In recent months the stars have aligned for the China Bear. Not be confused with its non-ursine cousin the panda, the China Bear—which commonly finds habitat in internet forums, late night business programs and hedge fund conference calls—was once rarely spotted, but its numbers have been rapidly growing in recent years and it is now, perhaps for the first time since Nixon visited Mao in 1972, gaining dominance in the capital market food chain.
China’s recent run of worrying-to-poor data in terms of credit, imports, housing and industrial production (we had another contraction of 48.7 in Thursday’s Flash PMI) has most certainly provided bearish nourishment, as has the concurrent breakdown in the pretence that China’s central government is unified and without factional discord. Moreover, investors are now favouring the bearish argument, giving additional reason to crow, I mean growl, whether that is evinced by the performance of Chinese stocks domestically and abroad or by capital outflows, thus creating an almost self-fulfilling prophecy. In the last day the Financial Times’ excellent Beyond Brics section has explored this latter issue in regards to the surge in wealthy Chinese applying for American EB-5 immigration visas as has its sister site FT Alphaville.
But despite what appears to be the unequivocal writing on the wall regarding a slow down, the government in Beijing has a long arm and even the most pessimistic of pundits must admit that there remain unconventional policy tools that economic leaders can and will employ. In the words of Bill Bishop of Sinocism, whose daily web links we re-post at MacroBusiness, “even if you think China is just kicking the can down the road, like most of the rest of the world is doing, do not forget that China has a lot of cans, a lot of feet and a lot of (new) roads.”
It is perhaps for this reason why the archetypal papa of the China Bears, Jack Rodman, has left China after waiting eleven long years for the short sale of the century to come good. As reported by CNBC, he’s off to find more reliable property bear markets in Spain.
Yet while this presents the intriguing possibility of a contrarian indicator—when the most vehement of a trade’s advocates switches tack you know its time to buy or sell—Rodman has a good reason to cut his loses. As someone who has also been sceptical of China’s so-called miracle economy for many years, I’m all too aware of the country’s immense ability to extend and pretend in contradiction to the so-called laws of economics, or, to paraphrase Bill Bishop, to just build more roads through which to kick more cans down.
But even the most controlled economy has limits to state control and as China has pursued its wealth it has also, by accident or design, laid the foundations for its eventual liberalisation. The restructuring of perestroika, after all, goes hand in hand with the transparency of glasnost and remembering the Soviet Union in the late 1980s we know how that story ended. More to the point though, and as with the contemporaneous example of Japan, economic expansions mainly fuelled by credit and fixed-asset investment don’t enjoy the self-reinforcing sustainability of consumption-driven economies and historically have never lasted very long.
Whether China’s unsustainable boom can last until the economy transfers to a more sustainable system has been the subject of heated debate, as has the longevity of that boom or otherwise. Attempting to time an opaque and hence unknowable market is a mug’s game—as Rodman has discovered (though Jim Chanos and Hugh Hendry, among other China Bears, have claimed to have profited from their bearish positions)—but this doesn’t mean we can’t have a good go at analysing the risks in an attempt to at least find a list of potential tipping points.
In my own research on China I’ve found the most convincing of potential tipping points to be in agricultural inflation, which is why I’m watching the price of soya and other commodities quite closely (see a short post on this from a fortnight ago) as well as news on China’s heavily-burdened water resources and natural environment. If agflation does again rear its ugly head as it did in 2008 and 2011, Beijing’s policy options (i.e. its can-kicking abilities) will be severely curtailed as most of these options—whether interest rate cuts, spending programmes or currency depreciation programmes—are inherently inflationary. Not wishing to inflame what would already likely be a volatile scenario (think a repeat of the Arab Spring events that commentators believed could have easily spread to China last year) the government is hardly going to reopen the monetary floodgates.
The other tipping point is of course political, but not being a member of the Chinese Communist Party I can only guess at what form that will take. The point to remember however is that China has a long history of political revolution and almost semi-regular regime change. Leading into this year’s handover to the next Politburo, it is no wonder, therefore, that the government is cracking down on internal dissent, negative media portrayals and uncensored internet forums.
The announcement of fast-tracked infrastructure spending approvals will surely keep the can kicked for some time yet, but remember that a kicked can does not a successful economy make. The over-hang of fixed-asset investments (and mal-investments) is real in China, as is the fragility of its formal and informal lending systems.
Eventually the music will stop playing and a reckoning will occur, much to the detriment of Australia’s own unsustainable dependence on China and the recycling of the fruits of that dependence into an equally unsustainable property boom through APRA’s misguided favouring of mortgage credit as opposed to something more useful like, say, small business lending.
Still, while that reckoning is surely on its way, when we can’t be sure whether it’ll be in two months, two years or two decades, we have to be cleverer than just holding a naked short on Japanese CDS, Australian mining shares, or Chinese construction firms. In due course I hope to share a few ideas for what you could do instead.