Last week in his China Financial Markets blog, Michael Pettis raised the interesting question What happens IF Chinese growth slows?. His answer may surprise you, and mine is quite different, even though I agree with most of his discussion.
How can that be? Let’s take a look at his post. Pettis writes …
Last week I suggested that slowly the consensus is shifting towards a recognition that Chinese growth may slow sharply in the next few years. When I discuss this prospect with analysts and investors, however, they almost always worry about two things. First, since China represents the largest component of global growth, it seems reasonable to expect that a sharp slowdown in China will also mean a sharp slowdown in global growth. Slowing Chinese growth, in other words, should be terrible for the world. Secondly, if growth does slow sharply, this should cause an equally sharp rise in social instability and, with it, rising political instability.
I disagree with both claims — not that they are necessarily wrong but rather that they are not obviously true, and depend heavily on the way China rebalances. To see why it is worth considering what happened to Japan.
Pettis goes on to explain how Japan in 1990 was 17% of the global economy, and every one figured Japan would soon take over the world. Yet in spite of the fact that Japan’s growth rate collapsed to 1%, the rest of the world expanded rapidly and there certainly was little social instability in Japan.
What Pettis failed to mention is 1990’s global economy received a tremendous productivity boost from the interment boom, more than making up for any slowdown because of Japan.
Moreover, that internet boom was quickly followed by global housing and credit bubbles, the likes of which the world has never seen.
Now we have global headwinds of extremely slow global growth outside of China, with credit contracting in the US for 10 straight quarters, and an increasingly hostile to further deficit spending in the UK and in US Congress.
I believe it is very safe to assume we are not going to have another internet revolution or another massive housing boom. History shows, the last bubble is never re-blown.
Could there be another boom-causing bubble? Of course, but I sure would not bet on it, or even think it is highly likely.
Nonetheless, Pettis cleverly left himself an “out”, and it’s one I agree with: “…not that they are necessarily wrong but rather that they are not obviously true”
Pettis continues ….
I think the Japanese story has important implications for our analysis of China. If China indeed experiences a rapid slowdown in GDP growth, the impact on the rest of the world may be far less than we expect. The real key is the evolution of the Chinese trade surplus. If it contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.
Of course that doesn’t mean that the world will grow quickly. My expectation is that global demand growth over the next several years is likely to be anemic with or without China. But it does man that a slowdown in Chinese growth might not be the disaster for the world that many believe.
Also a rapid slowdown in Chinese growth does not mean a social or political disaster domestically It depends on how serious China is about rebalancing its economy. If policymakers are willing to force up interest rates and wages, most of the adjustment pain will be borne by SOEs and the state sector, not by the household sector. In that case we might see a slowdown in Chinese consumption growth, but one not nearly as severe as the slowdown in Chinese GDP growth. Since the Chinese, like everyone else, probably measures their well-being in terms of purchasing power per capita, rather than GDP per capita, a sharp slowdown might not be nearly as painful as we assume.
Three Key Points From Pettis
- Global demand growth over the next several years is likely to be anemic with or without China.
- If China’s trade surplus contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.
- A slowdown in Chinese growth might not be the disaster for the world that many believe.
Point number one is a given. I agree with point number two and three although I can see how many would disagree. The devil of course is in the details, and that’s where I possibly differ from Pettis. It’s hard to say for sure because he did not expound on country-to-country differences.
This is how I see it.
China is clearly overheating. When (not if) China slows, that will halt pressure on rising commodity prices. Falling oil prices would help reduce the US trade deficit, especially if grain prices remain firm.
Falling energy, copper, and metal prices would help US homebuilders and small businesses hurt in a price squeeze of rising input prices and falling prices of goods and services.
The net effect of this would be to strengthen the US dollar, yet help the US economy. Ironically, Bernanke might not see it that way because short-term it might cause the CPI to go negative.
Moreover, it might not be good for multinational corporations or the US stock market in general which generally benefits from a falling US dollar. However, long-term it would help rebalance the global economy, and hopefully shut off protectionist trade measures in Congress. That last point is crucial. Everything depends on how fast China slows, and how rambunctious the next Congress is, and whether or not President Obama would veto currency manipulation legislation from Congress.
Assuming that Congress does not act to kill global trade (admittedly that’s a big assumption), net-net the overall global effect of China slowing would not be a disaster for the world “in general”, and in fact, the world would likely benefit.
The key words in the last sentence however, are “in general”. An additional caveat is: if Congress manages to kill global trade with ill-advised protectionist legislation, the whole world loses.
Australia and Canada Will Suffer
As noted above, the US would likely benefit from a normal slowdown in China (or a crash not caused by collapsing global trade). However, Australia and Canada with their housing bubbles already poised to implode would suffer mightily if commodity prices tumble.
Given that the US and Europe are far more important globally, A slowdown in China might be a net benefit for the world “in general”, yet a total disaster for countries overly dependent on continuous strong growth in China.
Australia and Canada would be especially hard hit, right at the worst possible time.
Why China Will Implode
Now that we have addressed what happens WHEN China slows. Let’s discuss WHY China will do so.
China’s Economic Treadmill to Hell
Please consider Fortune Magazine’s Chanos vs. China
The influential short-seller is betting that China’s economy is about to implode in a spectacular real estate bust. A lot of people are hoping that Chanos – who called Enron right – is wrong this time.
