China and the Chittagon tea auction

Pasquale Galassi
July 15, 2013

I'm not upset that you lied to me, I'm upset that from now on I can't believe you. Friedrich Nietzche

This quote from Nietzche states exactly what I'm feeling this morning after having been through the Chinese data.

China's second-quarter gross domestic product released early this morning showed the economy expanded 7.5% from the year earlier, slower than the 7.7% growth in the first quarter. That matches the government's full-year growth target of 7.5%, a rate that would make this year the slowest since 1990.


China also said that industrial output rose 8.9% in June from a year earlier, compared to a forecast of 9.1% and lower than May's 9.2% growth. Fixed-asset investment also disappointed slightly, with 20.1% growth in the first half compared to a forecast of 20.2%. Consumer spending was a bright spot, as retail sales accelerated to 13.3% in June, compared with 12.9% growth in May. But disposable income growth for urban households slowed, to 6.5% year-on-year in the first half, down from 9.7% growth in the first half of 2012.

As a result of this data, the Shanghai composite index traded 0.88% higher, while the Hong Kong's Hang Seng Index traded 0.18% lower after rasing 0.40% just after the data.

The question is: can we trust these numbers?

The real problem here is that the financial community does not trust Chinese numbers and China is not doing much to make itself trustworthy. Here you have a typical example:

In recent days, China’s Finance Minister Lou Jiwei spooked investors by reportedly saying growth may well fall below 7% for the full year. Over the weekend, however, there was a correction issued on Saturday by the Xinhua news agency saying:

“the 7% goal should not be considered as the bottom line” and replacing the mention of 7% with: “There is no doubt that China can achieve this year’s growth target of 7.5%.”

With China in the middle of a growth dilemma, at this point in time, capital markets' trust is paramount. Every single day we read about "draining liquidity in China" or "adding liquyidity in China", but there has not been a single day where the Chinese officials were clearly stating that their primary objective was to rebuild  the country's trust in the capital markets.

Something to think about:

Mr Draghi's "we will do whatever it takes" had its effect on the market because he enjoys the market trust, Mr Bernanke is able to "trade" expectations because the Fed enjoys the market trust.

To support my thesis,  I recall paper titled Market makers in Chittagong Tea Auction: the role of trust and reputation. 

The paper proves that the auctioneer tries to build trust and reputation among his clients, the tea sellers. Specifically the paper finds that there is a positive externality from raising the acceptable price for a lot on subsequent lots. Hence, an auctioneer, who must prevent auction prices from collapsing, will attempt to withdraw teas that are not fetching high prices, incurring short run costs.  Because of potential conflicts between the auctioneer and the tea sellers he can implement such a withdrawal policy only with tea produced by estates in which he has a stake as their incentives are better aligned. Thus, auctioneers gain trust of his clients by taking costly auctions on lots they have a greater stake in to benefit all the sellers. It is the auctioneers desire to appear non-opportunistic , rather than opportunism, which result in his differentiual treatment of tea from estates which are related and not-related to him.

Concluding, the Chinese leadership should learn something from the Chittagong tea auction.