Don’t Bet Against China
Ever since the global economy became dependent on China’s economic health for its own well being, there has been ongoing speculation about whether China’s next expected economic “landing” will be hard or soft. A lot of money managers have been busy shorting China, but the country has proven — again and again — that its next landing will be neither hard nor soft, but rather, no landing at all.
Western economists continue to make the mistake of presuming that historical western or Chinese economic statistics will foretell either continuation of China’s boom, or its pending demise. They forget that China is a country that continues to defy conventional thinking. Market forces have less impact than the will of the Chinese government, so the boom will remain sustainable, and the government will ensure that it is.
China needs to grow nine percent per year just to keep up with the ranks of new entrants into its job market. With an average sustained growth rate of 10 percent over the past decade, the country has proven that it can sustain its economic momentum – even in bad times. If we have learned anything about China since it adopted “socialism with Chinese characteristics” in 1993, it is that the country has defied most of the predictions about how it would grow and come to impact the global economy.
The government deserves a lot of credit, and has done a stellar job of keeping the Chinese economy humming. It has naturally made mistakes along the way — just as every other government has — but the government’s heavy hand is what enabled China to weather the Great Recession relatively unscathed. Given that the world has become dependent upon China to drive the global economy, we should all wish the government well in its task.
So is the Chinese economy built on sustainable fundamentals or is it a pile of quicksand? It is currently fashionable to be bearish on the Chinese economy, and there is much evidence that the foundation of China’s fantastic growth is unsustainable, but that has been the case for years, and it continues to grow and grow. Bank lending has been out of control for years, the sale of residences has risen by astronomical numbers, and two-thirds of the country’s gross domestic product consists of fixed-asset investment — which is clearly unsustainable. But these examples mask some hidden strengths, such as that most homes are paid for in cash, urban disposable income has risen an average of seven percent per year since 2000, and real output per worker rises between 10 and 12 percent per year. The checks and balances in place therefore enable China’s economy to maintain equilibrium.
Minxin Pei, a senior associate at the Carnegie Endowment for International Peace, notes that China’s banking system, which is dominated by half a dozen enormous state-owned banks, has almost unlimited access to low-cost credit, enabling it to engage in unbridled real estate speculation and giving the banks an incentive to keep the seemingly endless cycle of high growth going. Last year it was reported that there were approximately 65 million empty apartments that Chinese citizens have purchased not to occupy, but to flip at some time in the future. We know how that kind of behavior ended up in the U.S. and elsewhere. But local governments depend on the tax revenue generated from such purchases, so they, too, have a vested interest in keeping the system in place. Some western economists predict that the housing bubble will need to be punctured before inflation rises to such an extent that it risks causing social disharmony — something the Chinese government is anxious to avoid.
A thought-provoking article in Forbes last year claimed there is no bubble, and that the amount of leverage typically used to purchase real estate around the world — which is the reason so many markets have gotten into trouble — is simply not a major factor in China. Given that such a high proportion of homes are paid for in cash in China, most home buyers can actually afford to buy their homes. It adds that the government has imposed restrictions on the size and number of certain types of homes to erode some of the demand, and that as a result of the housing and office space glut, rental prices have dropped, taking some steam out of the equation. So the Chinese government has a handle on the real estate market as only it can.
China’s financial system should be seen as a source of strength for the Chinese economy, however imperfect it may be, because of its ability to support the financing of infrastructure and other investments needed to sustain rapid growth. That the banking sector is dominated by state-owned banks that can lend at will at low cost certainly has its advantages, and is a prime reason why China’s economy may be expected to continue to grow in the 9-10 percent range for the coming decade and beyond. The government is doing a good job at tapping the brakes or pushing the accelerator pedal when necessary, and it has many more fiscal and monetary options at its disposal than most western governments at the present time.
Let’s not forget also that China’s population is becoming wealthier — and not just in the country’s coastal cities. A report last year by the Brookings Institution noted that China’s middle class is poised to rise significantly, not only because of the country’s economic growth rate, but because more Chinese are continuing to break out of the ranks of poor. It is estimated that consumer driven domestic consumption will account for up to 50 percent of GDP by 2015, up from 33 percent last year. That is a guarantee of high growth going forward.
In short, there is every reason to believe that a combination of government economic control, a high degree of liquidity, an enormous domestic economy, and rising incomes and consumer spending should mean that there will be no landing, and the shorts are likely to end up on the wrong side of the long-term coin. Jim Chanos — the most famous of the China “shorts” — has never even been to China. The doomsayers and pessimists have been wrong every time they have predicted the Chinese economy’s pending demise. I believe they will continue to be wrong.