Earlier this week, Morgan Stanley’s head of emerging markets, Ruchir Sharma, quipped ‘the next recession will be made in China’. While not particularly inventive, I admit it does have a certain ring to it. And as far as catchy phrases go, it does capture the zeitgeist of today.
Increasingly, economists view Greece as a mere sideshow compared to the troubles plaguing China. The prevailing theory is that China is on the cusp of collapsing under the pressure of its hefty asset bubbles.
That sentiment was reinforced again today by Credit Suisse’s Andrew Garthwaite. He believes China is the single biggest threat to the global economy. Garthwaite thinks China presents the perfect triple-whammy of risks that, together, threaten to send global growth rates below 2%.
The three-pronged threat he refers to comes in the form of credit, investment and real estate bubbles. The fear is that one, or a combination, of these assets threatens to derail China’s economy.
That may be so, but how is this different to the rest of the world?
You could spin a globe with your finger and wait for it come to a stop. The chances of landing on a country facing the same problems as China would be fairly high I imagine.
It’s true that China’s problems are magnified because of its sheer size and economic heft. It’s also true that China presents a unique set of challenges for the globe. Certainly China affects the world in a way that, with all due respect, Fiji never could. Its continued slowdown would lower growth rates across the world, such is its influence on world trade. That’s especially true for resource exporters like Australia.
But China’s only fault is that its economy is much larger than most of the world. Yet the symptoms heralding an economic meltdown are much the same everywhere else. From Europe, to the US, right down to Australia; the story remains the same.
I have no intention of dispelling any arguments that seek to portray China as a troubled economy. Instead, I want to draw your attention away from governments, economies, and ‘feckless’ investors. There’s a far bigger disease in the world economy. What am I referring to? I’m talking about central banks, of course.
The curse of central bankers
China’s problems are the same ones dogging other developed nations because they’re propagated by the like-minded central bankers.
In the last decade in particular, there’s been a concerted effort to lower interest rates across both developed, and developing, economies.
These policies get the usual PR treatment. We need it to help our exporting sector. We need rate cuts to boost spending in the economy. To be sure, both of these things take place — to an extent. But often they fail to offset the problems associated with credit expansion.
Credit expansion, or money printing, isn’t a viable, long term solution to anything. All it does is lead to creeping inflation as the amount of money in the system expands. The result of this is that purchasing power erodes, and people wake up one day wondering how things got so expensive. Even worse, this system is reliant on further currency printing (debt) to maintain. It’s a veritable house of cards; a never-ending loop where debt accumulation becomes the strategy in and of itself.
But not to worry; at least the illusion of wealth doesn’t fade.
The influx of new ‘money’ gives people the green light to borrow more, and then some. When you give people access to credit that they have no business having, you get bubbles. You get a flood of capital pouring into real estate and stocks.
Once the effects of a round of credit expansion slows, the central bankers turn the valve by another notch.
I don’t believe investors are to blame for this. After all, they don’t write the rules of the game. Instead of blaming investors for buying homes and stocks, we need to make the central banks more accountable. Even lacklustre government fiscal policy seems harmless by central banking standards. Looser monetary policy is the single biggest factor leading China, and everyone else, towards disaster.
But how can anyone limit the influence of central banks? Is it even possible? Unfortunately, central banks are a law unto themselves. They answer to know one — not even the government.
Nonetheless, economists are happy to line up and condemn governments, and investors, for our present challenges. They post images of Chinese fruit sellers, sitting at their stalls with computers tracking stock market movements. That’s a sign of ‘our’ madness, they say. But investors don’t control the money supply. We’re not the ones printing money out of thin air.
China meets 7% target…or does it?
The Chinese government announced on Wednesday that it met its 7% growth rate for the year to June. Admittedly, I chose to remain cautiously optimistic about this development; convenient as it was. My colleague, Markets and Money’s Greg Canavan, was less convinced.
Here’s what he had to say on it yesterday:
‘Surprise, surprise, [China’s GDP growth] came in bang on target at 7% growth! You sure don’t want to announce below target growth in the middle of a stock market crash, especially when you’ve just made it a capital offence to sell stocks in a desperate attempt to prop up the market.
‘Meanwhile, more reliable economic data suggests China’s growth is much lower than the official 7%’.
‘’[In June, China] recorded a 3.4% monthly year-on-year drop in new car sales, its first decline in more than two years. More worrying, the China Association of Automobile Manufacturers also cut its growth forecast to 3% from 7% for this year’.
As Greg says, car sales are indicative of economic growth. Steel production is too, and China fared just as poorly on that front. Crude steel production fell by 1.3% in the first half compared with the same period in 2014. Greg continues:
‘The reality is that other data says China’s growth is much slower than the official line. The only explanation for the lucky seven growth number is the spike in activity in the financial services sector. However, the stock market bubble induced surge won’t last’.
Credit Suisse’s Garthwaite would agree with that. He says that Chinese private sector debt-to-GDP now stands at 196%. That’s 40% above the long term trend, and worse than the US at the height of its credit bubble. According to Garthwaite, history has shown that a financial crisis usually follows once credit goes 10% above the long term trend.
As for Chinese real estate, it’s had mixed fortunes. China’s property market, as a share of GDP, is a not-so-insignificant 23%. That’s roughly three times as high as it was prior to the US housing crash in 2007–08.
House prices in the biggest cities are starting to rise again. But that success isn’t spilling over into other cities; the so-called tier three and four cities.
According to Garthwaite, China still suffers from an overabundance of properties. Vacancy rates are between 15% and 23% depending on where you look.
China does have structural challenges facing it. But so does the rest of the world. We have good reason to worry about Chinese, US, European and Australian growth in equal measure. But again, we need to put the spotlight back on central banks.
Instead of asking ourselves whether the banks will raise or lower rates, we should ask why they hold such power over the global economy. And why central bankers seemingly act in unison with one another, setting the world down a road of classic boom and bust scenarios.
The asset bubbles cropping up around the world are there by design. All roads lead back to central bankers.
Contributor, Markets and Money
PS: The Aussie sharemarket will face its fair share of pain as global markets tumble. The fallout from an international collapse in equities will have big repercussions on the Aussie sharemarket.
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