China the countdown begins to the big “pop”…
China has a unique state-driven model of capitalism that has been very successful at creating growth in the country during the last 30 years. From a moderate undeveloped economy, China has been turned into the leader of the emerging markets group and it remains on course to become the world’s largest economy in terms of GDP in just a matter of years. During the last 33 years, between 1980 and 2013, the country has in fact averaged a growth rate that is just shy of 10% per year. That is a gigantic number for a single year, let alone being sustained over three decades.
When compared with the rest of the world over the same period, the numbers are even more impressive. While China grew at a 9.9% pace, to be precise, in contrast, the world grew at 3.4% with the US at 2.7% and the EU at a pale 1.9%. These numbers are so huge and off the scale relative to China’s peers that they seem odd at the same time. How is it possible to achieve such growth for so long? And how is it possible to avoid recession – supposedly a natural and unavoidable part of the business cycle where over investment gets rinsed out?
China has been following a model that is neither capitalism Nor socialism. It lies in a pretty unique economic “in-between”, being still a central planned capitalist economy but one where individual entities (that are largely majority State owned) operate in a free global market. It has grown over the last 20 years due to an undervalued Yuan and cheap credit with the government continually releasing the levers on liquidity whenever the natural business cycle threatens slower growth, let alone a recession. And it is true that this has raised the standard of living of hundreds of millions of Chinese although it must be said that the outsized spoils have gone to those with the closest links to the government (as ever). The system that this growth has been built upon cannot however outrun the business cycle. Sooner or later you must decide – communism completely or a free market completely and we rather suspect we are at this stage now.
Thus far, the growth of China’s economy over the last 20 years has been largely built upon government infrastructure spending (credit creation through the regional banks) and exports (from a weak yuan). In fact infrastructure spending still represents half the economy. Private investment which is required in a truly healthy economy is very much behind Government spending and this is the task and difficulty Chinese economic officials face – how to promote home grown activity within the domestic economy rather than the heavy hand of their own spending.
A good analogy to this situation is the monetary policy that is currently being unfolded in the U.S. Here, the Government, under cover of the Fed, has run a centrally planned economic policy for nearly 6 years now. Instead of allowing interest rates to rise to their “natural” level, they continue to pursue the so called ZIRP policy and it has created all sorts of distortions in the economy, not just there but right around the globe. It is worth remembering that Keynes was actually right about something. He saw economic policy as an adjustment tool to smooth the business cycle, not as a replacement for the economy. But then, politicians and policy makers will always find a way of expanding Keynes’ postulations to extreme cases (like the GFC) without accounting for the pernicious effects that can result from them. Economic policy just cannot remain pegged in one direction forever. That means that we simply cannot have ZIRP forever and in China, the government cannot spend forever. At some point a collapse will likely occur quite simply because of the artificial inflation within the economy prior to the policy withdrawal…
Here at SBM we believe that China is now nearing the end of the bubble period with at least four issues concerning us:
1) A number of property developers are now cutting their prices, something that has never been done before and which spells trouble for those owners sitting on empty condo’s with high LTV’s. With a supply that largely surpasses demand on many coastal cities, simple economic forces will likely impart a furious crash in prices. Some developers have actually already gone bankrupt and many others are in financial trouble. The shadow banking system and sub-prime lending boosted an inefficient sector that will end badly just as it did in the US and many European countries in the aftermath of 2007-08.
2) Some of the richest individuals, those who have the financial means to leave the country, are now considering moving overseas as they don’t trust the government, believing a bubble is forming and are concerned with their wealth preservation. Many have in fact parked considerable chunks of their wealth offshore in the US & UK property markets in particular (which in turn have had a distorting effect in London).
3) As a consequence of the distortions created, bad loans are of course rising. Private debt is higher in China than it is in the US. In fact, the current level of 190% of GDP is even higher than the 160% level that led to the Asia crisis of 1998.
4) Total country debt has grown dramatically, surpassing 275% of GDP. With such an amount of debt, it will become ever more difficult to pursue domestic growth as interest rates will need to rise and so choking on the ground activity.
The Chinese government have actually been allowing the country’s domestic GDP growth rate to decrease a little in recent years in trying to give some relief to the balloon that is their economy but, this is usually an almost always impossible task with real risks of a sudden and acute crash. When this bubble bursts, the fallout will resonate around the world. We have been looking for a way to short the London property market, perhaps a short position on the Yuan or Chinese property developers is a good way to play this!
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