“Arrogance is a killer, and wearing ambition on one's sleeve can have the same effect. There is a fine line between arrogance and self-confidence. Legitimate self-confidence is a winner. The true test of self-confidence is the courage to be open—to welcome change and new ideas regardless of their source. Self-confident people aren't afraid to have their views challenged. They relish the intellectual combat that enriches ideas.” - Jack Welch
Last week, we briefly outlined China’s various challenges. This week, we will have a look why the situation in the world second largest economy matters (hint: the answer is in the question). In recent years, the consensus about China’s long term prospects shifted rather dramatically, from bullish expectations to a growing mix of bearishness. As a result, a lot of companies found themselves short changed on the ‘miracle’ growth story.
When the developed economies sank during the Great Financial Crisis, China turned to a massive spending spree in order to support its domestic industry. Unfortunately, this program was launched just when China’s financial system started to recover from the previous debt binge that ended abruptly with the Asian Financial Crisis.
In addition, China’s economy was already severely imbalanced for previous Premier Wen Jiabao to lay out its Four Uns in 2007: unstable, unbalanced, uncoordinated and unsustainable. But the aggravation of these imbalances kept growth rates and demand for a variety of products high, when the previous engines of growth (Europe and the US) were stagnating. Companies and investors then targeted to this new growth haven, increasing competition within China’s domestic market and flooding it with new products and money.
Exposures increased dramatically, both for companies (e.g.: commodity producers) or whole countries (e.g.: Australia) and continents (e.g.: Latin America). Now that China is slowing down, competition is fiercer than ever, market trends are shifting rapidly and everyone is trying to adapt as best as they can. Like financial leverage, China’s turbo charged growth is working out as fast in reverse, catching bullish companies and countries on the wrong foot.
On article below shows a potential financial trail coming from the Chinese powder keg: “The most obvious is that low prices will result in loan defaults or bankruptcies by commodity producers that weaken financial institutions.” Indeed, stresses are already being felt throughout Asia Pacific and South America where many companies rely on Chinese demand for commodities or re-processing, or in the Western world where companies depend on Chinese growth to make up for their sluggish home markets.
Politically, the abrupt loss of confidence in the Chinese government capacity to handle its growing crisis will also weight on international relations with a rebalancing of bargaining power to the world outside China. Yet even if the colossus is shown to have clay feet, China’s power will continue to grow: its priorities will shift inward, even though they never really adventured far outside its domestic realm. And we must remember that countries can be both weak and strong: Russia is a poor country with a strong army.
Finally, China’s current institutional framework is warning sign that the country may not reach the status of developed country. But again, this doesn’t mean that Beijing will crumble and China disappear: instead, it is the Western vision of a globalized, democratic and open world that may run into a serious reality check. The various crises in Europe are at least partly about this paradigm change, and the eventual outcome may be a signal for the rest of the world of the direction of the world toward integration or gradual retreat.
History & Geopolitics
Germany’s demographics: Young people wanted – (Hat tip Lao Ho) – “Demographic change need not be a catastrophe. The question is how to react. Governments are all used to managing growth. They must now learn how to manage shrinkage. We need a complete rethink in our societies.“
Russia can break out of Putin’s thrall – (Hat tip Lao Ho) – “It rightly emphasises the importance of domestic factors in the way that Russia formulates and conducts its foreign policy. On the other hand, it risks falling into the conceptual error of confusing an authoritarian strongman with an entire society, as if the wills of Mr Putin and 140m-plus Russians are one and the same.“
Israel: The Case Against Attacking Iran – “The first is that militarily taking out Iranian facilities would be difficult, and the second is that attempting to do so would affect relations with Israel’s indispensible ally, the United States.“
How China’s Currency Policies Will Change the World – “While one group is now considering raising interest rates for the first time since 2008, another group is still pursuing quantitative easing programs, which are partly designed to devalue currencies and stimulate growth.“
Finance & Economics
Signs, Long Unheeded, Now Point to Risks in U.S. Economy – (Hat tip Lao Ho) – “The data points range from the obvious to the obscure, encompassing stock market and credit bubbles in China, the strength of the dollar relative to emerging market currencies, a commodity rout and a sudden halt to global earnings growth.“
Why worries about China make sense – Martin Wolf “The first is cleaning up the legacy of past financial excesses while avoiding a financial crisis. The second is reshaping the economy, so that it is more dependent on private and public consumption and less dependent on extraordinarily high levels of investment. The third is achieving all that while sustaining dynamic growth of aggregate demand.“
A Warning on China Seems Prescient – “At 282 percent of G.D.P., China’s debt as a share of G.D.P., while manageable, is larger than that of the United States or Germany. Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.“
Political Risks May Foil Economic Reform in China – (Hat tip Lao Ho) – “On average, autocratic nations grow faster than democratic ones up to around where China is now. But successful cases democratize at around this level of income per capita.“
Behind the commodities bust – “Over-optimism about China caused unneeded investments to be made. It will be harder for commodity exporters to generate jobs for their workers. There are other dangers. The most obvious is that low prices will result in loan defaults or bankruptcies by commodity producers that weaken financial institutions.“
China -Weakened foundations – (Hat tip Lao Ho) – “In selling this move to Beijing’s leaders, the PBoC dressed it up as a devaluation that would help exporters and sold it as being in the national interest. But to the outside world, it has tried to portray the move as a market-based reform on the road to a more freely traded exchange rate.“
China’s economic slowdown – Handy charts “China’s changing demographics have to mean a slower economic growth rate. Coming off an apparent bubble in real estate and stock markets is clearly going to make it a challenge to manage a smooth landing.”
Picture of the day: Track and Field World Championships 2015
About Carlito Riego
"Great perfection may appear imperfect, but its usefulness is inexhaustible. Great abundance may appear empty, but its usefulness cannot be exhausted. Great correctness may appear twisted, great skills appear crude, great eloquence appear awkward. Activity conquers cold; inactivity conquers heat. Clear serenity governs the world." - Lao Zi