미국과 중국, G2 경제의 미래
China’s Disruptive Transition Continues
China is the world’s second-largest economy. It’s a huge customer for Japan, Taiwan, OPEC, Australia, and South Korea, as well as a huge supplier to U.S. firms and an enormous target market for U.S.-based multinationals.
Over the past eighteen months, we’ve seen Chinese stocks soar and then crash. For those of us accustomed to OECD-based equity markets, it’s natural to assume that a country’s stock market reflects the condition of its economy, but that is not always the case.
What a stock market really should reflect is the consensus estimate of an economy’s future condition. More specifically, stock prices normally reveal future expectations for corporate profits.
However, the Chinese stock market includes many state-owned enterprises (SOEs) whose executives answer to bureaucrats in Beijing. The government views these companies as public policy tools. Everyone is happy if the SOEs make a profit, but profit is not the top priority.1
For this reason, Chinese stock prices tell us relatively little about the overall health of the economy, or even the specific enterprise.
The incredible 160 percent one-year run-up in Chinese stock prices that ended in June did not signal an economic boom. Nor does the ongoing decline signal an economic bust. The correlations aren’t just weak; they are non-existent.
If one relies on stock indexes, or even official government reports about China’s economy, it is no stretch to say, “they are flying blind.” Fortunately, we have diligent researchers at firms like China Beige Book, who do the hard work of gathering reliable data each quarter from thousands of companies in China and assembling it in a comprehensible form.
This data shows that China’s economy has actually been in good shape since the second quarter of 2014, when Chinese business leaders “stopped acting Chinese.”2
What does that mean? Faced with falling demand, they did the rational thing and stopped adding new capacity. Despite the availability of credit, they just sat on the sidelines. This was a good business decision. But it wasn’t consistent with Beijing’s expectations.
So what does the data tell us about the real Chinese economy and its implications for the rest of the world? To answer that question, we have to separate the Chinese economy into at least three components.3
First, Chinese real estate prices are heading toward stabilization. As we’ve reported on several occasions, China has indulged in a massive infrastructure boom, especially since the financial crisis, and this has resulted in “ghost cities” as well as highways and railroads to nowhere.
The government mandated the construction of entire cities to house the formerly agrarian population as it shifts to industrial jobs. Provincial governments earned as much as 80 percent of their revenues from land sales. Essentially, this is a process whereby they take possession of rural land that has very little value in price terms, declare it to be available for development, and can make profits several orders of magnitude greater than their costs.
As we’ve also explained, these ghost cities will not stay empty forever. There are hundreds of millions who are going to want to find a place to live in China over the next few decades. That seemingly endless source of buyers will eventually turn the ghost cities into real ones.
That doesn’t mean all of the ghost cities will be developed successfully. Some probably won’t, as they are too far outside the path of growth. But most of them have excellent infrastructure and connectivity to the rest of China.
Obviously, there was a lot of misallocation of resources, since this construction was largely a way to prop up GDP and actually create something tangible. Only time will tell whether the Chinese were better off putting their money into this kind of infrastructure rather than into temporary, non-productive stimulus currently favored by the U.S. and EU.
Second, China is actually making progress in shifting from an export- and investment-driven economy to a consumption-driven economy. As we’ve been highlighting for nearly ten years, the phase of China’s economic growth led by exports and infrastructure must end if it is to ever become an affluent nation like South Korea or Japan. The next task is to build an economy that relies less on exports and more on consumer demand and services.
No nation has ever achieved that leap on such an enormous scale. And it seems particularly challenging at a time when the global economy is relatively stagnant.
The August 2015 Purchasing Manager Index for Chinese manufacturing fell deeper into contraction territory, where it has languished for six months. The Services PMI also fell, but not nearly as much; and more importantly, it continues to show a mild expansion.
Yet, despite this lethargy, we need to recognize that “the China of today is not your father’s China.” Services now represent 50 percent of the economy. That part of the economy is still growing - and evidently growing enough to offset the contraction in the manufacturing sector.
And we must remember that China actually added twice as much to its GDP in the past year as it did in 2003 - when its growth was called a “miracle.” It is crucial to recognize that even though mature economies grow more slowly in percentage terms than embryonic ones, they actually grow much faster in absolute terms because they start from a much larger base.
Third, China will benefit from increased stimulus. The Chinese government is spending heavily to prop up the stock market and the yuan through various interventions. It’s likely they’ve already spent $200 billion. However, they will have to spend even more before it’s over.
Fortunately for China, they can afford it. Aside from several trillion dollars in foreign reserves, the People’s Bank of China still has plenty of room for monetary stimulus. Short-term interest rates in China are over 4 percent, far higher than in most of the rest of the world.
