Just as the earth spins on its axis, the financial crisis is making a slow transit from west to east. Having started in America, which built a colossal credit bubble during the Greenspan era, and then to Europe, which used the early years of Euro integration to paper over a widening north-south rift in productivity, competitiveness and prudence, it is now completing its journey in Asia.
And just as the US institutes a third round of quantitative easing, and Europe makes moves to address its imbalances through the legal ratification of the European Stability Mechanism and proposals by EU President Jose Manuel Barroso to form a banking union, deep worries are emerging out of China at a time when risks markets should otherwise, in theory, be celebrating.
Of course the irony of the US recovery is that in many ways it has contributed to the crisis now brewing in Asia. The monetary stimulus instituted by Ben Bernanke has not, as its critics feared, led to significant US inflation (notwithstanding its effects on commodity prices), but cheaper credit and lower rates of interest did indirectly increase hot money flows to Asia and support China’s own monetary stimulus, where M2 money creation soared alongside fixed-asset investment. But now, with arguably little more to show for it than empty skyscrapers and bridges financed by dodgy loans, Beijing is wondering how growth can be maintained sustainably between now and when the world economy is back to a firmer footing.
Being the only sprinter in a global economic race has its advantages in bragging-rights, but in reality it is a lonely and somewhat dispiriting affair. As recent trade data showed, Chinese exports are still weak and notwithstanding Europe’s own attempts at monetary stimulus in the past week – ECB President Mario Draghi’s so-called outright monetary transaction policy – China’s main trade partner is unlikely to recover anytime soon.
But more worrying than this is China’s internal state of affairs. Whereas exports merely slowed, imports actually declined at the last reading and in terms of current credit data, signs are also showing that China’s banks are unwilling to continue their lending binge, notwithstanding the scores of recently-approved infrastructure and development projects that some analysts are dubbing as a sequel to China’s 4 trillion yuan package in 2008.
And at a time when there is perhaps less than a month to go before China’s next group of leaders are announced – if the assumed paramount leader-to-be Xi Jinping can indeed be found (the London Telegraph has spread rumours of a heart attack) – concerns over declining economic growth are especially acute.
A range of commentators believe that if China cannot continue to produce high economic growth, the Communist Party will lose its ‘mandate of heaven’. Yet while this makes sense in theories of rational trade-offs between democracy and prosperity, and indeed as the Financial Times noted this week,fragile periods of transition are usually accompanied by a jump in government stimulus, closer analysis suggests that much of the top-line GDP growth generated recently in China has failed to trickle-down to the proletariat anyway and that such stimulus has instead favoured party cadres seeking recognition and rewards as well as local governments dependent on land tax and investment revenues.
Our investment team has spent months debating whether China will provide the next ‘big bazooka’ in market increasingly addicted to stimulus. But as each week passes without so much as a pop from Chinese fiscal and monetary authorities, we can only increasingly conclude that they’re not just keeping their powder dry, but are actually gun-shy.
As the government mouthpiece Xinhua wrote this week, further fixed-asset stimulus would “be detrimental” to sustainable Chinese growth in the long-term. With tax reform, welfare spending and credit liberalisation, perhaps accompanied by a small drop in interest rates or bank reserve requirement ratios, seen as more appropriate policy responses for the time, this means that even if China does manage to encourage further growth, it won’t guarantee the higher commodity prices that previously buoyed Australia’s terms-of-trade boom.
The way for Australian investors then to leverage China’s next economic phase is less to be in mining shares, or indeed banks and property, which have also benefited from higher money market flows on the strength of the Australian dollar, but by companies that directly address the issues that China needs to fix in its path to a more sustainable economic model. As we will discuss in this week’s edition of Macro Investor, what those companies are, however, may surprise you.
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