As the bulls run through Shanghai, Sinologist Bill Bishop is preoccupied with pigs.
Since this is, after all, the year of the Pig, one can’t blame punters for getting a bit greedy. But, Bishop warns, punters “should remember that eventually pigs get slaughtered.” And in the case of China’s stock rally, make that trumped, too.
The proximate driver of this sudden bull run is a possible end to Donald Trump’s trade war. Among the reasons the U.S. president’s approval ratings are rolling around in the mud is the mini-crash in stocks in late 2018. Punters drew a direct line between Trump’s tariffs and plunging shares. Since then, Trump has throttled back tensions, even delaying a March 1 deadline for new assaults on Asia’s supply chains. Hence the “Trump rally.”
Yet the slaughterhouse imagery that worries geopolitical experts like Bishop of Axios remains relevant. Though Trump pushed Xi Jinping’s economy toward the blade, China bears responsibility for its unbalanced financial system.
President Xi is the most powerful Chinese leader in generations. And yet even he veers more toward stimulus-as-usual over painful structural reforms. Of course, blame for China’s vulnerabilities pre-date Xi. The roots of Beijing’s current troubles can be found in 2008, when Hu Jintao held the reins.
What Trump’s trade war did was demonstrate the extent to which the bill for Beijing’s response to the 2008 “Lehman shock” is coming due. The slowest growth in 28 years–6.6% in 2018–is one metric. So is the drop in net earnings last year at 30% of China’s roughly 3,600 listed companies.
The most important, though, is last year’s surge in corporate defaults to a record $18 billion from $4 billion in 2017. Another vital metric: roughly $715 billion of bonds mature over the next 10 months, increasing the odds that the great Chinese default reckoning investors long feared could be coming.
Hence relief that Trump appears to be throttling back. Investors are right to rejoice if Trump and Xi come to an understanding, one that allows both nationalist leaders to declare some semblance of victory. Even if Xi gets the better of Trump, which the odds favour, Trump will declare “fake news” and move on.
Yet here’s the problem: nothing about a trade détente treats the addiction to runaway stimulus China Inc. developed since 2008.
It started innocently enough. Wall Street’s crash had leaders around the globe pondering existential questions about legitimacy and social stability. None more so than those presiding over the most populous nation. In that context, few questioned the 4 trillion yuan, or $597 billion, jolt of stimulus that Hu’s government back then pumped into the economy.
By 2017, the pump-priming strategy topped the $2 trillion mark. And that is just what we know of, given the vagaries that plague Chinese data. In the years between when Hu handed the baton to Xi in 2012, local governments ginned up many trillions of dollars of giant infrastructure projects.
National gross domestic product got epic boosts from dozens of tier 3 and tier 3 cities joining major metropoles in modern history’s greatest building boom. New dams, six-lane highways, airports, entertainment centres, international hotels, cavernous shopping centres and white-elephant projects kept GDP north of 6%. By 2017, analysts like Charlene Chu of Autonomous Research Asia were putting the bill for all the credit growth behind that stimulus at higher than $33 trillion.
The end of Trump’s trade war won’t help Xi’s government manage the bills coming due. Nor does it give Beijing back the last decade of putting stimulus over modernising the financial system.
To be fair, Xi has tried to reduce excesses. Regulatory tweaks to curb leverage and shadowing-banking activities have indeed injected an element of sobriety into China Inc.
But Trump’s tariffs reminded the world how little progress Beijing made shifting growth engines to services and innovation from exports. They also demonstrated a diminishing-returns challenge. It’s a matter of economic gravity that, over time, the GDP payoff from construction booms lose potency. China, as Ian Bremmer of Eurasia Group points out, already has an estimated 65 million empty apartments. It hardly needs more.
The trade war exposed a major flaw in Xi’s ambitious “Belt and Road” and “Made in China 2025” initiatives. Unless these global gambits are undergirded by a vibrant and sturdy domestic economy, they’ll falter in the long run.
The same goes for Beijing’s efforts to increase the yuan’s use in world trade. In 2016, Xi’s team appeared to think its work was done when the International Monetary Fund welcomed the yuan into its reserve-currency club, making it a top-five monetary unit. Unless Beijing loosens the capital account, increases transparency and give traders a bigger role in deciding exchange-rate levels, trust in the yuan will lag.
The same is true of the stock bourses that the bulls are rediscovering. Just like its IMF milestone, Xi’s government seemed to view MSCI’s 2018 decision to include mainland shares in its indices as a reform in itself. And given the Shanghai Composite Index’s 13% surge this month, the temptation may be to declare all’s well and move on.
Chinese stocks, though, are barely readier for global prime time than in the summer of 2015. Back then, free falling shares prompted Xi’s team to throw Beijing’s full weight at short sellers. It cut interest rates, bought shares, loosened margin requirements and leverage rules, suspended initial public offerings, halted trading in entire sectors of the market and let main landers use homes as collateral to buy shares.
Things stabilised. But nothing about that recovery made China Inc. more transparent, shareholder-friendly, innovative or socially responsible. Nor has Xi’s moves to create stock-connect schemes to link Shanghai and Shenzhen with Hong Kong. Trillions of dollars in transactions, yes. A more international and trusted investment climate, no.
Just something for bulls racing back to Shanghai to consider. If Trump is ready to make a substantive deal with Xi–still a big “if”–it would be a big plus for global markets.
But punters are still left with a China paying the price for 10 years of putting runaway stimulus above bold reform. Until Beijing tends to its problems, not just the symptoms, its markets may just be leading the bulls to slaughter.