In­vestors are in de­nial about China

The Pak Banker - - OPINION - Christo­pher Bald­ing

AS you've no doubt no­ticed, com­pa­nies and in­vestors around the world are feel­ing the pain of China's eco­nomic slow­down. They're wor­ried about all the lay­offs, cuts to sur­plus ca­pac­ity and delever­ag­ing to come on the main­land, which will fur­ther de­press de­mand. The nat­u­ral temp­ta­tion is to blame China for the world's woes. But out­siders should fo­cus just as much on their own mis­steps -- start­ing with the wide­spread mis­per­cep­tion that "this time" would be dif­fer­ent.

Back in 2009, as China un­leashed a mas­sive fis­cal stim­u­lus and in­vest­ment spree in re­sponse to the global fi­nan­cial cri­sis, the rest of the world was all too will­ing to be­lieve the im­pos­si­ble. Aided by­con­sul­tant re­search pre­dict­ing decades of ex­plo­sive growth, com­pa­nies placed huge bets on China and ex­pected to ride the never-end­ing boom to riches.

Amid the gold rush, they bulked up to sell China t-shirts or tons of iron ore. They urged their gov­ern­ments to sign free-trade deals with Bei­jing. Com­mod­ity pro­duc­ers heed­lessly ex­panded ca­pac­ity, be­liev­ing that 10 per­cent growth would con­tinue in­def­i­nitely. Con­sumer brands rushed to set up flag­ships in third-tier Chi­nese cities. Ship­ping com­pa­nies scram­bled to build new fleets to meet an ex­pected ex­plo­sion in global trade.

How­ever, as with so many pre­vi­ous bouts of ir­ra­tional ex­u­ber­ance, this time wasn't real- ly dif­fer­ent. The ruth­less rules of sup­ply and de­mand still ap­plied. And now, the longer that painful de­ci­sions are de­layed, the harder they'll be­come.

Com­modi­ties firms, in par­tic­u­lar, are learn­ing that les­son the hard way. As prices rose with Chi­nese de­mand, they made large up­front in­vest­ments fi­nanced by bor­row­ing -of­ten on a 20-year time­line, in the ex­pec­ta­tion that growth would last and last. Now, with China's econ­omy slow­ing and the prices of ev­ery­thing from oil to met­als plum­met­ing, the bills are com­ing due.

Ma­jor iron ore firms, which had pre­dicted that Chi­nese steel de­mand would keep ris­ing un­til about 2030, are now look­ing at sub­stan­tial over­in­vest­ment and de­te­ri­o­rat­ing credit. Dairy farm­ers, who in­creased their herds with fu­ture Chi­nese con­sumer de­mand in mind, are feel­ing the pinch as milk prices plunge.

Af­ter years of ramp­ing up pro­duc­tion to fuel China's ex­pected growth, oil-pro­duc­ing coun­tries from Saudi Ara­bia to Nor­way are fac­ing grim de­ci­sions about their pub­lic fi­nances. Rus­sia is rapidly drain­ing its sovereign wealth fund. Venezuela is plead­ing with China for loans -- on top of the nearly $60 bil­lion al­ready doled out -- to stave off col­lapse. Pun­dits are warn­ing that the large debt load of U.S. shale-gas and oil pro­duc­ers could pose greater risks than sub-prime lend­ing did a decade ago.

No less so than China, the rest of the world needs to face up to some new re­al­i­ties.

First, the golden age of Chi­nese con­struc­tion is over. There's now enor­mous sur­plus ca­pac­ity in vir­tu­ally ev­ery in­dus­try that re­quires fixed-as­set in­vest­ment. Com­pa­nies can no longer rely on the "Bei­jing put" of new gov­ern­ment stim­u­lus to boost growth. Iron ore pro­duc­ers and cop­per min­ers all need to be­gin a painful process of down­sizin­gand delever­ag­ing -- just as China's bloated state-owned en­ter­prises do. Pro­duc­ers around the world haven't faced up to the new nor­mal.

Sec­ond, com­pa­nies of all stripes have to put in the ef­fort to un­der­stand China bet­ter. Ex­pec­ta­tions of dou­ble-digit growth, re­gard­less of how poor the per­for­mance, have van­ished. Lux­ury brands that once hoped their Bei­jing flag­ships would smooth the bal­ance sheets at Euro­pean head­quar­ters need to rec­og­nize that dif­fer­ent mar­kets re­quire dif­fer­ent strate­gies, and that shops in China won't run on au­topilot. They need to com­pete.

Third, com­pa­nies and coun­tries alike need to face up to their own ir­ra­tional ex­u­ber­ance. Whether it's fail­ing to di­ver­sify, spend­ing reck­lessly on the back of high prices, or tak­ing on too much debt, fun­da­men­tal mis­takes can't be blamed on China. Do­ing so only de­lays the inevitable. Few in­vestors seem to fully ap­pre­ci­ate the bal­ance-sheet reck­on­ing that is com­ing. Fail­ing to ad­dress the global sup­ply glut only in­creases the risk of a larger cor­rec­tion. We know that be­cause this time isn't dif­fer­ent: The bill al­ways comes due.

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