For over a year now Chanos — the man who got Enron (among other things) right before anyone else — has been on a rampage about China. The guy who became famous — and rich — shorting companies now says he is shorting the entire country.
When I mention the “treadmill to hell” line to the group in Shanghai, the reaction is the usual one when Chanos’s name comes up here: “What does he know about China?” the American VC asks. “Has he ever lived here? Does he have staff here? Does he speak Chinese?”
The answers are no, no, and no. But our host, who counts Chanos as a friend, knows that is not the point. “He did get Enron right,” Pete says. “And Tyco. And the whole mortgage bust.” He concludes: “Look, he may be wrong, but you need to tell me why he’s wrong, not point out that he doesn’t live here.”
How did Chanos come to his China obsession? It started in 2009, when he and his team at Kynikos looked at commodity prices and the stocks of big mining companies. “Everything we did in our microwork [on commodities] kept leading us back to China’s property market,” Chanos says. China’s construction boom was driving demand for nearly every basic material.
One day, at a research conference in 2009, Chanos listened to an analyst tick off numbers about the scale of China’s building boom. “He said they were building 5 billion square meters of new residential and office space — 2.6 billion square meters in new office space alone. I said to him, ‘You must have the decimal point in the wrong place.’ He said no, the numbers are right. So do the math: That’s almost 30 billion square feet of new construction. There are 1.3 billion people in China. [In terms of new office space alone] that amounts to about a five-by-five-foot cubicle for every man, woman, and child in the country. That’s when it dawned on me that China was embarking on something unprecedented.”
To understand Chanos’s China skepticism — he calls it “Dubai times 1,000” — it’s worth visiting the Rose and Ginko Valley housing development near Sheshan Mountain, a new suburb outside Shanghai. Block after block after block of villas have gone up. And they are empty.
In the country’s largest, most affluent cities — Beijing, Shanghai, Guangzhou, and Shenzhen, known as tier-one cities to the real estate cognoscenti — it is not an unusual phenomenon. There is a lot of new, unoccupied housing in China. Just how much — and just how much of a concern it should be — is a central debate.
Fixed-asset investment accounts for more than 60% of China’s overall GDP. No other major economy even comes close. And of that fixed investment, slightly less than a quarter is attributable to new real estate investment.
Consider Dubai, he says: At the peak of its building boom, there were 240 square meters of property under development for every $1 million in national GDP. In urban China today that ratio is four times as high. “We’ve seen this movie before,” he says. Whether it was Dubai a couple of years ago, Thailand and Indonesia during the Asian crisis of the late ’90s, or Tokyo circa 1989, “this always ends badly.”
Chanos: China’s Treadmill to Hell Video
Shadow Over Asia
Inquiring minds are reading The Only Question About The China Crash Is When
by David Galland, Managing Editor, The Casey Report
An interview with Vitaliy Katsenelson
TCR: What our readers are looking for is a better sense of China and Japan, both of which are very important in the context of the global economy. As we have to start somewhere, let’s start with China.
Today the conventional wisdom is that somehow the Chinese economy is better managed than its competitors, very similar to how people viewed Japan in the 1970s and 1980s. Back then people were absolutely convinced that Japan was the superior country with superior policies and that its economy was unstoppable. We all know how that ended.
So, let’s start there. Is China’s system better than everyone else’s? Is it really possible the Chinese economy can keep steamrolling along?
Hyperinflation in Japan
The interview is quite lengthy and extremely good. It covers both Japan and China. It is hard to excerpt because I agree with nearly everything Vitaliy Katsenelson says.
I find it interesting that Vitaliy makes a case that Hyperinflation will occur in Japan before the United states. That is something I proposed 5 years ago and have stated a few times since.
Vitaliy makes a solid case …
VK: Japan’s story is very simple. The economy slowed down in the 1990s. To keep the economy growing, the government lowered taxes and increased government spending, sending budget deficits up. In order to finance those deficits, the amount of government debt has tripled.
The only reason they were able to finance that debt was because over 90% of the government debt was purchased internally; therefore, thanks to Japanese interest rates declining from 7.5% to 1.4%, the government was able to dramatically increase the amount of debt without the total borrowing costs going up.
Today, Japan is one of the most indebted nations in the developed world, and its population demographics are horrible because every fourth Japanese is over 65 years old. There’s no immigration into Japan, and the population is aging rapidly, and the savings rate went from the middle teens to quickly approaching zero.
TCR: So there is less demand for Japanese government bonds.
VK: Yes, exactly. With the demand for Japanese bonds declining, they are going to have to start shopping their debt outside of Japan, and the second they do, they’ll realize that no rational buyer would buy Japanese debt yielding 1.4% when they can buy U.S. debt or German debt with yields double that.
So the Japanese are going to have to start paying high interest rates, and they can’t afford that, because one-quarter of the tax revenues already goes to servicing their debt. If their interest rates were to double to just 2.8%, it basically wipes out the funding for the country’s Departments of Defense and Education. So this is a situation where they go from deflation to hyperinflation, because they’re going to have to start printing money to be able to keep paying off their debt, so this is the case where they are going just from one extreme to another.
The interview is well worth a read in entirety with lots of charts and ideas. The one thing Vitaliy doesn’t know is the same thing I don’t know: When.
Mike “Mish” Shedlock
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