Morrison can’t afford to ignore China’s economic woes
A British colleague of mine drew my attention to stock market folklore, where October has always been considered a dangerous month. This year, that could turn out to be the case, due to a dangerous mix of short-term and long-term factors that could spell the end of what has been a prolonged bull run.
These factors include ‘Pandexit’, where the overarching challenge for central banks is deciding how long they should keep pumping money into economies already inundated with liquidity and debt and, in some cases, starting to show. signs of overheating. A recent crucial meeting of the governors of the big four central banks – the United States, Japan, England and Europe – left the markets with much to think about.
In addition, there are lingering concerns on at least four other fronts. The first is China and its economic challenges. Then there are questions of US policy, including the fate of Biden’s large infrastructure package and whether the United States will be able to meet the October 18 deadline to raise the so-called “ceiling of the debt”. There are also concerns about a possible global energy shortage. Finally, there are the ongoing disruptions in supply chains that have resulted in severe global shortages of several key products.
I am writing this against the backdrop of the Morrison government’s apparent complacency with our economic prospects, in a very uncertain global environment. This is an important but largely ignored question. The government seems to believe that China is strong and that we are strong with it, but none of these things are true.
Sharemarkets didn’t have a good September. The S&P lost 5.1%, the Dow Jones by 4.5% and the Nasdaq by 5.8%. Europe was less negative, but the FTSE 100 was down 1.3 percent, the CAC 40 down 2.5 percent and the Xetra Dax down 3.4 percent. It was a little better in Asia with the Nikkei down 1.2 percent and the Shanghai Composite down just 0.8 percent. Bond markets have also recently seen longer rates rise, reflecting growing concerns about accelerating inflation.
The “miracle” growth rates of the Chinese economy have slowed as the economy attempts some key transitions and tries to cope with significant structural challenges. While the transition from an investment-dependent economy to a consumer-driven economy is clearly underway, it has proceeded more slowly than expected. The decline and aging of the population is a major constraint, as are the challenges of pollution – especially its health consequences – and corruption.
All of this is happening against the backdrop of President Xi Jinping’s campaign to purge China of “capitalist excesses”. A recent editorial in The Economist describes Xi as viewing “increased debt as the poisonous fruit of financial speculation and billionaires as a travesty of Marxism.” This is difficult to reconcile with the country’s massive total debt level, which some have estimated at 300% of gross domestic product.
You can imagine the challenge for the Chinese government. It is grappling with the collapse of Evergrande, one of the largest groups of Chinese real estate developers, which has claimed 1,300 projects in around 280 cities. The bankrupt company also has several ramifications in electric vehicles, media, financial services, a sports team, health services and theme parks.
Evergrande is said to be the most indebted company in the world, with some $ 300 billion borrowed in various forms. It has so far defaulted on several interest payments and the question for the Chinese government is whether it should bail it out.
Some see the Evergrande debacle as the start of a major Chinese real estate collapse, due to tightening government policy over concerns about the link between debt levels and the real estate market. Evergrande had been pushed into a very tight liquidity position as the government increased restrictions on real estate-related debt, the effect of which, according to the company in a Hong Kong statement, put “enormous pressure on cash flow. and the group’s liquidity ”. Subsequent media reports contributed to a drop in consumer confidence, making it difficult for Evergrande to sell its inventory of unsold apartments, even at substantial discounts.
The potential for negative shock waves from the collapse of Evergrande, to financial markets and the global economy, is obvious. Those waves started, with the exit of key shareholders and the abandonment of suppliers and those who had bought out the plan. Some have called it the Lehman Brothers Chinese event.
It’s important to recognize that Evergrande is not the full extent of China’s debt problems. The traditional banking system also has a problem, with exposures to non-performing loans and a very significant problem with secondary sector debts of non-bank finance or shadow banking. In addition, Goldman Sachs recently warned of “hidden local government debt” – which it estimates at 50% of China’s GDP – as another “serious brake on the recovery”.
As a result, Goldman lowered its forecast for Chinese growth this year from 8.2% to 7.8%, more in line with other private estimates. However, it’s important to recognize that official Chinese growth figures are notoriously unreliable because they are “fabricated.”
I remember a few years ago I was on a business trip to China when the Chinese government announced the growth rate for the September quarter. The problem was that it was only mid-September. The figure was for a quarter that had yet to occur. In Australia, similar figures would usually be announced in the first week of December.
Considering China’s growth for this year, it is important to note that the country has recently suffered some sort of energy crisis that has seriously restricted the supply of electricity to key sectors. There has also been an annoying side issue regarding China’s growth prospects, with proven accusations that a World Bank “Doing Business” report was tampered with to make China look better.
It should be noted that the American economist and New York Times columnist Paul Krugman recently warned “against a potential Chinese financial collapse”. He drew parallels between today’s China and Japan’s “economic bubble” of the 1980s and 1990s, which led to a prolonged period of little or no real growth.
The recent meeting of the big four central banks, sponsored by the European Central Bank, also raised some concern in financial markets. It was agreed that the Covid-19 crisis is still the # 1 priority and US Federal Reserve Chairman Jerome Powell has said vaccination is the main economic policy we have. Supply chain restrictions and disruptions are still significant and could worsen, but it is beyond monetary policy to tackle this problem.
The gloom of the meeting was well summed up by Powell’s comment “that economic policymakers tend to underestimate the economic damage and under-support economic recovery.”
The main finding was that central banks were the most likely to maintain accommodative monetary conditions and low interest rates. This position is becoming increasingly difficult for the US Federal Reserve, with Powell facing re-appointment and facing Congressional scrutiny and debate.
The current and future health of the US economy is questionable. At first glance, some say it’s going well, growing 6.7% in the second quarter this year, down from 6.3% in the first quarter. However, recent partial indicators have been mixed at best, appearing to suggest that growth is now slowing and inflation is accelerating.
The uncertainty of this situation is compounded by the complexities of Congress, especially with regard to infrastructure spending and the debt ceiling. Additionally, President Joe Biden’s star has weakened as the midterm legislative elections slated for Nov. 2 approach, threatening a resurgence of Trump’s influence.
Biden’s overall approval ratings are pretty bad after Afghanistan. As stated in The Washington Post, only 45.1 percent of Americans approve of his performance. “That alone makes Biden less popular at this point in his presidency than any president in the past 40 years except Donald Trump.”
On top of all this, slowing growth in Europe and picking up European inflation rates further complicate the global outlook. Much of the focus will be on Europe in the coming months with the 2021 United Nations Climate Change Conference (COP 26) taking place in Glasgow in early November. While the pressure will be on most countries to firm up their goals and transition policies, the backdrop will be a natural gas crisis in Europe and the United States, and panic buying of oil in Europe. Britain. These discussions may also include the possible introduction of carbon taxes at borders.
Obviously, Australia is particularly exposed in all of this given our dependence on China and global trade. There is absolutely no justification for the Morrison government to be complacent and it should be challenged to detail how our economy is likely to perform given these global challenges.
This article first appeared in the print edition of The Saturday Paper on October 9, 2021 under the title “Evergrande designs”.
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