That means the People’s Bank of China can make several more small cuts without overly weakening its currency. Unlike many other countries, China has a banking system that’s on a strong footing, and its banks have little exposure to the stock market.
As we explained recently in Strategic Wealth Advisor, China is likely to take the yuan as much as 5 percent lower, in addition to the 2-to-3 percent move they recently made.4 Given that the euro and the yen are down well over 30 percent against the dollar, markets should be able to absorb this shift pretty effectively.
This is especially likely since the IMF says China has to float its currency in order to be included in the Special Drawing Rights. When this happens, the likely direction of the yuan is down, not up. While this creates headwinds for America’s small export market in China, it gives American consumers and retailers a windfall on the much larger pile of Chinese imports.
Despite all this, China is going through an economic slowdown that may get worse, and it will certainly face a number of genuine problems in the coming years.
Given this trend, we offer the following forecasts for your consideration:
First, China will have to do something about its enormous idle industrial capacity.
The transition from an investment-driven export economy to a consumption-driven service economy will take years. China has already lost more steelworkers than the U.S. and Europe put together; every province wanted its own mills, so the country’s production capacity just grew too large - and it’s still too large. Fortunately, the government plans to retarget some of the idle capacity in industries like steel and cement in its ambitious New Silk Road initiative, also known as the “One Belt One Road” initiative.5 However, that decades-long initiative is unlikely to relieve much pressure over the next few years. Ultimately, the last thing Beijing needs right now is millions of unemployed factory workers fomenting dissent. The challenge for China’s leaders is to find a way to transition those factory workers to jobs in the service economy.
Second, Chinese stock markets can expect more trouble ahead.
Calculating “fair value” is difficult for Chinese stocks. Many companies are subject to government interference. Data integrity can be a problem in others. And, we can’t always make apples-to-apples comparisons with non-Chinese stocks. However, regardless of the yardstick you use, Chinese stocks are still quite richly valued, even after undoing the recent rally that was never justified in the first place. The 160 percent surge was simply a momentum-based rally in a market of retail investors who came to stock investing with a gambling mentality.
Third, China’s economic leadership will have to be transformed for the planned economic transformation to succeed.
Walt Whitman Rostow wrote a book back in 1960 called The Stages of Economic Growth in which he outlined five stages that mark the transformation of traditional agricultural societies into modern mass-consumption societies.6 The first three stages are actually well suited to top-down command and control governments. The fourth and fifth stages can’t happen under that same type of government. There must be a bottom-up, consumer-driven economy.
To see what we mean, consider the recent response to the stock market crash. In the space of about two months, Beijing reversed years of statements that had convinced the world that China really believes in “market discipline.” That PR campaign is now in shambles. The best-case interpretation is that the leadership is in disarray amid Xi Jinping’s corruption crackdown and unable to coordinate its messaging and intervention strategies.
Fourth, in the short term, the major China-related risks lie not with China itself, but with China’s energy and raw materials suppliers.
Countries like Australia, Brazil, Chile, Angola, Saudi Arabia, and Russia are all going to have to make major adjustments as China continues shifting to services and away from infrastructure building and manufacturing. China is not going to turn off the spigot, but it will reduce the flow of materials into the country. Those commodity-exporting countries could, in turn, reduce their purchases of U.S., Canadian, and European goods and services unless they are able to adapt to supplying the world’s new low-cost manufacturers.
Fifth, China will ultimately survive the transition, because its success is in the interest of the broader global economy.
By virtue of its sheer size, China has spread its impact over practically the whole globe. Just as we all shared in China’s boom, we will all share in its plateauing.
1. Mauldin Economics, September 8, 2015, “Thoughts from the Frontline: Muddling Through Shanghai,” by John Mauldin ⓒ 2015 Mauldin Economics, LLC. All rights reserved.
2. Mauldin Economics, July 31, 2015, “When China Stopped Acting Chinese,” by John Mauldin ⓒ 2015 Mauldin Economics, LLC. All rights reserved.
3. Mauldin Economics, September 8, 2015, “Thoughts from the Frontline: Muddling Through Shanghai,” by John Mauldin ⓒ 2015 Mauldin Economics, LLC. All rights reserved.
4. Strategic Wealth Advisor, September 2015, “Chinese Equity Markets No Surprise to Us.” ⓒ 2015 AudioTech, Inc. All rights reserved.
5. The Journal of Commerce, July 3, 2015, “Investment Floods into China’s One Belt, One Road Strategy,” by Greg Knowler. ⓒ 2015 JOC Group, Inc. All rights reserved.
6. The Stages of Economic Growth: A Non-Communist Manifesto (3rd Edition) is published by Cambridge University Press. ⓒ 1960, 1971, 1990 Cambridge University Press. All rights reserved.