How to profit from China's slowing economy
By
MoneyWeek Editor
John Stepek Dec 08, 2011
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It seems that China is not a one-way bet after all.
Over the past week, China’s central bank has had to intervene in the currency markets. But for once, it’s not been acting to keep the renminbi weak against the dollar.
No, it’s been intervening to prop it up. In the last few months, investors seem to have woken up to the idea that the renminbi might just be able to fall as well as rise.
So what’s got investors spooked about the world’s future economic superpower?
China’s property bubble is bursting
Last week my colleague David Stevenson noted that China’s currency is no longer a one-way bet. A large part of the blame lies with China’s property market.
As we in the West know only too well, property bubbles can be disastrous for an economy.
The good news for China is that its attempts to pop its own property bubble appear to be working. The trouble is, that’s always a painful process. And the amount of damage caused depends on how out of whack you allowed prices to become in the first place.
The country’s top real estate developer, China Vanke, reported earlier today that sales in November had fallen 36% on last year. Lower demand for property means developers won’t have the cash to fund new developments.
That’s already having a knock-on impact to construction firms. Credit Suisse reckons that as many as 80% of Chinese firms are complaining about developers being behind on payments. In turn, that’s hurting companies further down the chain.
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Last month, Chinese construction machinery manufacturer Zoomlion warned that demand for its products had shrunk “drastically and growth will no doubt continue to slow next year”.
That’s all bad news for the companies involved. But it could also be a huge problem for the wider economy.
Alongside exports, much of China’s rampant growth comes from spending on large infrastructure projects. Local governments raise money for these projects by selling land.
The trouble is, if the real estate developers are short of money, they can’t afford to bid for this land, even if they wanted to. The FT reports that land sales in the city of Guangzhou have tanked this year. The city government had budgeted for ¥50bn in sales, a little higher than last year. But in the first nine months of the year, it had only raised ¥14bn. Falling income means less money to spend on grandiose projects, which in turn means slower GDP growth.
The other problem is that bank loans to local governments are often secured against land. If land prices fall and indebted local governments can’t raise more money, then the Chinese banking system will be exposed to significant bad debts.
As my colleague Cris Sholto Heaton has pointed out before, this doesn’t necessarily mean we’ll see a banking crisis on the scale of 2008 in China. But it’s hardly going to be pleasant either.
Also, as Edward Chancellor pointed out in the FT last week, “the recent rate of credit growth in China has exceeded that of the US in the years prior to the Lehman bust. A mere slowdown in the flow of new credit, could have a serious impact on China’s economy”.
Even a ‘soft’ landing would be bad news for the rest of the world
The clearest signal that China’s authorities are worried came from central bankers last week. The People’s Bank of China made it easier for banks to lend more money, by cutting the level of reserves they have to hold.
But if there’s one thing we should have learned from the financial crisis by now, it’s that central bankers don’t have magic wands. Also, even a ‘soft landing’ for China is likely to be bad news for companies or countries geared up to service China’s commodity demand.
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Australia is a prime example. A while ago I suggested that shorting the Australian dollar against the US dollar was one of the simplest ways to profit from a China slowdown. The Aussie peaked at around $1.10, and has fallen as far as $0.96 or so. Just now it’s back above $1, but I suspect it’ll fall below parity again.
In the short term, this will be influenced as much by global mood in the wake of the big European summit tomorrow. If markets get excited by a new ‘shock and awe’ decision from the Europeans, all the ‘risk-on’ assets, which include the Aussie, will rise.
But in the longer run, it looks too expensive at these levels. If you agree, you could use spread betting to make the trade (sign up for our free email MoneyWeek Trader to learn more about how to spread bet). But if you’re not keen to take that sort of risk, then another option is to buy the ETFS Short AUD Long USD (LSE: SAUP). The fund gives you exposure to a short position in the Aussie dollar.
I’d still suggest that you keep a close eye on its performance if you do decide to invest. Currency trades are always highly speculative and you should always monitor these more exotic forms of ETFs to make sure they do what you expect them to. But if you’re feeling adventurous, and don’t trust your timing skills, this could be a good way to dip your toe in the currency markets.
• This article is taken from the free investment email Money Morning.
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