Monday, December 19, 2016

China Expecting Slower Growth In 2017

The Chinese Academy of Social Sciences has forecast China's economic growth will further slow in 2017 to 6.5 percent, this would be the slowest pace in more than 25 years. Chinese leaders are struggling to clamp down on asset price bubbles, especially in the property market while a sharp drop in the yuan has fed fears of markets turmoil. Heightened anxiety about the yuan has caused it to slid to the lowest level in over eight years last month because of continued capital outflows following Donald Trump's U.S. election victory. All this is occurring just as a rapid rise in bank lending, a dangerous build-up of debt in the corporate sector and a property market that has failed to fully flush out speculators are threatening to derail the economy. China is far too large and impacts the global economy to where we can not discount its importance.

The great capital unwinding is continuing as money that has flowed into China for decades attempts to leave and take with it much of the wealth it has produced. Interestingly many people fail to understand how the massive capital flows leaving China are distorting both currencies and economies throughout the world. In fact, many economist and investors are in a state of denial as to the magnitude of the problem and just how dire the situation has become. We still hear the faithful tout how China is still cranking out around 7% growth and how the country will be able to navigate from an export based to a consumer driven economy. I contend China is in far more trouble than most people imagine and the reason it has gone unnoticed is because of the control their government has over the economy which makes it impossible to get accurate or specifically detailed numbers and information.

The opaque nature of China's economy makes it difficult to gauge what is really happening in the most populous country in the world. The fact that its economy, media, and internet are all controlled by its government curtails getting real information and unbiased data. An "all growth is good" mentality that always included "building more and expanding more" has been China's mantra for years as politicians were rewarded for generating growth. The combination of these factors has created the gigantic credit trap that China now finds itself in. Political tinkering with economic data has produced a lack of clean and precise numbers when it comes to the economy, and this is not likely to change anytime soon. It often seems the only way the world would know the wheels had fallen off the economy in China would be if tens, or even hundreds of millions of Chinese hit the streets in protest but that is unlikely and would go against core values of the Chinese people, China has heavily discouraged such actions for decades.

China's Money Supply Soared From $10 To $24 Trillion 
Over the years corruption has flourished in China because politics and greed are so closely related. As a result, the growth of credit has gone unchecked. It is the nature of political systems to mask their flaws and in the case of China years of rapid growth have made this easy. It is important to remember that much of the growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program. This expanded credit and poured massive amounts of money into the system, but it also encouraged expansion and construction with little regard as to real demand or need. 

When critics and those who see the economy of China as containing major defects have made efforts to voice their concerns and point out weaknesses in the system they usually are drowned out by those touting the message that China is a case of potential unleashed. Even today while many people concede that growth has slowed they still refuse to recognize just how much of past growth has been constructed on a foundation of sand and the misallocation of capital. The recognition of this is written not to diminish the accomplishments of China or to question their progress, but to point out much of what we have witnessed is the result of one-time factors that have largely played out. Several factors have drastically changed politically, socially and from a military perspective since the days when America fueled China's growth. Recently, what many Americans viewed as a beneficial relationship has deteriorated into something akin to fear or resentment.

Many Americans have grown troubled by China's "new military swagger" now flowing out of Beijing. This coupled with a massive loss of American manufacturing jobs, the theft of intellectual knowledge and our massive trade deficit with China has caused concern. We must remember Beijing has been hit by the perfect financial storm as forces from a closed capital account, independent monetary policy, and a tightly managed exchange rate all have decided to plummet the economy at the same time. It is time for those who have tried to ignore the growing problems to understand that one of the least painful ways for China to confront its woes will be to shift them off to other countries. Selling products below production cost is an example of such a policy. This has allowed Donald Trump to talk during the election about proposing a tariff as much as 45% on Chinese goods flowing into America.

The lack of clean economic numbers combined with an intentional transparency issue has created a "guessathon" where we are forced to scan the latest pricing on what cargo ships are charging and how busy ports across the world appear to be in an effort to determine what is really happening. A big problem is that an "economy" by its nature can easily trick, hide, or mislead us as to what is occurring. We are often caught off-guard by what is happening off-stage or festering in the wings. Reality is often obscured without effort, but when a government is in full propaganda mode in an effort to reassure its people that all is well it can become impossible to see through the fog. This means we must really hunker down and go to a lot of work to get the truth.

Total Debt Is Soaring
Four big state-owned commercial banks and other mainly state-controlled banks account for nearly all official lending in China and their customers are largely state-owned firms. This has left little room for private banks and this means informal lending in China has grown rapidly over the past five years and even local governments borrow from the shadow banks. Today the shadow banking sector is estimated to make up 20% of all loans. This is only one of the problems that has developed and skewed China's development as the government controlled the economy from behind the curtain. For years the people of China have had the habit of saving much of what they earn but the low interest-rates paid at banks has not rewarded savers, this is reflected by growth in the shadow banks and the fact much of their money has drifted into a bizarre housing market where prices are sky high.

China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. For years credit expanded rapidly in China, and now much of the country is mired in debt. As Beijing pursued a strong yuan policy pegged to the U.S. dollar. Since 2005 the yuan has appreciated about 30%, this profited those who put money in China, but now that the economy of China has become very shaky a lot of investors are questioning the risk of holding yuan assets. Now the country is experiencing massive capital outflows as several events and the pain of attempting to hold its currency peg to the U.S. dollar finally became unbearable.  The  PBOC is under tremendous pressure as the responsibility of holding this mess together rest solidly on their shoulders. A massive scheme for the state to buy stock shares to halt a falling market while dealing with near bankrupt municipal authorities is only part of the woes they face.

It is clear the economic efficiency of credit has started to collapse in China and the unwinding of its giant credit spree looks to be very painful. For years it has always been thought that China’s current-account surpluses have fueled its huge money-supply growth within a largely pegged currency. As foreign exchange piled up, the People’s Bank of China continued to print more yuan. According to estimates, China’s banking system has grown from $10 trillion to $24 trillion since 2008, but now the reverse appears to be happening, and as the yuan weakens, the central bank will effectively have to buy its own currency using foreign reserves to maintain its peg. This could mean the external trade position would now cause the central bank to shrink the domestic money supply. Beijing will need to get used to the market forced deleveraging and slower growth.  All this plays into the view we all going to witness an overall deterioration that makes it logical for investors to get out of both the yuan and China. Expect to see a continuation of wealth leaving China and fleeing towards safety.

 Footnote;  As always comments are welcomed and please feel free to scan the archives for other articles that may interest you. Below is another article concerning how China is failing to achieve real reform.

1 comment:

  1. Jim Rickards sees a major devaluation of the yuan as the PBOC has less than a trillion in US $ reserves to try to keep the yuan "strong" so as to not piss-off Trump.