China’s economy is showing signs of failure, but people keep betting on it.
For example, last week an index of Chinese manufacturing output showed its fifth consecutive month of falls, and China-linked assets shot up.
Financial markets believe the Chinese government will come to the party with extra spending and extra stimulus.
Are they right? The question we are asking here is not merely academic. If we bet on China and lose, the following are likely to fall:
- The Australian dollar.
- Australian economic growth.
- Australian share market.
- Australian house prices.
The Chinese government obviously wants the economy to keep growing. The continued existence of the Communist Party is tied to the performance of the Chinese economy. They have to keep it ticking over. Their motivation is clear and pure and strong. But motivation is not always enough.
Consider this. The only reason markets need to trust the Chinese government to add more stimulus is that previous rounds of stimulus haven’t done enough. Financial markets are betting the guys that got the market into this pickle can safely navigate out again.
“We expect Beijing to launch a series of policy measures to stabilize growth. Likely options include lowering entry barriers for private investment, targeted spending on subways, air-cleaning and public housing, and guiding lending rates lower,” said Hongbin Qu, chief China economist at HSBC.
A few iterations is enough for the human brain to learn a pattern. We’ve seen the Chinese government come to the party during the GFC and during the European debt crisis that followed, keeping China’s growth rate up over 7 per cent, rain hail or shine.
No wonder traders and hedge fund gurus trust their guts on whether the dragon will roar again. But a well established patten hurts the most when it breaks.
This time the problems in China seem to be inside China. They are not dips in demand caused by a failing USA or Europe.
China recently experienced its first debt default and its first bank run. Corporate debt is being reined in.
The big pile of flammable material at the heart of China’s economy is house prices that are too high. China’s property market issues are unique. Everyone agrees prices are in bubble territory and will have to fall. Even the Asia editor of the Economist, who is otherwise totally excited by more China growth.
The question is what will happen when Chinese house prices fall. It’s easy to imagine that it will happen in a controlled way, or simply not be too important. That’s what Ben Bernanke imagined pre-GFC too.
China is enormous and its government freer to act than most, due to the absence of democracy. I suspect any crash would be over sooner than some expect. But even a short dip would be a big problem.
The value of China’s growth has been that it is consistent. It can be counted on. Having to risk-weight China’s future growth will take a lot of shine off Australian asset prices. House prices would be under attack from all quarters, with receding Chinese purchases, a falling share-market, and a weakening Australian economy. Bank shares, which account for a quarter of our stock market, tend to follow house prices. The Chinese government’s ability to manage its economy has become, it seems, one of the biggest risks to our wealth and well-being.