To our north, a dragon is dying.
The Chinese machine is grinding to a halt…much to the surprise — and chagrin — of economists. It’s a story that many expected to end with Chinese hegemony over today’s leading economies like the US or the EU.
We saw the remarkable results of market liberalisation like ramped up productivity, skyrocketing wages, and the birth of a middle class. Just a couple of decades ago, it was an economy of rice paddies.
We thought of China as a financial Cinderella story (although Mulan might be a better comparison)…and the data supported that. Look at this historical chart of China’s GDP, for example:
Source: TradingEconomics.com | World Bank
But in 2015, the plot thickened.
In a sudden move, Chinese authorities devalued the yuan against the US dollar…which sent the currency tumbling. It was a strategic move in preparation for the yuan’s inclusion in the IMF’s reserve currencies…something that would basically cement China’s role as one of the world’s economic superpowers.
However, weakening growth in the region has given some analysts pause…and created space for doubt for China’s strength.
Today, I’d like to address seven clues that signal dark clouds in China’s future. These factors are heavily based on a fantastic article by precious-metals expert Claudio Grass, for the Mises Institute. The article was called China’s Slowdown is Exposing the Cracks in the Global Economy and is worth a read. You can check it out here.
Impending doom clue #1: The trade war
As you probably know, Trump and China have been in an economic spat of sorts for many months now. There have been threats of significant tariffs being placed…and retaliatory counter-tariffs right back.
The point isn’t necessarily which tariffs are currently active…or which ones are paused. It’s that there’s a complete lack of certainty. That in turn forces business leaders to act conservatively.
So even if there’s a ceasefire, there are still deep economic consequences.
Impending doom clue #2: Mounting public debt
When growth slowed, the Chinese government stepped in in the only way they knew how — intervention. They carbo-loaded on debt to keep the machine humming along…a cost which now represents a serious weakness going forward.
As Grass reports, ‘Already by mid-2018, total debt-to-GDP had exploded to over 250%, a dramatic surge from 140% only a decade earlier. Today, according to Goldman Sachs numbers, it stands at over 300%, making the government’s efforts to engineer a “soft landing” look like wishful thinking.’
But sadly, that sort of ‘bail out first, ask for forgiveness later’ policy is one that’s becoming ever more popular among developed nations, including New Zealand.
Impending doom clue #3: Overwhelming corporate debt
In the same vein, the business sector heaped on debt as well. Part medicine for the weakened economy and part fuel for ambitious expansion, borrowing went through the roof. And in the end, the invisible hand still got its way.
You see, corporate debt isn’t normally a bad thing. It’s a sign that businesses have their eyes on getting bigger and more productive. And in an era of low interest rates, it becomes a no-brainer. But for savvy investors, it’s important to appreciate that debt-fuelled profits are fundamentally different than earnings-based growth. [openx slug=inpost]
Impending doom clue #4: ‘Zombie’ companies
The result of heavy government intervention, especially from the ‘80s onward, revealed that there are lots of inefficiencies. Loss-making factories. Excess production. Rampant insolvencies. It’s what you get when you centralise economic decision-making in the state. You miss out on the effectiveness and efficiency that the market typically provides.
Thus, a horde of insolvent ‘zombie’ businesses are kept alive through bailout after bailout…and they’ll continue to be economic parasites until the state cuts them loose.
Impending doom clue #5: Banking sector vulnerabilities
So, you’ve got lots of bad businesses taking on lots of debt…what do you get when you add them together? Bad debt. Lots of it.
Grass reports, ‘As official figures out of China are largely unreliable, independent analysis and estimates conducted by Autonomous Research put the actual losses Chinese banks are set to suffer through bad loans at $8.5 trillion. That’s 24% of total credit, bringing the estimated loans on which debtors have failed to keep up with scheduled instalments or interest payments five times higher than the official projections.’
$8.5 trillion of bad debt. That’s more than enough to obliterate an already crippled banking sector.
Impending doom clue #6: Unstoppable capital outflows
This one is something that Kiwis will certainly understand. Chinese wealth has been flooding overseas safe havens for many years, despite the Chinese government’s best efforts.
It’s investors and businesses moving their capital out of China for the sake of security…and for New Zealand, it’s meant an increasingly expensive housing market.
At a basic level, you don’t want wealth leaving your economy. You want to attract it. But unfortunately, China’s elite don’t seem to have much faith in the country’s future.
Maybe we should read that as an insider tip…
Impending doom clue #7: The demographic timebomb
The final clue to China’s looming demise is perhaps the most important — the demographic time bomb.
Remember the one-child policy? It caused havoc on today’s generation. A diminished workforce. A severe gender imbalance. And it turbo-boosted an aging population.
In other words, China’s getting older. Their ratio of old to young is quickly tipping in the elders’ favour…and that’s going to be expensive, if not unsustainable.
According to the China Academy of Social Sciences, the population will peak at 1.44 billion in 2029, followed by an annual decrease until 2060. The population could drop by as much as 200 million.
Not quite Black Death level, but close.
It’s not hard to see how destructive that could be for China’s economy…and how the rest of the globe could follow in its wake.
Claudio Grass sums it up this way:
‘At this point, the damage is irreversible and the imminent global economic slowdown will expose the deep cracks in our system.’
An implosion of the grandest sense.
Be prepared. Buy gold. Diversify.
Editor, Money Morning New Zealand