China is bouncing back. Apparently.
The stock market has rebounded from its recent low. Economic data is looking more positive. It has a nice shiny new group of leaders to take it on to its next stage of development.
Suddenly all those people who briefly turned bearish earlier in the year are now declaring that there will be no ‘hard landing’ for China.
We’re not convinced. The business model that got China to where it is today is irretrievably broken.
And as yet, it’s not clear what will replace it…
China’s advantages are all used up
There’s a great piece on China’s problems by Andy Xie in the South China Morning Post. It’s well worth a read.
Xie argues that China’s growth has been based on two major “dividends”. One was its becoming a member of the World Trade Organisation (WTO), which boosted its share of global trade. The other was its demographics. It had plenty of young agricultural workers who could be moved to work in cities, producing cheap goods for export.
The trouble is, both of these dividends have now been used up. The export boom was based on having a Western consumer hungry to buy at the other end. That no longer exists.
Why not? The average Western worker – ironically enough – saw their wages stagnate as global competition kept labour costs down. Meanwhile, central banks suppressed interest rates, meaning that living costs were higher than they otherwise would have been.
So credit was the only way to maintain a rising standard of living. When the credit bubble burst, that source of demand was cut off. The only manufacturers benefiting from loose monetary conditions these days are the ones servicing billionaires, not the ordinary consumer.
Meanwhile, China’s supply of cheap labour is drying up. As Xie notes, “the shortage of blue-collar labour, as reflected in wages increasing faster than exports, points to the end of the demographic dividend.” This trend won’t turn around.
On the one hand, workers are increasingly being replaced by robots as automation becomes ever more attractive. On the other, the US has a new source of extremely cheap energy in the form of shale gas.
Labour costs are becoming more competitive too, but if you’re going to be using fewer workers anyway, then power becomes a key cost to consider. Better yet, the US – and Mexico – are much closer to the end consumer. So after you account for transport costs, the benefits of shipping production out to China just don’t add up.
As the export boom collapses, so has the property bubble
Perhaps the biggest problem is what China has been doing in the meantime with the money earned from the export boom. Xie argues that this money went on inflating China’s property bubble, as individuals and companies speculated on ever-increasing land prices.
In turn, income from land sales and tax on property sales – “over half the proceeds from property sales end up in the government’s pocket” – helped fund China’s wasteful approach to infrastructure investments.
When most of us invest our money, we expect to get a return on it. Say you buy a property as an investment. Unless you are buying during a bubble, you expect to be able to rent it out to generate a return almost right away. You don’t expect to have to subsidise it for several years in the hope that it’ll all eventually come good.
That’s not how China invests. It builds ‘ghost’ towns and too many motorways, in the expectation that the capacity will one day be needed. But we all know how hard it is to forecast anything accurately. In some cases, this way of doing things will work out. In many others though, you’ll end up wasting the money.
This doesn’t matter too much as long as there’s a constant stream of fresh money to fund these projects. But with exports drying up, and the property bubble bursting, that’s no longer the case. “Like all other East Asian economic booms before, China’s asset bubbles deflate when the export boom ends.”
What’s the solution? Xie basically argues that China needs to become more capitalist. The size of the public sector needs to be cut back, and the government needs to stop interfering in the market. “Bad companies don’t die, because they get government support.”
Funnily enough, these are the same solutions that ‘developed’ economies like our own could do with pursuing. And this is the problem. Because I suspect there’s as much chance of China coming over all ‘pro-market’ as there is of our own government deciding it’s time to pull the plug on the zombie sectors of our economy.
Don’t buy into a China rebound
As Sean Corrigan of Diapason points out, it’ll take a lot more than words to help China make the shift from being investment-led to being consumer-led. And even if China does bounce back, don’t bet on the most obvious accompanying trade – a rebound in commodities – being successful.
Rebalancing is as much about giving consumers more rights, and going easier on the ‘financial repression’ (whereby savings rates are well below the inflation rate), as it is about moving even more people to the cities. It’s hard to see the next phase of China’s development being anywhere near as commodity-intensive as the last phase. In short, unless you’re a short-term trader, I wouldn’t buy into any China rebound. And as my colleague Merryn Somerset Webb pointed out recently, there are good reasons to be sceptical of Chinese equities regardless of how cheap they may look.
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