Yesterday, Houses and Holes posted an excellent video interview with Patrick Chovanec, Chief Global Strategist at Silvercrest Asset Managment, discussing the risks facing the Chinese economy as it attempts to transition from investment-led growth to consumption-led growth.
Last week, Chovanec toured Australia and provided some interviews where he explicitly discussed the implications for Australia’s resources-based economy as China rebalances and its demand for commodities wanes. Below are some key extracts from these interviews.
First, here’s Chovanec speaking to Ticky Fullerton on ABC’s The Business:
TICKY FULLERTON: Now, can I ask you first, – because on this program we heard last week about warnings on bad loans in China coming from a senior official at China’s accounting association This is something you’ve been quite vocal about when I’ve spoken to you before. Is it getting worse?
PATRICK CHOVANEC: Yes, it is. And we’re starting to see the results of accumulating bad debt in this system. And one of the big results is that the burden of rolling over that bad debt is growing greater and it’s sucking up more of the resources, particularly the credit resources in the system.
And that’s one of the reasons why we saw even though there was a huge credit expansion over the past six months and particularly the first quarter of this year, it didn’t really get much of a result in terms of GDP growth out of it.
TICKY FULLERTON: Well indeed, we had those disappointing GDP numbers, I think 7.7 per cent for the first quarter. What sort of report card on China are you bringing to Melbourne?
PATRICK CHOVANEC: Well China is really at an economics crossroads. It’s at the crossroads that it’s been really for the past four years and the question is whether it will make the adjustment that’s necessary to have more balanced growth and less dependence on – or overdependence on investment. Unfortunately, the past quarter, the past couple of quarters, there’s been a flood of credit to try to prop up investment and it doesn’t seem like they’re making the adjustment that’s really needed and unfortunately it’s producing less and less of a result.
TICKY FULLERTON: How do you think Australia is going at positioning itself, or put it another way: how exposed do you think we are to the China growth story?
PATRICK CHOVANEC: Australia’s very exposed because Australia has ridden the investment boom that China’s had for the past several years, providing the raw materials needed to fuel that investment boom. But China’s investment boom is not really sustainable. And we are seeing a squeeze on investment growth and I think we’ll continue to see that. And whether we see a hard landing or a soft landing, the direction of the Chinese economy is going to be towards less aggressive investment growth and that’s gonna hit Australia.
Now, in one of your previous segments you were talking about the imbalance really in the Australian economy between on the one hand that resources were really driving growth and even perhaps to the detriment of manufacturing in other areas. So, that – you know, that poses a real significant adjustment for the Australian economy if that resource demand slows down.
And here’s Chovanec speaking on the ABC’s Radio National:
CHOVENAC: First of all, there have been some questions raised about Chinese GDP figures and whether, whether they kind of give an exaggerated view of growth and I think last year, there were a number of serious analysts who said China’s economy grew at about five, five-and-a-half per cent last year. Now that aside though, a slowing Chinese economy is not necessarily a bad thing if it’s slowing for the right reasons. So if the reining in credit, and reining in over-investment that’s a good thing, but unfortunately, that’s not what’s happening.
Over the past several months, we’ve seen a huge boom in credit and particularly in shadow financing and the fact that we’re not getting that much to show for it I think is a very worrying sign.
EWART: So are we in a downward trend, and a downward trend for the worst reasons?
CHOVENAC: Well, we’re getting to a point where China has become, well China’s been over-reliant on investments for the past several years, but instead of weaning itself away from that, it’s trying to pump in more and more money. And unfortunately, this money increasingly goes to rolling over bad debt and rolling over bad debt at interest to pretend that it’s good debt. And what that means is you’re getting less and less GDP bang for your stimulus buck.
EWART: So the fact that the property market in Beijing and Shanghai, which is said to be overheating has been put forward for one reason why the economy needs to be reined in. That might be something of a red herring?
CHOVENAC: Well, in some ways you’ve got stagflation, you’ve got a lot of money being pumped in, it’s going into investment, particularly in real estate, it is bidding up the price of housing, a lot of the people who are buying real estate are buying it in order to have a place to stash their cash and not necessarily a place to live. And at the same time though, it’s not necessarily going to generate positive returns and that’s becoming a greater and greater drag on the economy.
EWART: So for a country like Australia, which is so inextricably linked to China in economic terms. Do they need to be having a rethink and looking at how that alignment works?
CHOVENAC: It’s a challenge, because Australia has benefited a great deal from China’s investment boom, iron ore, coal, copper, all these resources that feed China’s investment boom. Now Australia has really ridden that. But I think that it’s better to see that as a windfall, and not necessarily as a normal situation going forward. Because whether China sees a hard landing or a soft landing, there’s going to be a shift away from that very investment heavy development towards a more balanced approach between consumption and investment. That doesn’t mean that China can’t continue to grow, it just means that we won’t see the huge pace of investment that we’ve seen in the past.
And finally, here’s some discussion on Business Spectator that wasn’t captured in yesterday’s KGB video post:
RG: Patrick, we’ve had the most wonderful times selling minerals to China, particularly in the last four years. Can that continue?
PC: Not at the same pace. So, it was a windfall and Australia rode that windfall, but it’s not the new normal going forward.
RG: How far will it go down? What are you talking? Ten per cent, 20 per cent, 30 per cent?
PC: You know, it’s really hard to say. I think China’s behind the curveball already in terms of this economic adjustment away from relying on investment to a greater balance between consumption and investment. China’s investment story doesn’t have to end, but it does have to strike a better balance with the rest of the economy. A soft landing, which a lot of people hope for, I think would mean that investment would just flatten out and that it wouldn’t necessarily be contributing to GDP growth and so we wouldn’t necessarily see that much growth. But a hard landing could mean that we actually see, well you know, when we see booms and busts around the world, especially in investment or real estate, we don’t see investment level off, it just falls off. And that could really have a serious impact.
RG: So, on the optimistic scenario, consumption of minerals would roughly stay steady.
PC: That’s right. That’s right.
