Following on from his stellar effort in July, where he nicely articulated the huge structural imbalances plaguing the Chinese economy and the significant downside risks that such imbalances entail, Bill Smead, CEO & CIO at Smead Capita Management, returned to CNBC today to discuss his outlook for the Chinese economy.
In the video, Smead argues that a sharp deceleration in the Chinese economy is inevitable owing to the fact that 50% to 60% of growth comes from fixed asset investment (FAI), much of which does not generate an economic return (“rents”) above the cost of capital. Accordingly, the Chinese banks that lent to such projects are trapped continually rolling-over non-performing loans, which is hammering bank capital and stifling new growth.
Smead also argues that even if China could significantly increase consumption, because it is only around 30% to 35% of GDP, any increase is unlikely to be anywhere near enough to offset falling FAI, meaning growth will necessarily fall as the economy rebalances.
Finally, Smead notes that if China is to solidify its position as an economic powerhouse, it will need to let the business cycle run and stop trying to “kick the can” via stimulus, which ultimately heightens imbalances, destroys productivity, and creates zombie banks and growth. He also believes the 2008-09 Chinese stimulus package was akin to the US’ 0% car loans post-911. While it boosted growth in the short-run, it mis-allocated resources and damaged the economy in the longer-term.
Overall, it’s another good effort by Smead who, like Michael Pettis and Patrick Chovanec, understands the difference between high quality (balanced) growth and low quality (unbalanced) growth.
