The Dramatic Slowdown of China's Economy

The signs of weakness are pervasive. The trade dispute between the United States and China are just one – and not the most important – reason.

Sean Corrigan

Deutsche Version

Financial markets have been understandably focused on President Trump’s Twitter-led confrontation with China, but it is important not to overlook two more fundamental issues which are simultaneously at play.

Sean Corrigan

Sean Corrigan, Director of Cantillon Consulting, has been trading in, analysing, and commenting upon financial markets since the mid-1980s – firstly in the City of London, then moving to Switzerland over a decade ago. He has been responsible for formulating a macro overview and in figuring out its implications for various financial parameters such as bond yields and curves, credit spreads, equity prices, currency rates, and commodity prices, both in absolute and relative terms.
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Firstly, for all the President's characteristic bluster, it does not seem to be just a «Trade War» that is being fought. Worryingly, this may comprise an attempt to frustrate the further rise of Chinese power – both economic and geostrategic – and hence to postpone any challenge to America’s post-war hegemony.

Certainly, the online journals of the various branches of the U.S. armed forces trumpet their degree of pre-occupation with the perceived threat emanating from China – a menace felt particularly acutely in relation to the People's Liberation Army's rapid recent build-up of its deep-water naval capabilities.

President Xi Jinping has managed an ascent to the sort of unchecked power enjoyed by only two or three of his predecessors. Wielding this, he has promoted the «One Belt One Road» scheme of global financial and infrastructural linkages and coupled it with the «Made in China 2025» plan of funnelling state aid into achieving rapid advance in a set of ten selected, high-tech industries.

Has all this been the trigger for a much-anticipated conflict to begin with an opening barrage on the economic front?

Arrival of a Thucydides Moment

In this light, what would otherwise look like President Trump's overblown warnings that he possesses sufficient «emergency powers» to compel American businesses summarily to cut all ties to China might be seen as the arrival of what the Chinese refer to as the Thucydides Moment: the point where the reigning superpower decides it must act pre-emptively to forestall the ambitions of its up-and-coming rival.

One hopes that such scenarios remain firmly in the realm of war games and that any allusions to them are just a matter of Trump’s hardball negotiating tactics.

Nevertheless, the prudent investor would do well to at least entertain the idea that such a dramatic cleavage with two decades of diplomacy might now be underway.

The second major issue is the extent to which the Trade Wars are only one aggravating factor in the more deep-seated malaise from which the Chinese economy is now suffering.

It is evident, even from the highly-massaged official numbers, that the Chinese economy has undergone a swift deceleration marked by multi-year low rates of growth in consumer spending, industrial output, and fixed asset investment, to name just three broad categories of activity.

Trouble below the surface

Behind the curtain, there are glimpses of worse.

Take the double-digit collapse in car sales, the associated bankruptcy of the nation’s biggest dealership, Pangda Automobile, and the effective collapse of a key supplier of automotive components, Guowei. This has in turn disrupted production across a range of manufacturers, some of which were already operating at only 30% of capacity.

Or look at real estate – not only one of the country’s dominant spheres of activity but also the prime recipient of people’s savings. Officially, commercial sales and prices are in modest retreat but reports from the likes of Colliers International paint a much bleaker picture of some of the formerly high-growth areas.

«This year has been the worst for the Shenzhen office market in the last decade, but it could also be the best year for the next decade», as Feng Wen Guang, the firm’s regional head, bleakly observed to the magazine Caixin. Estimates vary, but it is sobering to realise that office vacancy rates in this erstwhile regional powerhouse lie somewhere in the mid-20%’s amid scattered local press reports of steep discounts of 50% and more being offered by developers anxious to be rid of certain projects.

Speculating with company funds

Adding to the woes, the real estate giants are among the country’s heaviest borrowers of U.S. Dollars, making them not only uniquely vulnerable to any U.S. Treasury embargo, but also to the homegrown ills of a fast-depreciating renminbi. Nor is it of comfort that all too many executives and major shareholders of other listed entities have been caught misappropriating company funds in order to speculate, often pledging their shares as collateral while so doing.

To put this in context, Wind Statistics reported that developers borrowed the equivalent of $46 billion abroad last year, well over six times what they did as recently as 2016. The same agency also said the first seven months of this year came close to surpassing 2018’s full year total.

As the state planning agency, the National Development and Reform Commission, tacitly recognised last month when issuing a partial interdiction on such funding, being highly leveraged in Dollars when the home currency loses 7% of its value in four months is no laughing matter – not least to such overlegeraged companies’ bankers.

For reference, the credit agency Fitch estimates that up to a third of all troubled Hong Kong’s banking assets consist of claims on Mainland entities.

Years of stop-go-politics lead to confusion

Years of stop-go monetary and regulatory policies; of reserve requirement shifts and changes in loan-to-deposit ratios; of tolerating and then clamping down on the «shadow banking systen»; of introducing targeted loan quotas backed with ad hoc fund provision by the People's Bank of China – this has led to confusion, misdirection, and the erosion of balance sheets in banking, as evidenced by this summer’s embarrassingly public rescues of two of them, Baoshang and Jinzhou Banks.

This was further made manifest in the People's Bank of China's embarrassingly swift compliance last week with Premier Li Keqiang’s demand it ease the liquidity spigots further.

The rot is pervasive. We read of high-speed rail lines whose ticket sales do not even cover the cost of electricity usage. We find an expanding count of municipal «mosquito» airports whose chronic underutilization exerts yet another drain on hard-pressed local government budgets.

The utter failure of agricultural planning and veterinary provision saw African Swine Fever devastate the local pig herds, drive prices of this staple sky-high, and so constrain discretionary consumer spending.

Marriage rate collapses to 11-year low

Societally, this muddle is reflected in the calculated exhaustion of the national social security fund by as early as the middle of the next decade. Tellingly, it has led to the last twelve months’ collapse in the marriage rate to an 11-year low and, with it, the plunge in the number of births to the Great Famine levels of around 1960.

The Communist Party is preparing to celebrate the 70th anniversary of its rule on October 1st this year, but, far from being a kind of Roman Triumph for its once-unquestioned head, factional knives are probably being sharpened behind Caesar’s back.

Meanwhile, the bitter harvest of a vast misallocation of capital, the problems facing Xi and the 1.4 billion citizens over whom he rules only continue to multiply.

Changes in the duties payable when the nation’s goods clear customs in Long Beach, California, may be among the least of these problems.