Western analysts’ China syndrome is just a lack of proximity
▶ Outsiders continue to make bearish forecasts for the world’s second largest economy, but investors closer to Beijing and Shanghai see a very different picture
When it comes to analysing China, distance seems to make investors’ views of the world’s second-largest economy grow, shall we say, less fond.
Whether it’s George Soros (who has likened China to the US before the 2008 subprime mortgage crisis) or Kyle Bass (who said the Chinese economy is built on sand) or Jim Chanos (who said, memorably, that China is on a “treadmill to hell”), there’s no shortage of gloomy outlooks.
Over-investment, too much debt, bubbly markets, faked data, Ponzi-like financial structures – the litany of looming pitfalls seems inescapable to many investors, especially hedge funds, based in financial hubs from Connecticut to Canary Wharf and Cape Town to Sydney.
That negativity is a sharp contrast to the majority opinion held closer to Beijing or Shanghai. There, booming consumption, a pick-up in global trade, and an increasingly innovative private sector are fuelling bets that China’s generation-long economic miracle still has plenty of room to run, albeit at a slower rate than the average GDP growth of almost 10 per cent a year since the early 1980s.
“I find it scary how many self-proclaimed US based China experts with real influence have barely lived in China, barely speak Chinese and barely have a clue …” tweeted Shaun Rein, who lives in Shanghai and is founder and managing director of China Market Research Group and author of The War
for China’s Wallet, on December 26. Later, he was on Twitter again, wagering that the “same tired group of China’s watchers will predict China’s collapse for the 40th year in a row… and they’ll be wrong for the 40th time but Western media will keep quoting them breathlessly as experts”.
Mr Rein may have a point, according to Bloomberg, but there are plenty of investors across the Pacific who take a longer view on China. Corporate America, for one, has long seen through the fog of gloom.
Boeing is building its first overseas “completion centre” for 737 aircraft on Zhoushan Island south of Shanghai. In 2016, Walt Disney opened a $5.5 billion theme park in Shanghai – its biggest-ever foreign investment. Tesla says that within the next several years it plans to begin making automobiles in China, where surging demand for electric cars contributed 15 per cent of the company’s revenue in 2016.
Meanwhile, in December, the world’s biggest Starbucks opened in Shanghai.
Western banks, which have long coveted the vast Chinese market but had mixed success entering it, are looking at new opportunities now that President Xi Jinping promised to open up the sector to greater foreign competition.
UBS is in discussions to acquire a majority stake in its Chinese securities joint venture, and Morgan Stanley and Goldman Sachs have signalled a desire to take majority stakes in their own Chinese ventures.
BlackRock, Fidelity International, UBS Asset Management and Man Group are among global fund managers expanding in China.
Some analysts and investors base their assessments on the assumption that China is destined to share the fate of Japan, whose three-decade boom hit a wall in the early 1990s. This supposition is questionable.
China is still at a much lower stage of development than Japan; on a per-capita basis, China’s GDP in 2016 was less than 40 per cent of where Japan was in 1970, according to World Bank Group data.
What’s more, China is a vast, multi-regional economy – not an island. That means it can keep posting world-beating growth even when some regions do turn down, as happened in 2016 and early 2017 when the industrial north-east slowed as the government pushed through an economic rebalancing that promotes consumption and services.
As China enters the lunar Year of the Dog, the gloomy bears say it’s unlikely that plans to curb loans and credit expansion can succeed without denting growth. Mark Williams, chief Asia economist at Capital Economics in London, for instance, thinks government statistics have inflated GDP readings. He reckons China’s GDP growth will slow to 4.5 per cent this year, whereas the more than 100-strong research team at China International Capital Corp, the country’s first Sino-foreign investment bank, thinks the economy will actually accelerate to 7 per cent.
The investment bank downplays the negative impact of total borrowing, which has risen to more than 2.5 times China’s GDP and is generally seen as the biggest risk factor facing the economy. It argues that both the state sector and households have more than enough cash on hand should trouble strike. In addition, it says, the most indebted sector – corporates – is sitting on cash equivalent to about 40 per cent of current debt. That, according to Liang Hong, the company’s chief economist, means that while government reforms to cut debt levels in China are important, they needn’t translate into negative growth.
