March 23rd, 2012
Written by Macrotides
Editor’s note: This is the third in a series of four articles reviewing the global macroeconomic factors that may affect investors in the coming 1-2 years. The articles are:
- When, Not If, Will Volatility Increase?(Includes global central banking and Eurozone outlook)
- U.S. Macro Factors Impacting Investors.
- China: Risk is to the Downside, but Hard Landing Not Likely. (This article)
- Whither Stocks, Bonds, Gold and the Dollar (To be published)
We continue to expect China to avoid a hard landing, since its central bank will lower rates and reduce bank reserve rates to free up reserves as they did in February. However, the deceleration in China’s growth rate will not come without additional risks to its economy and potential social problems.
China is embarking on an audacious program to shift from its reliance on exports and internal fixed infrastructure investment for economic growth, to a greater dependence on domestic consumption. This transition will take at least a decade to accomplish. Consumer spending in the U.S. accounts for 70% of GDP, while it is just 35% in China. Between 2000 and 2010, fixed investment averaged 13.3%, as China expanded its export production capacity and infrastructure spending. During the same period, consumer demand averaged 7.8%. As a result, fixed investment rose to 46% of GDP, while consumer consumption fell to 35%.
In order to increase domestic consumption, incomes for the average Chinese worker must increase. In 2011, 24 provinces increased wages by an average of 22%. In April, the minimum wage in Shanghai is set to rise by 13% to $230 a month. According to China’s Five Year plan, wages are expected to rise by 13% per year through 2015. While higher wages are good for Chinese workers and will lead to an increase in domestic consumption, they will also push China’s inflation higher. China’s central bank will face a challenge in balancing these opposing forces.
In an ideal scenario, Chinese export growth would remain strong in coming years as China boosts domestic consumption. That is not what is happening. Europe is China’s largest export market. In February, exports to Europe were down 1.1% compared to a year ago, rather than the normal double digit gain. The annual gain in exports to the U.S. also slipped, rising 14.9% in February from December’s annual gain of 17.4%. Higher wages in China will also mean the loss of the competitive advantage China has long enjoyed, as workers in Malaysia, Vietnam, and Indonesia will increasingly be able to produce goods for less than China. China’s export machine is being squeezed from the top by slow growth in the U.S. and no growth in the EU, and from the bottom by lower cost producers around the world. The Chinese Economy Minister said boosting exports this year by 10% would require “arduous efforts”, an acknowledgement of the tough export environment China faces.
Internally, China is confronting a deflating housing bubble, which emerged after a huge lending spree in the wake of the 2008 financial crisis. Slowly but inexorably real estate values are slipping in its major cities. In response to calls to reverse current policy and support real estate values, Premier Wen said home prices remained too high and existing curbs were necessary to avoid “chaos”. With housing costs too expensive for the average worker, the risk of social unrest will remain high. Lower housing costs would help the average worker, but not China’s banks.
Slower export growth and the resulting excess capacity, which is not being offset by current domestic demand, combined with falling real estate and land values will pose significant risks for China’s banking system in the next two years. Although China is likely to avoid a hard landing in 2012, the risks are to the downside, especially in 2013.
Global Rebalancing: No One is Making the Right Moves by Michael Pettis
Difficult Choices Ahead for China by Michael Pettis
Is Decoupling Possible in a Global Economy? by Macrotides
Will Stocks and the Global Economy Roll Over in 2012? by Macrotides
About the Author
Macrotides is a monthly subscription newsletter written by a wealth manager associated with a major Wall Street investment bank. The author’s firm has requested that he not use his name to avoid any incorrect implication that his views might reflect those of the bank. The author has written investment advisory subscription newsletters based on macroeconomic analysis and market technicals for more than 20 years. Enquiries can be made email@example.com.