China isn’t failing, we are failing to analyse it properly

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June 24, 2024
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By constantly trying to analyse a rapidly emerging China as if it is the US, we are constantly being surprised.

Sometimes it feels like we are constantly having to ‘add context’ to discussions on China. The below article was published in late May on the Australian site Livewiremarkets.com, but we thought it worth publishing more generally.

This time last year we were told that the China model was failing for a few key reasons:

  • Exports were falling
  • Youth Unemployment was so high that they stopped publishing the data
  • The property market was collapsing and
  • The stock market was in such bad shape that not only was there a negative wealth effect there but also that this was ‘proof’ that all the other issues were terrible.

‘Everyone’ in the west agreed that they needed to adopt ‘our model’ and stimulate the economy with lower interest rates.

Well not everyone obviously – not us, and certainly not the Chinese. Indeed, most seem puzzled as to why the supposedly capitalist west keeps trying to fix the prices of money, stock markets, exchange rates and energy to ‘stimulate demand’ rather than allowing markets to clear and deliver solutions.

In fact, with the exception of the youth unemployment, which is an issue, but not a large one from an economy point of view (the cohort is less that 6% of the total workforce, unlike, say India, where both the rate and the cohort are much higher) none of these are actually a problem and China has no intention of following us.

This is not to be ‘Pro China’, rather to point out that by constantly trying to analyse a rapidly emerging and industrialising China as if it is the heavily consumer led US, we are constantly being surprised.

Or to put it another way, getting it completely wrong. The irony is that, through its five year plans, China actually tells us how to look at its economy, it’s just that we choose to ignore it.

To start with exports. Like most emerging economies, China started by growing its exports and in particular China needed lots of US dollars in order to pay for imports of the essential goods and services for economic growth, most obviously oil. In the decade after the handover of Hong Kong in 1997, Chinese exports grew so fast that they had more dollars than they needed and FX reserves grew from S120 billion to $1.3 trillion, eventually peaking in 2014 at $4 trillion.

Of course, as the west focussed on China’s ‘export driven economy’ China itself had moved on and it was all about its imports not its exports, as the Australian stock market more than doubled as mining boomed.

Australian exports in the decade from 2001 leapt tenfold from Au$8 billion to AU$80 billion. This wasn’t just about the Beijing Olympics – although that was probably the first time that many in the west got a glimpse of the sheer scale of the projects – it was multiple cities across multiple time zones simultaneously, producing some extra-ordinary infrastructure in record time. As I like to point out to Californians, when the movie ‘Her’ about a man falling in love with his AI was made in 2013 they used 2013 Shanghai as a set to represent 2030 Los Angeles.

By then of course, China had moved to its next phase, which was to migrate 150m people from the countryside to the cities without creating the poverty seen in favelas and townships in other emerging markets. To comment on the housing developers without this context (which most people do) is to misunderstand what has just happened and see it as a crisis rather than a deliberately engineered deflation of a sector that had served its purpose.

The policies used to achieve this remarkable feat were to allow local government to sell land to private developers who would deliver the homes required, while the local governments would use that money to hep fund all the necessary infrastructure like roads, motorways, airports, high speed rail, energy, telecoms, schools, hospitals and central business districts. They also borrowed to do this, which is the root cause of the other ‘problem’ for China, over-indebted local government. Except of course that this isn’t like a local government in the US, UK or Australia running a budget deficit and needing to pay pensions, this is something the size of a European country that has just built multiple new cities and homes.

But to return to the property developers. They served their purpose in delivering 75m homes over the decade to 2022 (as in the plan), but by 2021 they had strayed too far into speculation and overbuild as they took deposits for homes and spent them not on working capital but on buying land for the project after next. Xi warned that homes were for living in, not speculation as he reinforced the concept of common prosperity. Investors who owned the stock and particularly the high yield bonds of these developers were thus warned three years ago, but even as recently as last year the bond holders were themselves speculating that the sector would be bailed out. It wasn’t, because China was never going to do it. This was creative destruction at work – a controlled demolition if you like. In the same way that post 2008 the Chinese authorities allowed a shadow banking system to emerge in order to identify where capital was really needed and then collapsed it, so the property developers had served their purpose and now that they were risking destabilising the economy they had to be pulled back.

Once again, the Chinese authorities told us what they were going to do, but we (largely) didn’t listen and both bonds and equities are now trading at around 5c on the dollar. The latest moves – to allow individuals more flexibility to buy the unsold inventory at a discount and local authorities to buy at an even bigger discount to convert to social housing are another example of a solution being painted as a failure.

As to the stock market, the fact that it is one of the best performers year to date means it has been quietly dropped as a ‘key indicator’ by most commentators. But important to note that it never was - unlike the US, the Chinese stock market is neither a major source of investment capital nor a major part of household savings. So its economic importance is far lower.

As to what China is doing now? Well it has already told us in 2015 with its ‘Made in China 2025’ initiative, which is to be a key player in major new technologies, which is exactly why the US has been at increasingly obvious economic war with China.

While the west was singing about 9 million bicycles in Beijing, China was moving from zero to the largest car manufacturer in the world and in the last year its exports of EVs have gone from 20,000 to 140,000 a month.

That wasn’t in the economic models. But you can’t say they didn’t tell us. Oh and they have told us that they don’t need to earn $s any more to buy their oil and gas, they can just print Rmb to buy it. Spot trade in iron ore as well. We should listen to that too.

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Market Thinking July 2024

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