By John Richardson
THE extent to which the global economic recovery has been dependent on China will become all-too apparent over the rest of this year, and into 2018, as China once again reduces lending. As UBS writes in a report released earlier this month:
The economy at the epicentre of the most significant growth impulse for the global economy has actually been China. Its import volumes rose by just under 15% over the last 12 months, providing a solid boost to global growth. By comparison, US import volumes grew by 3.5%, while Europe’s were nearly flat over the same period.
The above chart, from the same UBS report, visualises this analysis as it shows the extent of the rise in Chinese imports by volume and value over the last 12 months.
UBS adds: While there has been some degree of retail sales and labour market healing in most major economies, when we look for the core of the reflationary stimulus, a region that has also helped growth in other regions through higher imports, China stands head and shoulders above everyone else.
We must, of course, though, not forget the post Trump-election bounce to the global economy from Q4 2016. But that this is about to evaporate when it becomes obvious to the majority that he isn’t going to achieve anything on tax reforms and infrastructure spending in 2017. And following the healthcare-reform failure, it seems quite possible that the Trump administration will fail on tax and infrastructure period.
The boost delivered by China to the global economy is also now set to disappear as China’s president, Xi Jinping, accelerates economic reforms through reducing the availability of credit.
So far this year, the evidence that Xi is sticking to his promise to tackle China’s debt crisis is mixed.
In January-February, growth in Total Social Financing (TSF) was lower year-on-year. TSF is a measure of total lending in China from both the state-owned banks and the “shadow” private lenders.
March was a more nuanced picture. Lending via state-owned banks was lower than the previous month and outstanding bank loans to corporations saw their lowest monthly growth since March 2004.
At the same time, though, TSF was much higher than in February – and Q1 TSF was 12.5% greater than in the first quarter of last year. The explanation for this was a surge in short-term loans to households.
But I believe it is simply a question of time before Xi successfully reins in credit growth. The obvious target is now the shadow-banking sector, as this was the source of most of the loan growth to households in March. And most of that money, not surprisingly, poured into the real-estate sector. House prices in Beijing shot up by an incredible 63% between October 2015 an February 2016.
Why it is only a question of time is because Xi knows he has to deal with the financial damage left behind by the failed policies of the Populist, anti-reform political faction. Xi leads the Princeling pre-reform faction. Sooner rather than later makes sense for Xi before the damage gets any worse than this:
- Fitch warns that capital shortfalls to meet China’s debt are at 11-20% of GDP, with the potential for this to increase to 33% in the worst-case scenario by the end of 2018.
- In Britain and the US, the direct costs of bank rescues reached approximately 8% of each country’s GDP after the Global Financial Crisis (GFC).
- Lower global growth since 2008 has made it harder for China to grow its way out of debts.
We have been before, but the trouble is that too many people overlook the influence of China’s credit cycles on global economic growth. Here are the three phases of recent history:
- China increased lending by $10 trillion in 2009 when its nominal GDP was only $5 trillion. This was a desperate scramble to stimulate local demand in order to compensate for export-focused jobs that were at risk as a result of the GFC. The credit bubble also resulted in the growth of the shadow-banking sector. This involves highly speculative and complex – and so very risky – lending practices. Lending was an astonishing $18trn higher by 2013 when Xi came to power.
- He then reversed policy from early 2014, causing lending to fall by$4 trillion by 2015. This was one of the factors behind the decline in global oil prices from around September of that year. Commodities prices in general slid on a slowdown in the Chinese economy. Crucially, also, the global economy lost momentum.
- Lending then took off again in 2016. The real-estate bubble was reflated, and we saw a rebound in global commodities prices – and the global economy – from around the middle of last year. The chart below, which shows the Caixin China Purchasing Manager’s Index next to iron-ore prices, illustrates the point. As Chinese steel production expanded on greater availability of credit, iron-ore prices rose. The same pattern can be seen in some other commodities prices. It should be noted, however, that another factor behind the rally in iron ore was the closure of some uneconomic Chinese iron-ore mines. But I believe the main driver was the China credit cycle.
Note from the chart above that expansion in the Caixin PMI fell in March compared with February on signs of credit tightening. Iron-ore prices have also fallen.
I don’t buy the argument that the global economy has turned an important corner. The recovery we have seen over the last few months is, I believe, almost entirely down to the China and Trump factors and has little to do with stronger underlying fundamentals.
In the end, it all comes back to demographics. Until or unless the West confronts the challenge of rapidly ageing populations then there can be no return to the growth levels that we saw during the Economic Supercycle.
So the data will soon start telling us that the global economy is going backwards again, as the China and Trump factors dissipate. We are already seeing this through very low estimates for US Q1 GDP growth.
The first order effect will thus be a return to deflation as the reflationary boost from China and Trump disappears.
Then the issue will become whether or not China can successfully deal with its debt crisis and smoothly transition to a more sustainable economic growth model.
Goldman Sachs rates the chances of a financial crisis in China during 2017 at 25% and at 50% in 2018. The global implications of such a crisis would of course have to include recession – or even something close to the 2008 GFC.