures eased, a purchasing managers' survey showed on Thursday, the latest evidence the economy is losing steam in response to a spate of tightening steps.

The HSBC flash manufacturing purchasing managers' index (PMI), the earliest available indicator of China's industrial activity, eased to 50.1 in June, which was the lowest since July 2010 and close to indicating a contraction in the sector.

That compares with the final reading of 51.6 in the HSBC PMI for May. A figure above 50 points to expansion on the month.

"Demand is cooling thanks to the effect of tightening measures and the slackness in external markets," said Qu Hongbin, the chief China economist at HSBC.

I'd certainly say that demand is cooling--especially with the U.S. consumer, where China sends a ton of their exports. The American consumers are not buying, as they do not have any money to spend. The unemployment rate is at 9 percent here--possibly double if you add in the underemployed or those who have dropped out of the labor market. Housing is still in the pits. Food and energy prices have stayed relatively high. We've been the big market for China's products for years. Now that we have no money to buy China's products, where is China going to sell their stuff? So in some ways, it does not surprise me that China's factory index has dropped. I'll certainly be curious to see what the next quarter's index is--will it go below 50, to measure a real contraction?

Morgan Stanley reports $9.4 billion write-down

This is off The New York Times:

Morgan Stanley reported the first quarterly loss in its 72-year history, heightening fears that the financial toll would keep mounting from the fast-spreading crisis in the subprime mortgage market.

The company took a $9.4 billion charge on subprime-linked investments for the fourth quarter and, in a stark reflection of its diminished status, said it would sell a $5 billion stake to a Chinese investment fund to shore up its capital.

Wall Street banks so far have reported more than $40 billion of losses as a result of the crisis in the mortgage market. Worst-case estimates put the eventual bill at $200 billion or more. The tally is likely to rise again Thursday when Bear Stearns is expected to report a quarterly loss.

The developments on Wednesday mark a stunning turn of events for Morgan Stanley, an offshoot of the Morgan banking dynasty that has counseled corporate America since the Depression. John J. Mack, the bank’s chief executive, said he took full responsibility and would forgo a bonus for 2007.

Again, it is the subprime mortgage loans that were pre-packaged into investment securities that Morgan Stanley, and the rest of Wall Street, were speculating on. Everyone was busy raking in the supposed easy money, not realizing that they were building a house of cards that has now completely crashed. Thus we've got Morgan Stanley reporting a huge loss of $9.4 billion, and this new report of Morgan Stanley selling another $5 billion stake to a Chinese investment firm "to shore up its capital." Did Morgan Stanley sell these subprime mortgage-backed investment securities to this unnamed Chinese investment firm? There is more to this story than what is now being reported.

Going back to the NY Times article:

The drastic losses may heighten speculation about the fate of Mr. Mack, who returned to the firm in 2005 after the removal of his predecessor, Philip J. Purcell. One of Mr. Mack’s signature changes was to push the firm further into trading using its own capital, an effort to emulate its profitable archrival, Goldman Sachs. His strategy worked for a while but then backfired when trades in tricky subprime-linked securities went wrong, resulting in the biggest write-down in the firm’s history.

While Mr. Mack is expected to keep his job, his compensation will plummet — one of the harshest punishments meted out on Wall Street, short of showing an executive the door. Last year, Mr. Mack made $40 million. This year he will take home about $800,000. His paycheck is particularly humiliating since Lloyd C. Blankfein, the chief executive of Goldman Sachs, is likely to receive a $70 million bonus. James E. Cayne, the chief executive of Bear Stearns, is also expected to forgo a bonus.

With all the disgust of Wall Street firms taking big losses while the CEOs are fired wearing golden parachutes, Mack has ended up being the sacrificial CEO scapegoat in losing his parachute as a result of the subprime mortgage mess. I doubt that the rest of the Wall Street CEOs will give up their excessive paycheck as the financial firms continue reporting huge losses.

Now let's get into some details on the Chinese investment firm. From the NY Times:

As for the investment from China, Mr. Mack framed the transaction not as a desperate act but as a strategic move. And he refused to concede that Morgan Stanley was a weakened firm. “We remain bullish on Morgan Stanley’s significant growth potential,” he said.

