Two months ago I attended a dinner of Wall Streeters at a proper club in midtown Manhattan; it called to mind the locker room scene in the movie Wall Street where Gordon Gekko wisely opines, “That’s the thing you gotta remember about WASPs – they love animals, they can’t stand people.” Anyhow, in attendance at the dinner was my friend Bill, the Smartest Strategist on Wall Street. Bill told me after the dinner, “Tom, the reason the ISM was so weak [it was 49 that month] is that China is slowing down.”
Bill was right, as usual. I know almost nothing about China, except what I read in The Financial Times. But what I read is pretty scary; if you apply a little logic it is reasonable to conclude China growth will be much worse than current consensus. Yesterday in an FT column, “wise man” Gavyn Davies made these salient points:
- China will need to spend several years tackling a combination of excess credit and overinvestment.
- China is in the midst of a classic credit bubble. The ratio of total credit to GDP has climbed from 115% in 2008 to 173%, a danger level.
- The debt service ratio in the economy, which the Bank for International Settlements says reliably signals risk of banking crisis, is around 39% (according to SocGen). The danger level is 20-25%.
- Much of the credit financed “low return” capital spending by local governments—i.e., the Chinese equivalent of Alaska’s “bridge to nowhere.”
- The arithmetic to get a soft landing is “formidable.” Private investment growth needs to slow to about 4% in the next decade from 10% in the last decade.
- On the bright side, government has the money to capitalize the banks if necessary.
It gets worse. The latest figures on exports and imports were much weaker than expected, which is not surprising because all of China’s major markets are growing slowly, if at all. The FT quotes a “spokesman for the customs administration” as saying, “Our country is facing serious challenges.”
So, to summarize, the two major drivers of China’s growth, exports and investment, are slowing sharply. A credit bubble is being popped. And much of the credit growth of the past few years funded government projects which, by definition, were made at least partly for political not economic reasons.
Even if the government has the capital needed to prevent a “China Syndrome” meltdown, we can expect Wall Street economists to keep ratcheting down their forecasts—a lot. For the past couple of years the major Wall Street houses have been playing a dainty parlor game of cutting their China GDP growth forecasts 10 or 20 bps at a time—7.5%, 7.4%, 7.2%. My guess is that, before they are done cutting, they will be debating whether growth is above or below 5%. Even competent, well-managed governments of giant, sprawling nations that are simultaneously grappling with a credit bubble, overinvestment by governments, and a sharp slowdown in exports should not be expected to engineer an oh-so-soft landing in GDP growth.
Copyright 2013 Thomas Doerflinger. All Rights Reserved.
