China is in for a hard landing - here’s what to do about it
By
Matthew Partridge Feb 16, 2012
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Will China have a 'soft' landing?
More than 80% of fund managers think it will, according to the latest Bank of America Merrill Lynch survey. The bulls point to strong consumer sales data and low official levels of government debt.
However, other experts are more worried. They point to the collapsing property bubble and slumping imports as evidence that the slowdown will be more serious. Jim Chanos of Kynikos Associates even thinks the situation could end up being as grim as the crashes in Ireland and Japan.
So, who’s got it right? The answer may lie in China’s recent decision to roll over local government debt (ie give them more time to pay it back) - here’s why.
Why the debt rollover is a bad sign
The Chinese government reacted to the 2008 crisis by getting local governments to spend more, financed by loans from state banks. The belief was that regions, cities and villages would be able to pay the money back by selling land to developers.
As long as house prices soared and demand from developers was high, this strategy looked like it could work. Indeed, there were so many land sales that there were protests from those who were displaced.
However, the property boom is now over. Empty homes and falling prices mean that developers don’t want to – even if they could – buy any more land. There is even satellite evidence of entire 'ghost cities' with no-one living there.
Cities have tried to 'persuade' developers to keep buying, by bribing them with low- or no-deposit deals. However, even in China political pressure and cheap credit has its limits. Caixan Online has noted that land sales for houses and apartments in Beijing fell by half in 2011.
So local governments are stuck with huge loans and no means to pay them. The rollover is a sign that they have run out of options.
But China’s move can only buy time. In the end, the state-run banking system will have to write the loans off, threatening the banks’ solvency and adding to government debt.
The burst property bubble will also have other effects. Professor Patrick Chovanec points out that building as a share of China’s GDP is nearly double what it was for the US economy in 2005. He estimates that even a 10% fall in property investment would cut GDP to 5.3%. Given that housing starts fell by 25% in December this is an optimistic scenario.
China isn’t quite as dynamic as it looks
Some argue that China can survive a recession because its trend rate of growth is so fast. Even if it stumbles, its long term prospects are still great.
We disagree.
Firstly, much of recent Chinese growth is partly due to the real-estate bubble – making the 'trend' rate seem higher than it is.
Next, some of the key factors that boosted the economy are coming to an end. Rising wages means that the days of low cost offshoring are over. As we reported in MoneyWeek magazine recently, firms are starting to bring back production to the developed world. Meanwhile, growing popular anger at pollution may hit China’s cost advantage.
China’s population is also ageing. Indeed, population experts suggest that the number of workers may peak as early as next year. Even if the one-child policy ends, and it remains for the moment, it will take decades to reverse.
Don’t look to the data for the true scale of a slowdown
While China may have changed from the days of Mao, nearly all large firms are still state-run. Corruption and very weak property rights are also problems. The pace of reform has slowed.
Investors should also be wary of taking official data at face value. Experts agree that statistics – especially around growth and inflation – are changed so that they meet political goals. Even officials admit that some figures can’t be trusted.
In 2005 the World Bank cut its estimates of China’s total GDP by 40%. It has also criticised the way in which price changes are measured. This suggests that even if growth figures remain rosy, the true picture may be much worse.
How to play a China slowdown
There are two ways to play a China downturn. One way is to bet against commodity-rich currencies. This is because weaker Chinese growth means less demand for raw materials. We’d be wary of shorting energy-rich countries like Brazil – because trouble in the Middle East could send oil prices sky-high. However, weaker demand for Australia’s metals could hit the Aussie dollar.
Another option would be to invest in gold. As we have noted, demand from China has been one of the key drivers of the recent gold boom. Although lower growth means there will be less money around to chase precious metals, many Chinese investors have been buying gold to protect their savings from the property crash. More economic uncertainty could drive even more of these savings into gold.
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Matthew Partridge
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