on Sat Nov 12, 2016 10:52 am
- China’s long term outlook is very positive and its debt is not worrying.
- However, due to the nature of economic cycles, we have to expect and prepare for potential trouble coming from China.
- When trouble will happen is anybody’s guess as many have called negative scenarios several times, but those have so far failed to materialize.
China is the growth motor of the global economy. It consumes about half of the global produced copper and produces half of the global steel output. This is due to the incredible GDP growth China has achieved in the last 25 years, which has averaged 9% per year.
- Chinese GDP. Source:
High investments in urbanization have been necessary as 300 million people have moved into Chinese cities in the last 30 years, and another 300 million are expected to move into cities into the next 30 year.
A very important development for investors is the rise of the middle class in China because those are the people that can afford a car, education, discretionary pleasures, and further fuel the Chinese economy and spur global demand for everything from commodities to iPhones.
Chinese economic growth has recently slowed from 9% to the current 7% and sent short term shockwaves across the world. It is very important to see if China will be able to continue on this growth path or if there are a cumulation of risks.
Legendary billionaire investor George Soros is worried that credit in China is rising too fast and resembles the U.S. situation in 2007-2008. Soros forces an unavoidable hard landing in China at some point in the future as the credit cycle is feeding up on itself which he believes is postponing a turning point. However, Soros has made similar assertions in the past that haven’t materialized.
Credit in China is rising fast but when compared to the economic development represented in figure 1 above, the debt growth seems logical and in-sync with the economy.
- Chinese total credit:
- China’s economic growth rate and debt growth:
Credit ratings for China are still very stable with AA- from S&P, Aa3 from Moody’s, and an A+ from Fitch with a stable outlook from all rating agencies. On a global map, you can see how China is relatively safe when compared to other emerging market countries.
- S&P credit rating for each country:
- Chinese annual GDP growth:
Rapid economic development has brought many challenges to China, from demographic pressures related to an aging population, high inequality, rapid urbanization, challenges to environmental sustainability, and external imbalances. As China transitions from a low-income economy toward a middle income and hopefully into a high income economy, many structural reforms will be necessary. The Chinese 13th 5-year plan strongly addresses such issues. Services development, measures to address environmental and social imbalances, setting targets to reduce pollution, increased energy efficiency, improved access to education and healthcare, and expanded social protection are the highlight of the new 5-year plan. All the above will come at the cost of more uncontrolled growth and the Chinese government also predicts a slower growth rate at around 6.5% for the next 5 years.
Given the success the Chinese have had in the past 30 years, we can expect them to continue with their growth path, albeit a slower one. However, even a slower one will still continue to put pressure on global demand supply balances and pull the rest of the global economy along with it. The following table clearly identifies what we can expect from China in the next decade. Of course cycles have to be expected, but the long-term path and reforms are clear and therefore we shouldn’t buy much into China related fears as what has been put in motion up until now will certainly continue to move on that path.
- Projected growth pattern for China with no major shocks and a steady reform:
- U.S. soy beans exports increase as Chinese demand grows:
Just imagine what the Chinese middle class growth will do to tourism. Despite only 5% of the people in China having a passport, they already account for 10% of global tourism. With an additional 300 million people entering the middle-class, demand for tourism will hugely increase globally in the coming decades. When the opportunity presents itself to buy cheap leisure industry assets, perhaps due to an economic downturn, they will be great investments to grab.
- Importance For Investments In The Short Term:
Will a cyclical downturn emerge in China at some point? Yes, it will. Will it affect the global economy in a severe way? Yes, it will. Will financial assets and commodities get hammered? Yes, they will. When will this happen? It is anybody’s guess. George Soros has called for such a moment several times in the last decade, and the markets anticipated such a situation in August 2015 and January 2016. But nothing has happened.
We will undoubtedly see more failed anticipations until some real economic shock hits China. The government will then intervene and put China back on to its growth track. Economic cycles are natural, especially for a fast-growing country. The downturn might last for a few months or years but eventually the long-term trend is clear.
As investors, we must be ready to withstand such possibly hard scenarios and have the courage to invest more in bad times as that’s when assets are the cheapest. This is very hard to do, but it is necessary to discuss these possible scenarios in order to be prepared when, and if, these scenarios materialize. In the meantime, business as usual.
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