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.

Last year, 2011, was a noticeably slower growth year for China as the government implemented a host of restrictions on loan growth, real estate investment and more. These measures seemingly played a major contributing role in decelerating growth rates throughout the year.

The first quarter's 8.1% GDP growth isn't slow by most any measure, but it's slower than China's seen in recent years. The second quarter's 7.6% is similarly fast relative to the globe, but clearly not as hot as in prior years.

China's Year-Over-Year GDP Growth Rate

Also decelerating? Inflation, which slowed from over 6% year over year in mid-2011 to just 2.2% last month. This disinflation is one part of China's goldilocks scenario, giving room to boost lending without overheating the economy.

So it's unsurprising that as inflation has cooled, China has begun reversing 2011's tightening efforts.

Recall, in December 2011 the government first loosened loan quotas, and loan growth responded by accelerating for the first time in a year that month. After a relatively muted start to 2012, March loan growth surged to 1.01 trillion yuan. April loan growth was tepid, but the biggest May loan growth figure on record followed. June loan growth demonstrated continued strength, rising 285 billion yuan to 919.8 billion yuan.

Additionally, the People's Bank of China for the first time in eight years, cut one-year interest rates in June, by 0.25 percentage points. Subsequently, the PBOC cut another 0.31 percentage points in early July.

These two rate reductions have been paired with two successive reductions in the lending floor rate -- the minimum percentage of the benchmark rate banks can lend at to attract borrowers -- a move designed to magnify the rate cuts' effects.

Additionally, the PBOC announced it would delay implementing Basel III capital requirements until 2013 and reduce risk weightings for loans to small businesses, a move likely forestalling potential Chinese bank deleveraging and allowing needed capital to continue flowing to businesses.

Now, as GDP illustrates, we've yet to see these measures fully translate into acceleration in data, which isn't unusual, considering monetary policy normally takes time to work its way through an economy and be reflected in official data.

But there are nascent signs a reacceleration seems to be taking root. (And, as Ken Fisher often says, stocks tend not to wait for data to reflect reacceleration as they tend to move ahead the economy.)

But at a broader level, whether growth quickens or stays roughly akin to the first quarter isn't what's important. What's important is an 8.1% growth rate -- or even a bit weaker -- doesn't seem much like a hard landing, and an economy the size of China's is hugely additive to global growth.

For stocks, since many investors seem to fear a sharp slowdown in China or worse, chances are an approaching reacceleration or even stabilization in Chinese growth rates could buoy global stock market returns nicely.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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