Pettis on Chinese liquidity

From Michael Pettis’ exclusive newsletter:

Because of the lunar New Year festivities not a whole lot happened in China last week, not counting of course the never-ending stream of fireworks and the several really great jiao zi dinners I have managed to snag from my students and their families.  I have nonetheless been getting a lot of questions recently about what I expected for the stock market this year.

The market been closed for the past week but, in brief, I think ample liquidity is going to drive stocks higher until at least the end of the summer (assuming of course, perhaps unrealistically, that no more countries unexpectedly fall into default or revolution).  But later this year I think a lot of people are going to be rethinking their positions and that investors should be prepared for a rocky end of the year.

Why?  Remember that we will have new leadership next year when President Hu Jintao and Premier Wen Jiabao retire.  My guess is that the new leaders will be formally announced in October of next year, but since no one in the Party likes surprises, the succession will be more or less sewn up by early 2012.

If I am right, I would imagine that by the end of next year a lot of people in Beijing and Shanghai will be seriously considering what changes in policy and orientation the new leaders might bring with them.  The rumors are that they are very uncomfortable with the unbalanced nature of China’s investment-driven growth, and there is some talk that they will move quickly to rebalance the economy and that we should see the consequent slowdown in investment-driven growth by 2012-2013.

This may or may not be true.  I imagine that even if there is a great deal of discomfort with the current growth model, it will not be easy to engineer a major shift – requiring a fairly rapid slowdown in growth – without widespread consensus in the Standing Committee and perhaps the State Council.  Whether there is or isn’t I can’t really say, I have no inside sense of the factional disputes, but I do think one way or the other we will all need to re-examine our positions by later this year

Until then I assume that there will be plenty of excess liquidity to drive asset markets.  Last May I argued that in an effort to keep growth rates high in 2010 and 2011 we were going to see rapid credit expansion in China which, coupled with increases in hot money inflows, would mean tons of liquidity in the Chinese markets.  This, I argued, would be very good for the stock markets and for asset markets in general.