By Michael Feller
In the 1994 film Speed, Keanu Reeves must drive a Santa Monica commuter bus through the streets of LA, never letting the speed go below 50 miles per hour lest it detonate a bomb, killing all on board.
While lacking the Billy Idol soundtrack, or the presence of Dennis Hopper as the bad-guy extortionist, something similar is happening in China, with the added complication of the bus driver needing to change hands sometime over the coming months.
With 1.3 billion passengers on board, the stakes are high for the Chinese Communist Party as it navigates the winding laneways of slowing exports, an uncertain property market, rising capital outflows and a Europe – the country’s biggest trade partner – mired in recession.
Yet though China’s helmsmen, if you will, have been adept at the wheel, keeping growth above this year’s targeted 7.5% GDP growth so far, secondary indicators – ranging from oil imports to electricity production to factory output – suggest that the next quarterly data release will test the government’s target.
How much this matters of course is anyone’s conjecture, but with the CCP deriving, in part, its legitimacy from the maintenance of strong economic growth one can assume that fears of a slowdown are more than merely a matter of face. In a year when the Politburo changes hands – an event that could happen as early as September, if recent reports from Hong Kong newspaper Ming Pao are to be believed – and political tensions are already high in the wake of the Bo Xilai fallout, history suggests that maintaining rapid growth will be even more a priority. Furthermore, with export-focussed factories in Guangdong shedding workers and rural joblessness still a concern, strong growth will be necessary to stem an employment problem that China can neither fiscally nor socially afford.
At the same time however, the chief driver of China’s growth – the speeding bus’s engine as it were – has been part of the problem, with fixed-asset investment now exhibiting signs of a significant structural overhang that respected economists such as Andy Xie believe will take decades to unwind. While using China’s prodigious savings to produce surplus housing, infrastructure and productive capacity may seem to many in the West as wiser than, say, bailing out bankers or disincentivising labour through generous welfare and retirement benefits, a fixed-asset investment overhang has problems of it own.
While experience cannot offer us any examples of investment spending similar to China’s levels – Japan at the height of its property bubble didn’t come close – there is something deeply worrying about the scope for mal-investment and bad debts within a sector that accounts for more 50% of the economy, or even over 80% in cases like Bo Xilai’s former fiefdom, Chongqing.
So while we can assume that China will press the pedal before its 50mph minimum is hit, such a manoeuvre could end up crashing the bus before the fuse has a chance to be lit. And, moreover, while China has ample amounts of fuel in the tank, not to mention the overdrive to cruise at much faster pace, there is the grim prospect that any pending stimulus effort could be more in the form of a rescue package to those parts of the economy that accumulated too much dodgy debts or built too many white elephants during the first speed-obsessed stimulus package of 2008.
While a racing car driver may be tempted to power through a difficult turn rather than apply the brakes, when the Chinese juggernaut is more shaped like an over-crowded commuter bus, the chances of survival diminish significantly. And despite assurances from Wen Jiabao this week that China can fulfil its growth target, the experience of a fatal three-bus pileup this week on a typically poorly-built Guangxi highway provides a chilling omen as do other ongoing transport-related disasters in China, ranging from the cratering of a “jelly-built” Gansu expressway due to heavy rains to the ongoing trial of China’s bacchanalian former railways minister to Wednesday’s recall of thousands of Chinese-built vehicles in Australia.
Those who depend on rapid Chinese growth of the fixed-asset variety, particularly Australian miners and their financial backers, might be optimistic about the chances of a Chinese stimulus package, but until we have greater clarity on how big that will be, what form it will take and when it will happen it’s unsurprising that capital outflows remain as they are.
Michael Feller is an investment strategist at Macro Investor. In this week’s issue we are producing a special report on the chances and risks of a Chinese stimulus package.