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Mid-Year China Check-In

Slowing Chinese economic growth has been a prominent topic of concern for the better part of 2012.

In the second quarter, weak Chinese data -- slowing GDP growth, declining inflation, weak manufacturing results -- led many folks to fear the world's second-largest economy was headed for a hard landing.

But in our view, folks fretting about a Chinese hard landing are likely missing this year's full story -- and powerful recent developments in China's monetary policy.

As Fisher Investments' CEO Ken Fisher recently wrote , 2012 marks a political "election" year for China. These power shifts, held every five years, are anything but an exercise in democracy.

The ruling Communist Party's members (only about 2.5 million people of China's one billion-plus population) indirectly select the country's next president and members of the powerful nine-member Standing Committee.

It's actually a little more complicated than that. In essence, locally elected officials select the next rung of leaders, who select the next rung and so on -- all the way to the top, culminating in the selection of the president and premier.

However, don't mistake this for bottom-up representation. In practice, power flows the other direction. However, selections are largely dictated in advance by the party, so the election is really a bit of a façade.

With so much of the populace lacking a real political voice to express discontent, China's authoritarian rulers fear social unrest. As such, during these election years, Chinese officials are incentivized to support economic growth as a tool to maintain general contentment.

To accomplish this election-year goldilocks scenario, China flexes its control over bank loan quotas, which subsequently controls money flow into the economy. The year before the power transition, quotas are generally tightened to slow inflation--and in the transition year, they're loosened, goosing growth.

In our view, this is the real story: China's rulers like power and, given their vast reach over the economy, will do what it takes to maintain it. Our research shows they've been relatively successful at this -- historically, election years feature the fastest average growth, and the year prior the slowest.
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