China welcomed in 2019 with a bit of a hangover, and there is a chance that it might just be contagious.
The Chinese stock market suffered a 25% drop in value for the year. The world’s second largest economy is still growing however, and faster than almost all major economies, a relatively robust 6%, but in comparison to the double digit growth it enjoyed for much of the mid noughties it is looking a little lacklustre. Its domestic production is slowing, exports, and imports are slowing and Chinese consumers are cutting back.
So how did we get here, and why does it matter? …. Debt, isn’t it always.
As a reaction to the financial crisis of 2008, China did as many economies did, it printed money, to increase liquidity to get things moving on nicely, it worked for a bit, but it seems likely that they did it a little too much. In simple terms, the government printed money to lend to itself, and spend on infrastructure, hoping that this would fuel future expansion of newly created cities, and bring people from the countryside, into production as a new class of urban workers. And they didn’t do it in half measures.
The borrowed money built whole new cities, road networks, mass transit systems, inter city rail networks, schools, shops and lots and lots of homes. Between 2012, and 2016 China produced three times more concrete than the United States produced in the entire 20th century. Debt ballooned to 300% of GDP, and 50% of that GDP is counted as the building of the infrastructure itself. The real kick in the teeth is that it hasn’t really worked. ‘Build it and they will come’ was the mantra, and some did. But not enough. An estimated 20% of urban homes, around 65 million, are empty, in many cases that has equated to entire population centres. Part of the problem is demographics, China has a rapidly aging population, and a relatively low birth rate. By the mid 21st century it will have lost about a third of its working age population, around 220 million people, the very people who were due to populate these cities and busily add to the nation’s GDP.
Donald Trump also has a part to play in this story, he does have a knack of showing up everywhere it seems. Early last year in a bid to redress the imbalance as he saw it in trade between the US and China, he imposed tariffs on imports of Chinese steel, aluminium and other raw materials, as well as some finished goods for import. This had the effect of a fair few of his voters losing jobs as their manufacturing employers could no longer get the steel they needed at a competitive rate, but the main effect, of course was to kill off demand for Chinese imports. Naturally China retaliated with tariffs of their own, pushing up the prices of American products, already trading at a premium, beyond what the average Chinese consumer was willing to pay.
Over the last two decades China’s relationship with the global economy has changed, and become more inextricably linked to global fortunes. In the early days of its own version of capitalism it was all about inward investment and technology. These days it’s about production and consumption. As hundreds of millions of formerly rural, poor people became an urban, sophisticated middle class with money burning a hole in their pockets they became enthusiastic consumers, and what they wanted was the trappings of Western capitalism. European cars, Scotch whisky, French and Italian fashions, American iPhones and there were a lot of them, and they did much to boost the bottom line of the companies that could sell them what they craved. This market has matured, and cooled off a little in the last few years. Now everyone who wants a Smart phone already has one, and a Chinese made Huwawei is just as good as an iPhone and 50% of the price. As the economy slows and these traditionally debt averse consumers see falls in their wages so their appetite for the swish foreign imports diminishes. End of year profit warnings from Apple, Samsung, Jaguar Land Rover and other will bear witness to that.
2019 looks like a bumpy year in prospect for the Chinese economy, this destructive trade war between China and the US must be halted, but this isn’t the whole story. The People’s Bank of China is going to have to perform miracles to turn the ship around, and we all have an interest in them getting it right.
Islander Feb 2019 Phill McCoffers