Still, the investment shows how reliant Morgan Stanley and Wall Street are on foreign funds and gives additional credence to the joke now circulating on trading floors. The joke is: “Shanghai, Dubai, Mumbai or goodbye.”

The fund, the China Investment Corporation, has agreed to purchase almost 10 percent of the company. It will have no role the management of Morgan Stanley. Citigroup recently sold a stake to a Middle East fund.

The deal marks an abrupt shift in strategy for China’s $200 billion sovereign fund and underlines the extent to which it appears to be under the direct control of the country’s leaders.

Morgan Stanley executives first began discussing an investment with the fund this summer, but it wasn’t until recently that the deal was struck. For Morgan Stanley, the terms of the deal are severe. The firm will pay annual interest of 9 percent on bonds that will be convertible into Morgan Stanley stock in 2010.

The China Investment Corporation is under the control of China’s finance ministry, with some influence as well from the People’s Bank of China, the country’s central bank. There has been discussion in the Chinese government over whether even more foreign currency should be injected into the investment fund, as the People’s Bank of China continues to accumulate $1 billion a day as it buys up dollars to prevent the value of China’s currency from rising in international markets.

I wonder if the Chinese were feeling nervous about their own investments into the subprime mortgage-backed securities, or perhaps even their own stake in Morgan Stanley investment funds, and wanted to sell those securities. Morgan Stanley couldn't sell them for the Chinese, precipitating a potential collapse here. Perhaps Morgan Stanley couldn't pay the interest payments to the worthless securities they sold to the China Investment Corporation. Either way, a harsh deal was made against Morgan Stanley, where the firm would have to pay 9 percent interest on the bonds, before they will be converted into Morgan Stanley stock in 2010. What is especially scary here is how many other Wall Street firms are also feeling such heat coming from the Chinese dragon?

Some more information on the U.S. dollar, and China's diversification

I found some more information through Marketwatch on the falling U.S. dollar, and on China's diversification of its dollar holdings. From Marketwatch:

SAN FRANCISCO (MarketWatch) -- The dollar was off new lows hit Wednesday after a Chinese official called for his country to shift more of its foreign-exchange reserves out of the greenback, but remained sharply down, under pressure from pricey oil, slumping stocks and expectations that U.S. interest rates are headed lower than those in Europe.

"The single most important factor that differentiates the current dollar bear market is the contrasting growth and interest rate landscape between the U.S. and global economies, as most foreign central banks are closer to raising interest rates while the [U.S. Federal Reserve] is forced to cut rates further," wrote Ashraf Laidi, chief currency analyst for CMC Markets.

The single most important factor that differentiates the current dollar bear market is the contrasting growth and interest rate landscape between the U.S. and global economies, as most foreign central banks are closer to raising interest rates while the [U.S. Federal Reserve] is forced to cut rates further. I've read this quote four times already, and something just doesn't make sense about it. It is like the foreign central banks are raising interest rates in order to slow the global economy down, while the Feds are cutting rates to keep the U.S. economy from stalling. And through all this economic uncertainty, the only certainty there is will be the dollar's continued slide in value.

Continuing into this Marketwatch story:

Comments during Wednesday's Asia session from a Chinese policymaker provided a convenient shove to send the dollar hurtling downward, though analysts were quick to point out that his views probably don't reflect official Chinese policy.

Cheng Siwei, vice chairman of the Standing Committee of the National People's Congress, was quoted by wire services as saying that China should shift more of its $1.43 trillion of currency reserves into "stronger currencies," such as the euro, to offset "weak" currencies like the dollar.

"The comments were quickly retracted, but fed a beast that wanted to push [the dollar] lower, and merely wanted a reason," wrote David Watt, senior currency strategist at RBC Dominion Securities.

Cheng also said that a rapid appreciation of the yuan -- as Washington and increasingly Europe are requesting -- is not necessarily the right move, though he insisted the country wasn't actively seeking a major trade surplus.

Cheng "has in the past made errant remarks that have no bearing on policy," according to Marc Chandler, currency strategist at Brown Brothers Harriman.
Nonetheless, the reports sent the dollar into a tailspin.

