The China Story

Two newspaper reports from the New York Times on the 20th June, highlight the competing views on China.

The first "China’s Boom Is Beginning to Show Cracks, Analysts Say" highlights that

economic analyses of China provide further indication that the nation’s supercharged economy is beginning to slow, and warn that soaring inflation, rising labor costs and mounting local government debt threaten to weaken growth even more. ...

Credit Suisse said data recently released by the Chinese central bank showed that credit in China had expanded at “alarming levels,” far more than previous government estimates suggested. Credit Suisse downgraded its profit forecasts for Chinese companies and state-owned banks, as it warned of slowing growth for the overall economy. ...

Since the financial crisis, China has been the world’s leading growth engine. But for much of the past year, China has been trying to rein in overly aggressive bank lending as way to tame soaring inflation and property prices.

Those tightening measures have not only weakened growth in China, analysts say, but have also begun to expose a host of other problems in the nation’s financial system.
While few analysts expect China’s growth to slow to below 8 percent in the next year, they still paint a troubling picture. The Chinese stock market has been in a slump for much of the last two years, the property market looks weaker and inflation is running at a 34-month high.

...

China's national debt narrowly defined is 20% of GDP, but if all obligations of the sovereign were added up it is closer to 80%. This is before this round of local government loan acquisition, and before considering the other 70% of the stimulus loans made to state enterprises, which history has repeatedly shown are bad credits.

With few voices able to question its actions, Beijing will apparently continue along the path of increasing systemic financial leverage. The weight of its inability to halt profligate spending by local governments and state enterprises will be put squarely on the backs of future generations.

The fact that China may have wasted $400 billion should put an end to reflexive praise for Beijing's great economic planners. If that money had been added to the National Social Security Fund, China might be several steps further along the path of creating an economy driven by domestic consumption rather than infrastructure investment.

Perhaps Beijing's willingness to assume a portion of local government debt shows the political will to act decisively. But it must be remembered that the central government approved these loans in 2008 and 2009 in the knowledge that many projects were of questionable quality. The experience of these two years shows that a large part of the Chinese economic miracle has been built on a foundation of ill-considered lending and accounting sleight-of-hand.

This moderate warning is much more subdued than some of the real China bears who see a bursting of the China bubble with catastrophic consequences. Walter and Howie coauthors of Red Capitalism: The Fragile Financial Foundations of China's Extraordinary Rise write in "Beijing's Financial Day of Reckoning Is Near" that the scale of China's financial problems is massive:

The first wave of problem loans originating from the 2009 economic stimulus is about to hit China's banking system. If the reports citing anonymous officials are true, Beijing is considering assuming responsibility for some two trillion to three trillion yuan ($300 billion - $450 billion) of loans that were made to local government borrowing vehicles.

The scale of such a rescue is staggering—at about 7% of gross domestic product it is bigger than the U.S. Troubled Asset Relief Program. It also comes out of the blue; the banks' audited accounts still show that their nonperforming loans have fallen dramatically.

Ironically, the proposed bailout also approximates the size of the original four trillion yuan stimulus of 2008. China survived that disease, but it's now clear that the cure made it sicker.

How did this happen? When the global financial crisis affected China's exports in 2008, Beijing ordered its banks to support a massive credit expansion to create jobs and stimulate growth.

The banks eagerly went into action, and in 2009 and 2010 made new loans amounting to a total of 20 trillion yuan ($3.1 trillion). A significant amount of these went to local government borrowers. Estimates of how many would go bad range from 25% to 30%, which suggests a total figure of eight trillion to nine trillion yuan.

The argument is that the attempt to save the economy merely delayed the inevitable day of reckoning. Although I am sceptical about China's ability to grow without the ups and downs of the business cycle and about the ability of the Communist Party to continue to manage Chinese growth without major policy mistakes, I am also aware that writers have been warning of impending doom for China for many years. 

Our second article "Miners Keep Their Bets on China" highlights the bet that mining companies are making on a long-lasting resources boom built on the back of Chinese demand.

resource companies are betting billions that rapid urbanization and economic growth will soak up the country’s spending on infrastructure projects and prevent a hard economic downturn.

They are buying up competitors, investing in new capacity and speeding the pace of expansion projects to feed the strong growth in China’s demand for raw materials.

In the past week, Noble Group, Nyrstar, Rio Tinto and Xstrata have announced plans to expand output or capacity.

The article points out that they are ignoring the prognostications of Nouriel Roubini who contends that
“There is a meaningful probability of a hard landing in China after 2013”.

For Australia the extent of investment is revealed by the following chart from an earlier blog entry.



It is clear that mining companies don't listen to 'academics' on these issues. But just because they have a lot of money invested doesn't make them right as the global financial crisis makes clear. Plus there are many others in finance shorting China right now.

What will happen? I really don't know and I think those arguing for the radical case on either side don't really know either, but there's no doubt that the stakes are high for the mining companies and the Australian economy.