The Chinese hard landing. Remember that one? It started around 2010 and went until around 2015 until proponents threw in the towel. With new tariffs on Made in China goods, and a government reluctant to stimulate the economy through deficit spending, investors are getting anxious.
True, more than a few investment firms believe China will weather this storm. Stimulus will kick again later this quarter, and the second half of the year will be better, Morgan Stanley analysts wrote in a note last week.
Worth noting here, China’s shadow banking system — a provincial form of funding pet projects with little economic viability — has been clamped down upon by Xi Jinping. Because of that, credit growth has declined dramatically in China. That’s one of the reasons for the slowdown in the growth rate, even if China is still growing over 6.5%, according to Beijing.
“Sentiment is weaker than what the growth rate indicates,” says Weijian Shan, founder of Asia’s largest private equity firm, PAG, with over $30 billion in assets under management. “If you look at the 6.6% growth rate in China you’d say ‘wow, that’s a pretty good number’, but business sentiment is weak despite that number. Business people are worried. Shenzhen listed stocks are down over 30%, which is a better reflection of the private sector than Shanghai. So it doesn’t look like an economy growing at 6.6%, does it?”
Shan was separated from his family in his early teens and sent to communist labour and education camps, where he spent the rest of his teens. He wrote about his life in the book “Out of the Gobi.”
To many in the market, no it does not look like China is growing at 6.6%. Bears put it at half that, which is too low for a country that is coming to the grips with a demographic shift of more old people than working people.
China stimulus includes the central bank intervening in the stock market.
Last week, the People’s Bank of China (PBoC) announced its latest liquidity injection scheme. China bears said it was a precursor to Chinese QE.
The new scheme allows China’s primary broker-dealers to swap their holdings of perpetual bonds for central bank T-bills, and then use them as collateral to get cheap PBoC credit. This sounds like an economy facing, as Xi put it last week, “serious dangers.”
The measure is designed to increase demand for Chinese bank-issued bonds, making them “riskless” thanks to the PBoC backstop. That demand can be used to bolster capital and keep markets moving. Yeah, this isn’t your grandma’s communist system.
Three years ago, China had the largest current account surplus in the world. This year and next, China is expected to run a slight deficit, transforming China from the world’s largest exporter of capital to a modest capital importer, Barclays Capital economist Mike Gavin says. In other words, China goes from being a net lender to a net debtor. It is this debt burden that moves the China hard landing doomsday clock closer to midnight.
PBoC now has a trillion dollars less in foreign currency reserves than it did in 2015, around $3 trillion today.
Even so, a hard landing is a long way away. It would require a massive misstep by the PBoC, which to date has proven to be quite mechanical and able to contain crises. Against this backdrop, however, investors believe the yuan weakness to CNY7.0 to the dollar in the near future, which is what bearish investors like George Soros have been waiting for now for at least two years.
China: Less Money to Cut U.S. Trade Gap
China is approaching a negative current account. In 2010, it had a current account surplus equal to roughly 10% of GDP. Today it’s near zero. Next year, Barclays Capital thinks it’s below zero. One of the reasons for that is because of China’s maturing economy. For starters, more middle class people spending money abroad. Money is flowing out of China more than ever before.
“The erosion of the Chinese current account surplus reflects a desirable re-balancing of the economy that is likely to continue for some time to come,” says Gavin from Barclays.
For those chomping on the bit for a hard landing in the Chinese economy, the good news is that China’s ability to run large, sustained current account deficits is constrained by market forces and the trade war. Chinese officials are coming to Washington this week for the second round of talks during the ceasefire agreement reached in Buenos Aires back in November.
Washington’s rumour mill put leaked to the press that the Chinese were considering zeroing out U.S. China trade gap by 2025. They were going to go on an American shopping spree. But now that investors have had a few days to chew on those stories, they are positive that China will not zero out the trade gap because China doesn’t have the money (let alone the market) to do so.
“It is very difficult to believe that China’s current account balance would not worsen significantly if its U.S. trade surplus approached zero,” says Gavin.
Moreover, maintaining a current account deficit runs directly opposite to China’s One Belt One Road initiative designed to export excess domestic savings (and notorious Chinese oversupply) abroad. China is in a pickle like it hasn’t been since the first hedge funds started predicting a crash landing nearly 10 years ago.
As the hard landing outlook becomes more plausible today than it was even a year ago, investors should treat any announcement this week in Washington about China buying more Made in the U.S.A. with scepticism.