The buck plunged to new lows against the euro, with the shared currency surging as high as $1.4731 - its highest level since it began trading in January 1999.

Perhaps Siwei is worried that China is holding too many dollars, and would like to diversify the dollar holdings into other currencies. But the official Chinese government policy disapproves of Siwei's "diversification," or at least the public revelation of such a diversification by Siwei. I'm thinking that China may be just as addictive to their economic expansion fueled by Chinese exports to the U.S., as the U.S. economy is addictive to the Chinese imports. It is like both country's economies are so intertwined, that a crash on one economy could result in a crash on the other.

Stock market's rollercoaster ride

A look at the major stock indexes for the past two days. From the New York Times.

It is time now to look at the roller coaster ride over the past two days. Let's look at this ABC News story of the Dow's 416-point drop on Tuesday:

NEW YORK Feb 28, 2007 (AP)— Stocks had their worst day of trading since the Sept. 11, 2001, terrorist attacks Tuesday, hurtling the Dow Jones industrials down more than 400 points on a worldwide tide of concern that the U.S. and Chinese economies are stumbling and that share prices have become overinflated.

The steepness of the market's drop, as well as its global breadth, signaled a possible correction after a long period of stable and steadily rising stock markets that had not been shaken by such a volatile day of trading in several years.

It began with a 9 percent slide in Chinese stocks Tuesday, which came a day after investors sent Shanghai's benchmark index to a record high close, setting the tone for U.S. trading. The Dow began the day falling sharply, and the decline accelerated throughout the course of the session before stocks took a huge plunge in late afternoon as computer-driven sell programs kicked in, and also as a computer glitch caused a delay in the recording of a large number of trades.

The Dow fell 546.20, or 4.3 percent, to 12,086.06 before recovering some ground in the last hour of trading to close down 416.02, or 3.29 percent, at 12,216.24, leaving it in negative territory for the year. Because the worst of the plunge took place after 2:30 p.m., the New York Stock Exchange's trading limits, designed to halt such precipitous moves, were not activated.

A display board at the New York Stock Exchange shows the Dow Jones Industrial Average down more than 415 points during the closing moments of the trading session in New York February 27, 2007. (Mike Segar/Reuters)

It was the Dow's worst point decline since Sept. 17, 2001, the first trading day after the terror attacks, when the blue chips fell 684.81, or 7.13 percent. In percentage terms, it was the biggest decline since March 24, 2003, when the index fell 3.6 percent as investors started getting rattled as U.S. casualties mounted in the early days after the invasion of Iraq.

The broader Standard & Poor's 500 index fell 50.33, or 3.47 percent, Tuesday to 1,399.04, and the tech-dominated Nasdaq composite index was off 96.66, or 3.86 percent, at 2,407.86. Both indexes have also turned negative for the year.

The Russell 2000 index of smaller companies dropped 31.03, or 3.77 percent, to 792.66.

And today, the market's rebounded somewhat after yesterdays big sell-off. This is off Businessweek:

Stocks were modestly higher in heavy trading Wednesday afternoon, though well off their best levels of the session, after Tuesday's plunge in China's stock market sent U.S. indexes to their worst day in years. Shanghai rebounded overnight, but European bourses were lower and most Asian markets took a second straight tumble.

In afternoon trading Wednesday, the Dow Jones industrial average rose 35.49 points, or 0.29%, to 12,251.73. The broader Standard & Poor's 500 index added 6.67 points, or 0.48%, to 1,405.71. The tech-heavy Nasdaq composite gained 9.04 points, or 0.38%, to 2,416.9.

Market breadth was positive, with 21 stocks advancing for each 11 declining on the NYSE. Nasdaq breadth was 17-12 positive. Trading was heavy amid margin calls, notes Standard & Poor's MarketScope.

[....]

But upside may have been limited by some less-than-encouraging economic reports. U.S. fourth-quarter gross domestic product growth was revised down to 2.2% from the advance reading of 3.5%, for a third straight quarter below 3%. The headline number was "exactly as expected," says Action Economics.

