Is China’s rebound for real? Don’t bet on it

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.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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9 Responses

  1. 19/12/2012, Jessica King wrote

    Just so you know, China is estimated to have the world’s biggest natural reserves of shale gas which they are currently in the process of extracting.
    So although the US has certainly benefitted from its own reserves, that does not exclude the possibility of China’s adding natural gas to its list of exported commodities.
    Also, it remains the world’s biggest provider of rare earth minerals – 90%? of the global total, – which are necessary components of batteries and smartphone screens among other things.

  2. 19/12/2012, Avon Barksdale wrote

    MoneyWeek/Morning should just put their hands up and admit they got it wrong on China. . . and Japan . . . and UK property. I realise you’re running a business that relies in no small part on convicing readers that the world’s going to hell in a hand-basket but you can’t make up for consistent inaaccuracy with endless repetition.

    Sure, China may indeed suffer the “hard-landing” MoneyWeek’s been ramming down everyone’s throat but it ain’t happening any time soon.

    Frankly, I’ll take Jim Rogers’ forecasts over yours ANY day of the week.

  3. 19/12/2012, DRH2761 wrote

    Avon, to be accurate you spell inaccuracy thus.
    Jim Rogers acknowledges China will suffer a major slow down it will just not land as heavily as the US. Jim owns Chinese stocks but is not adding to them.
    I have been to China many times over the past 15 years and I have no doubt it will be the worlds prime economy before too long.
    However they have some bitter pills to swallow.

  4. 19/12/2012, MichaelL wrote

    Jessica – there are a lot of rare earth minerals sitting in the ground in Australia and Africa – I also wouldn’t discount the possibility of resource nationalisation as regimes in Africa change; though China will probably try to counter that either by subsidy or force.

  5. 19/12/2012, pedantic wrote

    DRH2761: Since you’re keen on accuracy, world’s in the context of your sentence has an apostrophe thus.

  6. 19/12/2012, jrj90620 wrote

    Seems like the Chinese value education,of their children,much more than Americans.That should be a major benefit for them,over the long run.

  7. 19/12/2012, jimtaylor wrote

    I still don’t see what is in it for a UK investor.
    China seems to be generating wealth for China, but not foreign investors. It might be worth apunt that might come good in 10 years time, or may be worth nothing instead?

    Much better to buy shares in UK-listed companies with a Global business and let the business leaders generate wealth for investors by doing business with China.

  8. 19/12/2012, Marc wrote

    I think although Moneyweek often have useful information they are often bearish after huge sell offs.

    An example is miners which were sold off hugely and bounced from the bottom. Moneyweek were bearish at the bottom.

    I think we are seeing something similar with China. I couldn’t care less about the economics of it. It’s stock market has been hammered down and in general the mood is bearish. I always prefer buying at times like these.

    When things are looking good you have already missed the bottom by a long shot.

  9. 21/12/2012, Cribby Hempster wrote

    China’s two great advantages are used up. AGREED! but that doesn’t mean China is in the dumps. 1st- those two parts of the economy won’t just vanish into thin air. 2nd- the China government is engineering the next engines of growth by pushing, intentionally pushing themselves into higher value products.

    I enjoy the stimulating effect of this article, though it’s misleading for those who know nothing about China.

Commenting on this article closed

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