Coming back from a three week break that covers the end of one year and the start of another, there’s a tendency to look for new trends, new beginnings…a new start. But the world doesn’t wipe the slate clean at the end of the year. Debtors and creditors remain just as they were. Interest needs to be paid, and principle repaid.
The western world has spent the past decade trying to ignore this reality. Whenever debt servicing costs got too onerous, central bankers just lowered the rate of interest. And when that didn’t work, they resorted to quantitative easing to ensure there was enough liquidity flowing through the economy to service the ever growing pile of outstanding debts.
If you want evidence of the growing debt pile the global economy is labouring under, check out the chart below. It shows total credit outstanding for the world’s biggest economy, the US. It’s approaching US$60 trillion. As a percentage of GDP it’s a massive 344%, better than 2009’s record 370%, but much worse than the 280% recorded at the start of the century.
That mild little dip you see just prior to 2010 caused the GFC, or as they called it in the US, the ‘Great Recession’. Since then the US economy has experienced a fitful expansion, largely thanks to a renewed expansion in outstanding debt.
So there you have it. Debt growth leads to economic growth. The trick is to simply ensure the debt growth leads to productive economic growth, so that there is enough income to satisfy debt servicing costs and keep the game of pass the parcel going.
This is sort of a long winded introduction into the issues facing China and Australia right now.
China ended 2013 with a brewing credit crisis, and it enters 2014 with the brew heating up. The Financial Times reports today that tighter monetary conditions in China are beginning to bite:
‘China’s peer-to-peer lending boom is beginning to turn to bust.
‘Dozens of the P2P lending websites that sprang up in recent years have shut as borrowers default on loans. The biggest companies are unscathed so far, but the rapid collapse of smaller rivals highlights the mounting difficulties in the Chinese micro-lending industry as economic growth slows and monetary conditions tighten.‘
To be clear, this is still only on the periphery of China’s credit system. It’s the intention of the People’s Bank of China (PBoC) to cause some pain in the smaller, ‘peer-to-peer’ lending industry. But all credit troubles begin on the periphery. The challenge for the PBoC will be to stop the problems moving into the core.
Right now, the consensus view is that China’s central planners will be successful in doing that. We spent a great deal of 2013 saying such containment isn’t possible, and we haven’t changed our tune in 2014. It’s really a matter of time and degree.
Don’t forget though, based on the most recent figures, China’s credit growth is still booming. The month of November saw credit growth of US$200 billion and represented an acceleration on October’s US$140 billion growth.
But you should see a slowdown taking place over 2014. Market interest rates are starting to rise in China. Debt servicing is becoming more expensive. Combined with the PBoC’s efforts, this should see a slowing of credit growth back down to much more normal levels.
The big unknown with rising interest rates is to what extent it turns debt ‘bad’ and impairs the banking system. And it’s especially unknown how it will work in a state owned banking system like China.
It’s widely believed that the government will protect the banks. Maybe so, but it’s the household sector that funds the government, and it’s the household sector that lends to the banks (via deposits) so any bailing out of the banks will be indirectly funded by China’s households. If that’s the case, you can say goodbye to any meaningful increase in domestic consumption over the next few years. This will just make China’s rebalancing challenge even harder.
But even before you see evidence of a slowdown in credit growth, China’s economy is cooling. Clearly, the late stage credit expansion is no longer providing enough fuel to maintain China’s historically high growth rates.
Late last week, data showed that China’s exports grew slower than expected at 4.3% year on year for the month of December. That’s much slower than the 12.7% year on year growth experienced in November. Along with weak manufacturing and services sector data out recently, it shows that China will struggle to achieve its stated aim of 7.5% growth.
Poor unemployment data out of the US followed China’s weaker than expected trade numbers. Economists expected growth of 200,000 for December’s non-farm payrolls, but instead got just 74,000.
Continuing one of 2013’s primary themes, the market considered this ‘good’ news because the Fed would surely leave its stimulus intact just a little longer, right? So stocks went up on the news. Brilliant.
If only from a short term perspective, there is one major difference between 2013 and 2014, and it raises considerable uncertainty for Australia.
Thanks to prolonged bouts of cheap money, the developed economies like the US, the UK and Europe have more momentum now than they did this time last year. This is leading many to expect the start of a tightening cycle, which includes higher interest rates for Australia.
But depending on how things go in the Middle Kingdom, we could be looking at further rate cuts as 2014 unfolds. We argued last year that Australia still has some monetary stimulus in the system from the extensive cuts throughout 2012 and into 2013, so the Reserve Bank will likely be on hold for its next few meetings.
The worst scenario for Australia would be much weaker growth in China combined with rising inflationary pressures stemming from a lower dollar. That would prevent the Reserve Bank from cutting rates at a time when our economy would be very close to a recession.
That’s the biggest risk we see for Australia in 2014. A China induced slowdown made worse by the fact that the RBA has already used most of its recession fighting ammunition.
On that note, happy new year!
for Markets and Money