Another point missed by the Connecticut-set mentality is this: China’s debt is largely self-funded and will remain that way as long as the country hangs on to a healthy current account surplus, according to Michael Spencer, global head of economics at Deutsche Bank in Hong Kong. “Hedge funds in New York have been saying for seven years it’s going to be a crisis, but it clearly hasn’t been the case,” he says. “China is not investing New York hedge fund money. It is investing Chinese home savings.”
That’s not to say the China bears don’t have legitimate concerns. The country’s total debt from the government, households and non-financial companies reached 256 per cent of GDP in June 2017, already surpassing that of the US (250 per cent), according to the Bank for International Settlements.
That’s up from 146 per cent a decade ago, and it marks a faster pace of debt accumulation than occurred in the US during the period leading up to the housing crisis. Even officials in Beijing are taking the possibility of asset-price collapse seriously: outgoing People’s Bank of China Governor Zhou Xiaochuan in October warned of the risk of a debt-induced Minsky Moment, and Mr Xi has prioritised financial stability through his second term in office.
Confidence in the ability of China’s policymakers to manage the economy wavered in 2015, when an epic stock market crash and bungled exchange rate reform sent global markets into a tailspin. But more than two years on, the clear takeaway from that episode is the need to distinguish market ructions from real economic activity: economic growth largely held up through that crisis as authorities used levers such as capital controls to stem the fallout.
For all the talk of reform, the central government retains a firm grip on the economy. The heavy fist of the state still often trumps the invisible hand of markets, credit is still channelled from state-owned lenders to state-owned firms, and local governments can still ramp up infrastructure investment at the first whiff of a slowdown. That sort of investment rationale is behind one of Mr Xi’s signature policy initiatives
I find it scary how many self-proclaimed US-based China experts with real influence have barely lived in China
SHAUN REIN
Founder, China Market Research
– the Belt and Road initiative that Beijing says will pump $1.3 trillion into roads, ports and other construction projects designed to connect China to trading partners across Asia and into Europe. While the state and local involvement is a plus for near-term stability, it could also be a tax on the future if capital is misallocated.
Banks are often identified as China’s weakest link. A deepdive analysis by the IMF in 2017 recommended that the nation’s lenders should increase their capital buffers to protect against any sudden economic downturn. The fund last month raised its forecast for China’s economic growth in 2018, amid an upbeat outlook for the global recovery, according to Xinhua state news agency. The IMF expects China’s GDP growth to stand at 6.6 percent this year, up from the 6.5-percent prediction made last October.
Also last month, the IMF pointed out the importance of China to the rest of the world. “The Chinese success story is deeply intertwined with the fortunes of the world economy,” IMF first deputy managing director David Lipton said.
He said that as a trading nation, China is a key partner for over 100 countries, which represent more than 80 per cent of global GDP. He said that China alone is providing one-third of global growth, and is outweighing other countries in areas of digital commerce, FinTech, robotics and artificial intelligence.
He also pointed out that Chinese investors and creditors are “playing an increasingly important role in the development in infrastructure finance”, and China’s foreign direct investments are “growing in size and importance, bringing positive benefits to other developing countries”. Kevin Smith, Denver-based chief executive and founder of Crescat Capital, says a banking implosion is inevitable; the only question is when. Mr Smith has held short yuan bets since at least 2014, a position that helped his global macro fund gain 16 per cent in 2015 when the PBOC surprised the world with its mini-devaluation, Bloomberg reported.
Mr Smith was less fortunate last year when China’s economic recovery and tightening capital controls helped the yuan to rally. His fund lost 23 per cent in 2017. The loss cut the fund’s annual return since its 2006 inception to 11 per cent, which still outpaced the S&P 500 index’s gain of 8.8 per cent during the period. Mr Smith is undaunted. “We remain grounded in our analysis,” he says.
“Credit bubbles burst. Ponzis implode. In the end, we believe China will be forced to print trillions of US dollars equivalent of new money to recapitalise its banking system and bail out its depositors.” In that scenario the currency will crash, Mr Smith says, who’s also short on various Chinese equities.
Because changes across China’s extensive economy tend to be subtle and gradual, it’s often hard to get a feel for the pace of development, according to Mo Ji, Hong Kong-based chief economist for Asia ex-Japan at Amundi Asset Management, who called a bottom to China’s slowdown in late 2015, well before it was a consensus view.
She has been working for the past 13 years with the Nobel laureate economist Joseph Stiglitz on analysing China’s economy, having first met him when she studied under him for a doctorate at Columbia University. “The further away from China, the more difficult to feel all the real changes,” Ms Mo says.