Meanwhile, U.S. new home sales tumbled 16.6% in January to a 937,000 pace, the largest decline since 1994, from an upwardly revised 1.123 million in December.

The Chicago purchasing managers' index, a gauge of factory sentiment in the Midwest, eased to 47.9 in February, weaker than expected, from 48.8 in January.

So what happened here?

From what I can gather, this whole mess started in China where a government crackdown on "illegal share offerings and other banned activities" caused China's stock market to drop the most in 10 years. According to Bloomberg:

The Shanghai and Shenzhen 300 Index slid 250.18, or 9.2 percent, to 2457.49. The measure, which jumped 13 percent in the past six sessions, closed at a record yesterday.

Today's rout wiped out $107.8 billion from a stock market that doubled in the past year as 249 of the key index's 300 shares plunged by the 10 percent limit. The 300 index is valued at 38 times earnings, compared with 16 times for the Morgan Stanley Capital International Emerging Markets Index.

The State Council, China's highest ruling body, has approved a special task force to clamp down on illegal share offerings and other banned activities in the market, the government said. The group will provide advice on regulations and policy explanations of the securities market, according to a statement published Feb. 25 on the central government's Web site.

Banks in China are banned from lending money for stock investments. The regulator last month ordered banks to examine personal loans to prevent them being used to buy shares. The central bank carried out similar crackdowns on unauthorized margin trading in 1997 and 2001 after indexes surged.

The government must pay attention to ``bubbles'' in its stock market before they get out of hand, Cheng Siwei, vice chairman of the Nation's People Congress, wrote in a commentary published Feb. 6 in the Chinese-language Financial News. The Congress next convenes for an annual meeting on March 5.

China's economy has been growing spectacularly. The World Bank is estimating that China's growth will fall from 10.7 percent in 2006 to 9.5 percent for 2007. Even a 9.5 percent growth rate is still impressive. A lot of investment money has been flowing into China. According to a January 15, 2007 International Herald Tribune story:

Excluding the financial sector, foreign direct investment in China rebounded last year after a fall in 2005, the Commerce Ministry said Monday.

Not including banks, insurance and securities, foreign direct investment amounted to $63.02 billion in 2006 — a 4.47 percent rise over 2005, the ministry said on its Web site.

Including the financial sector, China drew $69.47 billion in foreign direct investment in 2006, down 4.06 percent from 2005.

But China reported cumulative nonfinancial foreign investment of $54.26 billion in the first 11 months, suggesting a December figure of about $8.76 billion.

China's economy has surged more than tenfold since foreign investments were allowed in 1980, with money pouring into factories on the east coast.

So is it no wonder that the Shanghai and Shenzhen 300 Index was valued at 38 times earnings, as the Bloomberg story reports? There was certainly some speculation going on, as investors were chasing after some big profits in a sizzling Chinese economy here. The China Securities Regulatory Commission decided to issue new regulations in the securities market, perhaps as a means to limit a potential Chinese stock market bubble. We had a little panic start up in the Chinese stock market, as these regulations were announced. The panic reverberated into both the European and U.S. markets.

There is more here to this story than just a Chinese government crackdown on illegal trading causing a world-wide panic. There is also still a weakness in the U.S. economy. U.S. economic growth slowed to a 2.2 percent annual rate during the last three months of 2006.

U.S. real economic growth slowed to 2.2 percent during the fourth quarter of 2006. Graphic by New York Times.

New home sales in the U.S. fell 16.6 percent--the most in 13 years, according to the Commerce Department.

New home sales plunge 16.6 percent. Graphic from New York Times.

And finally, the Commerce Department reported that new orders for durable goods plunged 7.8 percent in January. There is even talk that the U.S. manufacturing is now in a recession.

U.S. manufacturing orders for durable goods dropped by almost 8 percent in January 2007. Graphic by The New York Times.

And I haven't even talked about the problems with the U.S. budget, the rising war costs of Iraq, or the already $8 trillion in U.S. debt. These are all serious problems with the U.S. economy. This U.S. economy is not strong. If a speculative shock Chinese stock market can cause a major drop in stocks on Wall Street, what will happen when a serious economic crisis takes place within China?