Commentary on Political Economy

Friday 2 February 2024

 

China’s economy looks more unstable than ever

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OPINION

China’s economy looks more unstable than ever

ByAmbrose Evans-Pritchard

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Chinese equities are a screaming contrarian buy. Investor revulsion has become indiscriminate, a sign that the Shanghai and Shenzhen sharemarkets are close to touching bottom.

All the stars are aligned for a catch-up rally this year. Xi Jinping appears sufficiently worried about capital flight at home, and loss of confidence abroad, to start throwing the kitchen sink at the immediate problem.

Xi Jinping is throwing the kitchen sink at China’s problems.

Xi Jinping is throwing the kitchen sink at China’s problems.CREDIT:AP

“One trillion here, one trillion there. Since November, Chinese policymakers have been ramping up easing at an accelerating pace. Every drop is now several hundred billion to one trillion yuan ($140 billion),” said Wei Yao and Michelle Lam from Société Générale.

It is not the shock and awe bazooka of 2009 but it is starting to add up to serious fiscal, monetary, and regulatory stimulus, and is probably enough to head off a deflationary spiral for now. “Are we there yet? No. Are we getting close? Bit by bit,” they said.

My old colleague Tom Stevenson, now at Fidelity, wrote that Chinese equities look irresistible at a price to earnings ratio below 10, and I agree.

In rapid succession, the authorities have added an extra one trillion of fiscal stimulus for social housing and water projects, with another trillion flagged for March; the central bank (PBOC) is adding quasi-fiscal money through special loans, and last week announced another trillion of liquidity by cutting the reserve ratio for banks.

The regime is preparing a two trillion yuan fund to prop up the stock market directly, drawing on the offshore cash piles of state companies (SOEs). The heads of listed SOEs will henceforth be judged on share price performance. Short-selling by traders is to be restricted. The State Council on Monday pledged to “stabilise the market”. Journalists, bloggers, and academics have been told to talk up equities.

These are potent signals, and Chinese investors act on signals from the state, though you can also interpret this ferment as a warning sign. “Marshalling so much capital smacks of desperation, and makes me wonder if policymakers are worried [that] perhaps some big institutions are at risk of huge losses,” said Bill Bishop from Sinocism, a prominent Substack newsletter about China.

Chinese equities have been a “value trap” for an eternity. The Shanghai Composite index has halved since 2007 even in nominal terms. Xi’s erratic political assaults on China’s wealth producers have been calamitous. Debt-deflation has done the rest. The market has decoupled drastically from US, Japanese, and European equities.

But the catalysts for a short-term rebound are coming into view. Beijing wants a truce with Washington, and with global capital. The US Federal Reserve will be cutting rates within months, allowing the PBOC to loosen without risking capital outflows and a repeat of China’s currency crisis in 2015.

China’s sharemarket has been flailing over the past three years.

China’s sharemarket has been flailing over the past three years.CREDIT:GETTY

China’s reversion to stimulus-as-usual can fuel an equity boom, but it does nothing to lift the country out of a structural dead-end. Société Générale says it will take a “TARP-style” programme comparable to the US Treasury’s emergency measures in 2008 to clear property losses in the banking system.

The state will have to swallow the bad debts one way or another, and the longer it delays, the worse it will be. But that alone is not enough either.

Former premier Wen Jiabao famously described China’s economy in 2007 as “unstable, unbalanced, uncoordinated and unsustainable”. It is in even worse trouble now. The demise of China Evergrande is the latest titan to fall.

A study by Capital Economics found that all the key indicators of economic deformity are as bad today as they were 15 years ago, and must be tackled in far less auspicious circumstances: the debt ratio has doubled to 300 per cent of GDP; the world is less willing to tolerate predatory Chinese mercantilism; the demographic dividend has been spent. The workforce contracted by 6.6 million in 2023, and will shed 7.9 million on average each year through to 2030.

The regime has backed away from tough love reform every time it hits trouble, launching fresh bursts of infrastructure spending by Pavlovian reflex.

Investment was 43 per cent of GDP in 2023, higher than it was when Wen Jiabao deemed it a dangerous addiction. No major country in modern history has been close to this. It is a formula for grotesque over-capacity.

The state sector’s share of fixed investment has risen from 32 per cent to 39 per cent over the last decade as the state companies gobble up credit and misuse it for Party patronage or ideological objectives.

Real estate and construction are still taking 46 per cent of the pie, just as they did in 2007. Cement output per capita remains three times higher than in most societies.

China’s economy is facing a painful adjustment.

China’s economy is facing a painful adjustment. CREDIT:BLOOMBERG

The incremental capital output rate (ICOR), measuring how much investment is needed to generate each extra unit of GDP, was two in the 1990s, three in the early 2000s, and is now nine. Government credit policy has lost all traction.

The proclaimed switch to a mature consumer-driven economy never happened. Xi Jinping talks of “high-quality development” and self-sufficiency, but 57 per cent of China’s manufacturing activity was dependent on foreign demand last year, close to where it was in 2007.

“The upshot is that China is still due for a painful structural adjustment. The hangover from years of imbalanced growth will probably be costly and long-lasting, knocking China off the path of rapid income convergence. We think the country’s trend growth rate will be just 2 per cent by the end of this decade,” said Capital Economics.

This failure to grasp the nettle has large global consequences. The true current account surplus (including exports from bonded trade zones) is back to the most extreme levels of the post-WTO accession boom as a share of world GDP.

The regime has backed away from tough love reform every time it hits trouble, launching fresh bursts of infrastructure spending by Pavlovian reflex.

It was such levels that led to the seminal “China Shock” paper concluding that China’s entry into the international trading system had compressed manufacturing wages in the US through labour arbitrage, caused the loss of 2 million US jobs, and pauperised blue collar workers (Trump’s base).

“We may now be in the midst of another China trade shock, possibly on a comparable scale to the first one,” said Capital Economics.

China has stellar success stories – solar panels, EVs, batteries – but these perpetuate the pathologies of extreme excess capacity and dependency on foreign markets. They do not lift China out of the middle income trap. They push it further into the trap.

Some of us have been arguing for a decade that China mania was a naive extrapolation of untenable past growth rates, and that the country would not displace the US as the world’s economic superpower by mid-century as long as the Party clung to Leninist control and allocation of credit. The failure is now beyond doubt.

That said, the stock market is not the economy, ever, anywhere. The Tokyo bourse saw torrid boomlets all through its post-bubble deflation and its two lost decades.

If the Chinese Communist Party wants to use all levers of state control to engineer a stock market rally this year, there will be a rally.

Telegraph, London

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