Quote of the Day:
The case for reform is compelling because China has now reached a turning point in its development path.
Robert Zoellick – World Bank President
Recap Michael Pettis On China
- It’s about time I put a word in for Michael Pettis, every now and again he writes golden stuff on China and I always appreciate commentary from a man who actually lives and works in China.
- Firstly to add relevance I should point you to an article I wrote not long ago on the potential growth recession in China. This is not a recession as we define it, it is simple a point where extremely fast growing countries get to a point where Real GDP growth becomes comparable to underlying inflation. At this point, in my view, the smoothing effect of growth on the economy begins to get overridden by the adverse effects of inflation. Here is an excerpt from my piece:
- Breakneck Growth in China hides a lot of cracks beneath the surface. I’m not just talking about NPLs it’s the entire nature in which capital is allocated in a business society used to persistently high growth and relatively low inflation.
- This has been touched upon by Peking University Professor, Michael Pettis, in particular in a couple of pieces:
- To quote a couple of sentences from the second piece:
“In all previous cases of countries following similar growth models, the dangerous combination of repressed pricing signals, distorted investment incentives, and excessive reliance on accelerating investment to generate growth has always eventually pushed growth past the point where it is sustainable, leading always to capital misallocation and waste. At this point – whichChinamay have reached a decade ago – debt begins to rise unsustainably.”
- All investors interested in World Affairs should read those two articles in my opinion they highlight many of the hidden pit falls with investment in Asia – particularlyChina.
The World Bank Frets About China
- Fast forward to today and The Telegraph has a pretty assertive article on the Chinese economic prospects – citing a Zoellick, President of the World Bank (a respected organization in China) as saying:
The country’s current growth model is unsustainable. This is not the time just for muddling through – it’s time to get ahead of events and to adapt to major changes in the world and national economies
- OK, more Western doom-mongering on China every time has a “blip” in data, you might think – and it probably is just that. But, while I thinkChina’s rise to super-powerdom is something to be embraced as an inevitability I do not believe it will be without considerable volatility. Zoellick’s comments are probably political to some degree and are, incidentally, timed perfectly with China’s change in administration.
- All this brings us to Michael Pettis’ latest comment in Seeking Alpha – which is worth reading too. Here are a couple of excerpts to whet your appetite, but I recommend you read the entire piece.
This what I worry about most for China as it decides its adjustment process.Beijingcould easily choose to absorb debt rather than pay it down through asset sales, and as debt rises it will be all the harder to raise interest rates. It will ultimately also create what is potentially a destabilizing debt overhang, although as Japan showed, it can take many years before the debt itself becomes unsustainable.
That is why although I don’t think it is a certainty, I am expecting that the most likely economic outcome for China for the rest of this decade is a combination of much slower growth and rapidly rising government debt. Privatizing assets and using the proceeds to shore up household wealth, directly or indirectly, is politically tough to do.
And how much will growth slow? The World Bank report apparently doesn’t say, but the consensus has been slowly moving down towards 5-6% annual growth over the next few years. That’s better than the crazy numbers of 8-9% most analysts were predicting even two years ago (and some still are), but it is still too high. GDP growth rates will slow a lot more than that. I still maintain that average growth in this decade will barely break 3%. It will take, however, at least another two or three years before a number this low falls within the consensus range.
And by the way when it does, metal prices should fall sharply. Copper prices have done reasonably well in the past few months as Chinese buyers have restocked, as we suggested might happen to our clients last fall. With the recent easing we may see more strength in copper over the next month or so, but I have little doubt that within two or three years copper prices are going to be a whole lot lower than they are today. Chinese investment demand simply cannot hold up much longer.
A Rampant Chinese Stock
- Just to buck the form. Unrelated to the comments above, I’ve decided that Chart of the Day is China Mobile [Ticker: 941 HK]. Note: I am not making a recommendation on this stock – only that the chart looks interesting.
- HSBC, Goldman and Credit Suisse have all upgraded the stock to a “Buy” and the stock has gone ballistic.
Volatility Back To the Lows
- My other Chart of the Day is The VIX. Volatility back at it’s lows would indicate that everything is back to hunky dory again. What do you think?
Chart of the Day
VIX (Source: Bloomberg)
- Italy GDP came out at -0.7% QoQ (that was expected)
- Nothing Significant
- Prudential [PRU LN],
- Coca Cola [KO], Merck [MRK],