It’s not always easy being a rising superpower, and the delicate task of returning the world to a bipolarity unseen since the height of the Cold War while managing to maintain some semblance of diplomacy with a dying hegemon that doesn’t realize its glory days are behind it is made all the more difficult when the future of global growth and trade depends on the trajectory of your economy. That’s the monumental geopolitical and economic task facing China and its leader Xi Jinping (or, "Big Uncle Xi", as he’s affectionately known).
China’s economy and financial markets have both experienced explosive growth, but are now plagued by a kind of policy schizophrenia, in which the government is at pains to live up to China’s responsibilities as the driver of the global recovery and shepherd of a new economic world order (both of which necessitate some base level of transparency and market liberalization) while preserving enough of the command economy to ensure that the Party and everything it stands for isn’t swallowed up by capitalism. This is made all the more difficult by the fact that Beijing must now manage a transition from an investment-led economy to a consumer and services-driven model.
The conflicting nature of the country’s economic and financial imperatives is everywhere apparent in China. Capital markets are being liberalized, but a stock market bubble necessitated heavy handed government intervention to preserve social stability. The world is still mired in a demand hangover from the crisis, but thanks to tremendous pressure for China to make the transition to a consumer-driven economy, it’s in no position to step up to the plate. Local governments struggling under a debt pile worth 35% of GDP must deleverage, but that means cutting off shadow financing (LGFV loans) and thus stymies credit growth. And on, and on.
Clearly, balancing all of this is well nigh impossible and China now finds itself staring down multiple bubbles which need to be perpetuated in order to maintain domestic stability and avert the “made in China” recession Morgan Stanley warned about last week, but which also need to be slowly deflated in order to avoid a sudden collapse. In short, China needs to de-leverage and releverage at the same time.
Here with more on China’s bubbles is Credit Suisse.
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From Credit Suisse
The critical issue: China and China plays
A Chinese hard landing still remains the biggest long-term macro risk that we see globally
We have the following main concerns on China:
1. Growing credit bubble
China has had the third biggest credit bubble over a 5-year period of any country in our database. Moreover, private sector debt is now 40% above trend and it is more extended than was the case even in the US at the peak of its credit bubble (and the BIS points out that historically, a financial crisis has been preceded by credit being more than 10% above trend).
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2. A record investment bubble
We continue to see the investment share of GDP being higher than any other country in modern history has ever had, even those that went through rapid industrialisation.
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Typically a move from investment to consumption-led growth leads to a halving of the growth rate. While investment is a flow concept, the stock of investment is also high in some areas. According to the US Geological Survey, China has consumed more cement in the past three years than the US did in the entire 20th century. Moreover, China has a higher density of motorways per capita than both the UK and Japan.
3. A housing bubble
Finally, we think that there is a clear cut housing bubble. Almost by the nature of a bubble, the participants are reluctant to acknowledge that it is one. But three factors indicate that it is a bubble:
- The size of real estate as a share of GDP: This is now triple that of the US at its peak and similar to peak levels in Spain and Ireland (Moody's claim that real estate is around 23% of GDP, directly and indirectly);
- Overbuild: Housing starts are 12% above housing sales, and vacancy rates, according to the SHFO are 15% to 23%. Inventories in third and fourth-tier cities are now equivalent to 5 years' worth of demand, and 18% of completed homes have become vacant.
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We believe the time to be worried about bubbles bursting is when (i) excess investment leads to deflation (China has close to record deflation), (ii) house prices fall (they are currently down by a record amount), (iii) we see FX outflows (which are now close to record highs), (iv) deposit growth slows down sharply (they are close to a record low), and (v) the labour market shows signs of full capacity (the job offer to application ratio is at an all-time time high). Furthermore, nominal GDP growth has fallen to 5.8%, only a third of average levels.
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