Stirring up unpleasant echoes of the market chaos that swept the world in the opening days of 2016, Apple's decision to cut its quarterly revenue guidance for the first time in 16 years - citing slowing iPhone sales in China as the primary culprit - reinforced concerns about slowing growth in the world's second-largest economy that could have wide-ranging repercussions for global markets.
This wasn't the only factor prompting fears over slowing Chinese economic growth: a batch of soft economic data including consumption, manufacturing surveys and retail sales indicators has undoubtedly helped contribute to the paranoia. As we argued on Friday, when prognosticating the direction of global markets in 2019, all eyes will be on the USA's largest trading partner.
For the first time since it overtook Japan as the world's second-largest economy back in 2011, China has displayed surprisingly weak economic data that have somehow obscured the widely held, if rarely discussed in public belief that these data, which are compiled by the Chinese state, are largely suspect. Contributing to its goal of maintaining order and stability at home, the Communist Party is widely believed to doctor and goalseek its data to present a rosier picture. Apparently, the notion that this is probably happening has become so widely accepted that investors often lose sight of it.
But in an well-timed reminder, the Financial Times has published a story citing a presentation by a controversial yet widely recognizable Chinese economist and others who argue that China's GDP growth could be much weaker than the official data - which showed the Chinese economy grew at an annualized rate of 6.7% through the third quarter - reflect.
To the consternation of Chinese censors, a presentation delivered by an economics professor at Renmin University in Beijing sparked a controversy last month when the professor claimed that a secret government research group had estimated China’s growth in gross domestic product could be as low as 1.67% in 2018, far below the official rate.
Even experts who are skeptical of the official data dismissed the presentation, delivered by a professor Xiang Songzuo, as unrealistic. Yet despite being scrubbed from Chinese social media and the mainland Internet, the presentation has been viewed 1.2 million times on YouTube (clip above), suggesting that Xiang's warnings are resonating with everyday Chinese consumers, who are struggling with one of the worst-performing stock markets of 2018, a collapsing shadow lending sector, a crackdown on China's vast online peer-2-peer lending infrastructure, and a currency that has weakened significantly over the past 12 months.
To be sure, (almost) nobody is forecasting a recession in China or even a slowdown to sub-5% growth over the next two years (for the simple reason that Beijing would never allow such an admission due to social instability fears).
But regardless of whether the presentation is accurate, it doesn't change the fact that China's economy has slowed...
...and leading indicators suggest that the slowdown will continue.
At the end of 2018, the China Beige Book (CBB) fourth-quarter preview, released Dec. 27, reported that sales volumes, output, domestic and export orders, investment, and hiring all fell on a year-over-year and quarter-over-quarter basis. A much-weaker 2019 appears to be in the offing for China, but it’s not solely due to trade tensions with the United States. The domestic economy was already on weak footing and the CBB argues that government support is unlikely.
“China is an aging, leveraged country, with excess industrial capacity. Appearances by inflation should be cheered,” according to the CBB Q4 preview. “They are also rare.”
At least one prominent financier who has an on-the-ground view of Chinese consumer sentiment says the mood is more dour than even the depths of the financial crisis. And since this will likely continue to constrain private spending and investment, the big question on every domestic investors' mind is will the Chinese government revive its stimulus efforts, like one powerful committee of economic policy makers recently promised to do?
"Domestic sentiment is definitely very bad, perhaps even worse than during the 2008 global financial crisis," said Fred Hu, founding partner of Primavera Capital, a Hong Kong-based private equity group, and former Greater China chairman for Goldman Sachs.
"In theory, China has wide latitude to boost domestic demand to offset the trade war hit on external demand. But with sagging business and consumer confidence, private spending on both capital expenditure and personal consumption is more likely to trend down."
Far from being some impossible task, bypassing China's opaque official statistics is as easy as recognizing that there are other measures that are more difficult to falsify. And these indicators still point to relatively robust growth.
Huang Yiping, vice dean at Peking University’s National School of Development, who stepped down from the People’s Bank of China’s monetary policy committee in June, acknowledges that the official growth rate may be overstated. But he says that the so-called "Li Keqiang Index" - a gauge of tamper-resistant indicators such as electricity production and freight volumes, which premier Li Keqiang privately told a US ambassador in 2007 that he views as more trustworthy than GDP - still points to growth of "6 per cent or slightly below."
But more importantly, one individual who spoke with the FT pointed out, to a significant extent, the slowdown is largely the government's own fault (for having the gall to try and force through some macroprudential deleveraging).
Starting in mid-2016, policy shifted from stimulus to austerity, a response to years of warnings about financial risks from a rapid debt build-up. A "regulatory windstorm" targeting shadow bank lending, which had channeled loans to the riskiest borrowers, led to a sharp drop on off-balance sheet credit.
Tighter credit combined with stricter environmental enforcement and a drive to shutter low-end factories — part of Mr Xi’s broader call for a "new era" in which growth quality would take priority over quantitative targets.
"To some extent the slowdown is a result of the government’s own priorities. China is transitioning from relatively low cost to high cost, so a lot of old industries need to be shut down," says Huang Yiping, vice dean at Peking University’s National School of Development, who stepped down from the People’s Bank of China’s monetary policy committee in June. "The key economic policy battles like cleaning up the environment and containing financial risk all contributed to the slowdown in economic activity," he says.
More recently, Beijing appears to have gotten second thoughts about its deleveraging campaign, although the government’s light-touch approach to stimulus reflects the reduced policy flexibility today compared with 2008, when debt levels were lower and a simpler growth model based on investment in housing and infrastructure had more room to run.
At the end of the day, China is simply mired in the same problem plaguing the rest of the developed world - it has too much debt. The amount of new capital investment required to generate a given unit of GDP growth has more than doubled since 2007, according to Moody’s. In other words, investment stimulus produces little bang for Beijing’s buck, even as it adds to the debt levels
And yet, Beijing's restrained stimulus has left markets underwhelmed, with China's stock market tumbling 25% in 2018.
"[Beijing] will soon have no choice but to launch massive stimulus,” says Alicia García Herrero, chief Asia Pacific economist at Natixis in Hong Kong. “They do not want to give away their credibility because they said they wouldn’t do it, but there is no time to be cautious any more. Not having growth is ultimately the worst outcome of all.”
He's right, although as we discussed last night, a further complication for Beijing arises from the fact that China's economy is in the middle of a "tectonic transition" as its formerly massive current account surplus is about to turn negative...
... which in turn is creating serious disruptions in capital flows that could portend weakness beyond China's borders, assuming the trade war continues to impede the foreign investments that China's increasingly consumption-based economy needs to expand.