by John Mauldin
All weekend long and this morning as I wake up in Monaco, the number of disparate publications screaming at me about problems in China is just overwhelming. Then I get myself up early to hear a speech by the esteemed British economist Charles Dumas of Lombard Street fame, and I am confronted with even more China. I have been watching China for a long time, expecting a crisis, as I readily admit I simply do not understand a country that has defied so many of the economic laws of gravity for so long. Some kind of return to normal economic paradigms seems almost mandated, but the question has always been when. Have the Chinese discovered some new control mechanism, found some different levers to pull that they should share with the rest of the world, or will we see them revert to something that looks more like whatever it is that passes for "normal" these days? My bet has always been the latter.
That said, I do not expect China to slip silently away. It is here to stay, and it will be bigger and more dynamic in the future, but the transition from an economy driven by investment and massive debt into one more soundly based on domestic consumption will not be easy. Today's Outside the Box will focus on two readings on China that came my way this weekend. The first is from the formidable Lyric Hughes Hale, an expert on Japan and Asia, founder of China Online, who is married to the eminent economist David Hale. I have had the pleasure of meeting with them and find them quite the economic power couple. She gives us a tour of recent work on China. Perhaps, as she asserts, the current Chinese economic model, based on cheap labor and cheap money, has run its course. The challenges that face China are daunting.
Then we turn to a thought-provoking piece of analysis from the Financial Times that underscores Hale's central point. China is grossly inefficient, with severe overcapacity in many industries: "The problem with subsidies everywhere is they tend to support activity not outcomes and they become more of a problem when they're just subsidizing inefficiencies…"
Just a few quotes from some of the other pieces I read in the last 48 hours:
China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned. The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead. "The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation," said Charlene Chu, the agency's senior director in Beijing." (from Ambrose Evans-Pritchard in the London Telegraph)
And then Stratfor writes:
A cash crunch over the past three weeks has caused rates on loans between banks to spike to the highest levels since mid-2011, drawing attention back to China's financial instability. Rates have since subsided, but conditions exist for them to remain elevated over the next month or beyond. Unlike two years ago, at least one bank has already defaulted on a loan and there are rumors that other defaults have occurred. The emergence of bank defaults poses a serious challenge to the central government's efforts to clamp down on credit growth as part of its broader attempt to reform the country's economy.
And finally, my friend Simon Hunt, who has been deeply involved in China for decades and spends many months each year traveling throughout the country meeting manufacturers, writes:
The credit crisis that we have been warning about has arrived. Debt has reached such peak levels that it can no longer be put under the carpet and rolled over for another day. The economy is having a mini-recovery this month but will weaken again in July.
Not expecting a collapse, Simon does see that serious adjustments are needed and believes they will be enacted:
Nor is there much of a risk that China's credit markets will implode because banks have built up a US$3 trillion war chest which is lodged with the PBOC and because [the] government has assets that can be utilized. The question is how the pain will be shared out throughout the country.
China always has my attention. I believe that Japan is forcing their hand with its own massive quantitative easing. China may have the easiest answer of all the major global trading countries, however. All they have to do is gradually float their currency. As Charles Dumas noted, they have $4 trillion in savings that will look for a home outside of China. A floating currency will weaken the renminbi against major world currencies and help their export businesses. It will also drive US Senators Schumer and Graham nuts, which is a side benefit. A floating currency with no significant QE when the Fed is printing with full abandon will be the strongest argument against the accusation that China is manipulating its currency. Interesting times.
My speech at GAIM will be tomorrow, and then I will take a few days to explore the south of France before heading off to Cyprus. I will speak at a venue that is being arranged on Wednesday in Nicosia, and the event will be open to the public. I will announce the time and place in this weekend's letter. And then it's on to Croatia and a long weekend with David McWilliams and his family on some idyllic little island in the middle of nowhere. Sounds divine. I hope you are enjoying your summer, wherever you may be.