Outlook on China’s economy seems darkest from a distance

By Enda Curran and Ye Xie  /  Bloomberg

Sat, Feb 10, 2018 - Page 9

When it comes to analyzing China, distance seems to make investors’ views of the world’s second-largest economy grow, shall we say, less fond.

Whether it is George Soros, who 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 memorably said that China is on a “treadmill to hell,” there is 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.

That negativity is a sharp contrast to the majority opinion held closer to Beijing or Shanghai. There, booming consumption, a pickup in global trade and an increasingly innovative private sector are fueling 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 percent 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, Shanghai-based founder and managing director of China Market Research Group and author of The War for China’s Wallet, published on Dec. 26 last year.

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.”

Rein might have a point, 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.

Chicago-based Boeing Co is building its first overseas “completion center” for 737 aircraft on Zhoushan Island south of Shanghai. In 2016, Walt Disney Co opened a US$5.5 billion theme park in Shanghai — its biggest-ever foreign investment. Tesla said that within the next several years it plans to begin making automobiles in China, where surging demand for electric cars contributed 15 percent of the company’s revenue in 2016.


Meanwhile, in December, the world’s biggest Starbucks — all 2,787m2 of it, about half the size of a soccer field — 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 Chinese President Xi Jinping (習近平) has promised to open up the sector to greater foreign competition.

UBS Group AG is in discussions to acquire a majority stake in its Chinese securities joint venture, and Morgan Stanley and Goldman Sachs Group Inc have signaled a desire to take majority stakes in their own ventures. BlackRock, Fidelity International, UBS Asset Management and Man Group are among global fund managers expanding in China.

If much of the commentary on China from the West remains bearish, blame Japan. 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 percent of where Japan was in 1970, according to World Bank Group data.

What is more, China is a vast, multiregional 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 last year when the industrial northeast 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 have said it is 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, said government statistics have inflated GDP readings. He said China’s GDP growth would slow to 4.5 percent this year, whereas the more than 100-strong research team at China International Capital Corp (CICC), the nation’s first Sino-foreign investment bank, thinks the economy could actually accelerate to 7 percent.

CICC 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 No. 1 risk factor facing the economy.

The investment bank argues that both the state sector and households have more than enough cash on hand should trouble strike. In addition, the most indebted sector — corporates — is sitting on cash equivalent to about 40 percent of China’s debt, CICC said.

That, according to Liang Hong (梁紅), the company’s chief economist, means that while government reforms to cut debt levels in China are important, they need not translate into negative growth.


Another point missed by the Connecticut-set mentality is this: China’s debt is largely self-funded and should remain that way as long as the nation hangs on to a healthy current account surplus, said Michael Spencer, global head of economics at Deutsche Bank AG 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 said. “China is not investing New York hedge-fund money. It is investing Chinese home savings.”

That is not to say the China bears do not have legitimate concerns.

The nation’s total debt from the government, households and non-financial companies reached 256 percent of GDP in June, already surpassing that of the US (250 percent), the Bank for International Settlements said.

That is up from 146 percent a decade ago and it marks a faster pace of debt accumulation than occurred in the US during the period leading 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 (周小川) in October warned of the risk of a debt-induced Minsky Moment, and Xi has prioritized 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. Yet, 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 channeled 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 Xi’s signature policy initiatives — the Belt and Road Initiative that Beijing has said would pump US$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 deep-dive analysis by the IMF last year recommended that the nation’s lenders increase their capital buffers to protect against any sudden economic downturn.

Kevin Smith, Denver-based chief executive officer and founder of Crescat Capital LLC, said a banking implosion is inevitable — the only question is when.

Smith has held short yuan bets since at least 2014, a position that helped his global macro fund gain 16 percent in 2015 when the People’s bank of China surprised the world with its minidevaluation.

Smith was less fortunate last year when China’s economic recovery and tightening capital controls helped the yuan to rally. His fund lost 23 percent last year. The loss cut the fund’s annual return since its 2006 inception to 11 percent, which still outpaced the S&P 500 index’s gain of 8.8 percent during the period.

“We remain grounded in our analysis,” Smith said, undaunted. “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 recapitalize its banking system and bail out its depositors.”


In that scenario the currency would crash, Smith said, who is also short on various Chinese equities.

He was not alone in getting the yuan bet wrong last year. Consensus estimates at the start of last year forecast the dollar would buy 7.15 yuan (US$1.14 at the current exchange rate) by year-end — it ended at 6.50 yuan.

Headline economic data do not tell the story of trends and developments actually taking place on the ground, from the industrial northeast to the high-tech south and the agricultural interior, said Frederic Neumann, co-head of Asian economics research at HSBC Holdings PLC in Hong Kong.

The government’s firm hand on the tiller, he said, needs to be closely watched.

“The further away students of China are located, the more easily such nuances get lost, leaving many to focus more on the risks than on the promises of the country’s economic future,” Neumann said.

Because changes across China’s extensive economy tend to be subtle and gradual, it is often hard to get a feel for the pace of development, said Ji Mo (紀沫), 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 Nobel laureate economist Joseph Stiglitz on analyzing 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,” Mo said.

Stephen Roach might spend a lot of time in Connecticut — he is a senior fellow at Yale in New Haven — but he would never be accused of being part of the Connecticut set.

A former non-executive chairman of Morgan Stanley in Asia, Roach first went to China in 1985 and still travels there four or five times a year. He said there is a tendency to project the West’s crisis-prone outcomes onto China.

“Connecticut-based hedge funds and Washington-based politicians,” he said, “are equally guilty of this long-standing bias.”