Superpower China

An article published by the Council on Foreign Relations in 2011 about China called it “The Inevitable Superpower”1. Some see the recent numbers pointing to the contrary:

  1. China’s GDP showed that it grew 7.4% in the first quarter2, making the growth look like it is on a downtrend from the double-digit growth of the recent past (see below),
  2. Corporate defaults in the news3 (does China face the bursting of a credit bubble?)
  3. The HSBC China Manufacturing Purchasing Managers’ Index (PMI) at 48.3 in April (a figure below 50 indicating slowing growth).

Superpower China Pic1

Source: http://www.tradingeconomics.com/china/gdp-growth-annual

Does all this add up to the Chinese dragon going into hibernation?

Unicorn, however, sees China very differently – we see a resilient economy.

According to Reuters, the official PMI edged up to 50.3 in March from 50.2 in February”4, showing an expansion.

As for its GDP, it stands at USD$9.31 trillion5 which is bigger than 154 other economies combined6; that is, a GDP that already eclipses 78% of the world’s economy. Besides that, it still has lots of room to grow as “its income per head (at market exchange rates) is only 13% of America’s and ranks below that of more than 80 other economies6.”

We see the credit defaults as necessary for the better maturity of the young capital market in China. Other analysts also feel that “the market will benefit in the long term3” with such failures weeding out the weaker companies and teaching investors to choose carefully and avoid believing that the authorities will always bail out every corporate borrower.

China is in the spotlight, which it isn’t used to and doesn’t welcome. The Economist explains: “Because China is already the world’s second-biggest economy, it attracts scrutiny that smaller economies escaped when they were at a similar stage of maturity… (March’s) bond default, for example, represents a painful but necessary step towards maturity for China’s capital markets.6” So, more defaults are to be expected and not to be feared – the authorities have the controls and the financial muscle to avoid a collapse of confidence.

China’s personal savings rate, at more than 50%, is the highest in the world7. With interest rates capped by their central bank, the Chinese simply save more to be able to afford what they need to buy, for example, housing, children’s education and health care7. Yet, China is being accused of borrowing excessively. How does one save so much and borrow even more?

Again, the Economist explains: “Consider a one-farm economy, which yields a GDP of 100 ears of corn. The farmer gives half to a fieldhand as wages and keeps the rest for himself. The fieldhand eats half of his wages and lends the remainder (25 ears) to the farmer. The farmer now has 75 ears of corn. He eats 25 of them, ploughs 48 back into the field as seed corn for next year’s harvest and lends two to a neighbouring farm.

To an economist, saving means anything not consumed. Therefore this economy, like China’s, has a remarkably high saving rate (the 50% of corn not eaten). But this high saving is combined with heavy domestic borrowing: the farmer has added 25% of GDP to outstanding debt. If, instead of lending corn to the farmer, the fieldhand ate it, saving would fall (because more corn is now being consumed) and so would borrowing (because the fieldhand is now consuming his own earnings, rather than lending half of them out)6.”

Thus, most of its debt is owed to itself. With China’s total foreign debt amounting to only about 9% of its GDP, even if the renminbi should fall further (it has dropped about 3% so far this year8), it would not necessarily mean that there would be a significant increase in borrowers’ debts in local-currency terms which would then force bankruptcies.

The borrowings are mostly to fund investments, unlike in the U.S. and Europe where the borrowings went mainly to fund consumption; it is true that China has ended up with empty buildings or and townships, but they have also invested in some “superb infrastructure” and facilities9. Thus China just needs to spend on different things; in our view it isn’t over-leveraged, nor is it overspending.

The defaults are also part and parcel of what the market needs to grow; and with the low Chinese government debt8, they can well afford to spend on bail-outs, if necessary.

There is also concern in the press about inflated property prices and large unsold stocks of property. We see a big difference between the U.S. property market in the past and China’s current property market. The U.S. property bubble had soared before it burst, resulting in casualties far and wide; whereas China’s property bubble was identified and addressed before it reached calamity proportions.

China’s leaders are well aware of the issues that their economy are facing, and they are and have been sure-footed in reforming the financial system to work better for China in the years to come. They also enjoy total control over the important levers of power in the economy.

The composition of China’s growth is changing for the better: “services have grown from 42% to 46%, exports have fallen from 38% of GDP to about 25%6” in just the past six years; domestic consumption is increasing fast and urbanisation is underway to generate jobs and growth9.

The inevitable superpower that is China is just biding its time to come alive as a vibrant and resurgent dragon that will see the country very soon as the world’s biggest economy with a growth rate the rest of the world will envy.

References

1The Inevitable Superpower – Why China’s Dominance Is a Sure Thing

http://www.foreignaffairs.com/articles/68205/arvind-subramanian/the-inevitable-superpower

2China’s economy grows 7.4% in 2014 Q1, better than forecast

http://www.bbc.com/news/business-27045527

3S&P: Not All Shadow Banking Exposures In China Are Risky

http://www.chinamoneynetwork.com/2014/04/28/sp-not-all-shadow-banking-exposures-in-china-are-risky

4China factories struggle, adds to expectations for stimulus

http://www.reuters.com/article/2014/04/01/us-china-economy-pmi-idUSBREA3003220140401

5China’s GDP up 7.7 pct in 2013

http://news.xinhuanet.com/english/china/2014-01/20/c_133058484.html

6On cloud nine trillion

http://www.economist.com/news/china/21599806-our-asia-economics-editor-takes-his-leave-less-worried-many-his-peers-about-frailties

7China’s savings rate world’s highest

http://english.people.com.cn/90778/8040481.html

83 Reasons Why a Chinese Economic Crisis Is Unlikely

http://blogs.wsj.com/chinarealtime/2014/04/29/imf-three-reasons-not-to-worry-about-a-crisis-in-china/?mod=WSJBlog

9China’s debts do not signal imminent implosion

http://www.ft.com/intl/cms/s/0/2b66ba78-b672-11e3-b230-00144feabdc0.html#axzz30Fmoanv3

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