Trade War Is Hiding China's Big Problems

By Panos Mourdoukoutas


The ongoing US-China trade war is a distraction from China’s big problems: the blowing of multiple bubbles and the country’s soaring debt, which will eventually kill economic growth.
It happened in Japan in the 1980s. 

And it’s happening in China nowadays.
The trade war is one of China’s problem that dominates social media these days.

 It’s blamed for the slow-down in the country’s economic growth, since its economy continues to rely on exports. 

And it has crippled the ability of its technology companies to compete in global markets.
But it isn’t China’s only problem. 

The country’s manufacturers have come up with ways to minimize its impact, as evidenced by recent export data. 

And it will be solved once the US and China find a formula to save face and appease nationalist sentiment on both ends.
One of China’s other big problems , however, is the multiple bubbles that are still blowing in all directions. 

Like the property bubble—the soaring home prices that makes landlords rich, while it shatters young people’s dreams of starting a family, as discussed in a previous piece here.
New Home Prices 2015-19

Unlike the trade war, that’s a long-term problem. 

Low marriage rates are followed by low birth rates and a shrinking labor force, as the country strives to compete with labor-rich countries like Vietnam, Sri Lanka, the Philippines and Bangladesh—to mention but a few.
Then there’s the unfavorable “dependency rates” — too few workers, who will have to support too many retirees.
And there’s the impact on consumer spending, which could hurt the country’s bet to shift from an investment driven to a consumption driven economy.
Japan encountered these problems over three lost decades, even after it settled its trade disputes with the US back in the 1980s.

China experience many more.
Meanwhile, there’s the infrastructure investment bubble at home and abroad, as discussed in a previous piece here. 

At home infrastructure investments have provided fuel for China’s robust growth. 

Abroad infrastructure investments have served its ambition to control the South China Sea and secure a waterway all the way to the Middle East oil and Africa’s riches.
While some of these projects are well designed to serve the needs of the local community, others serve no need other than the ambitions of local bureaucrats to foster economic growth.
The trouble is that these projects aren’t economically viable. 

They generate incomes and jobs while they last (multiplier effect), but nothing beyond that—no accelerator effect, as economists would say.
That’s why this sort of growth isn’t sustainable. 

The former Soviet Union tried that in the 1950s, and it didn’t work. 

Nigeria tried that in the 1960s; Japan tried that in the 1990s, and it didn’t work in either of those cases.
That’s why bubbles burst -- and leave behind tons of debt.
Which is another of China’s other big problems.
How much is China’s debt? 

Officially , it is a small number: 47.60%. 

Unofficially, it’s hard to figure it out. 

Because banks are owned by the government, and give loans to government-owned contractors, and the government owned mining operations and steel manufacturers. 

The government is both the lender and the borrower -- one branch of the government lends money to another branch of government, as described in a previous piece here.
But there are some unofficial estimates. 

Like one from the Institute of International Finance (IIF) last year, which placed China’s debt to GDP at 300%!
Worse, the government’s role as both lender and borrower concentrates rather than disperses credit risks. 

And that creates the potential of a systemic collapse.
Like the Greek crisis so explicitly demonstrated.
Meanwhile, the dual role of government conflicts and contradicts with a third role -- that of a regulator, setting rules for lenders and borrowers. 

And it complicates creditor bailouts in the case of financial crisis, as the Greek crisis has demonstrated in the current decade.

China's Growth Story Has Plenty of Holes

Don’t get carried away by the green shoots. Ample data show that Beijing’s targets are increasingly unrealistic.

By Christopher Balding

As China posts yet another quarter of six percent-plus growth, analysts have been quick to brand the latest upswing as a rebound. 

Buoyed by this year’s double-digit stock-market gains, large flows of credit and tax cuts for consumers, Beijing is trying to sell the narrative that growth remains stable.
Some official statistics seem to support that theory: Gross domestic product grew an annualized 6.4 in the first quarter from a year earlier. 

Retail sales rose 8.7 percent and factory output climbed 8.5 percent.
Dig beneath the headline data, though, and we get another story.
Beijing has been flooding the market with credit, with total social financing up 40 percent so far this year. 

Notably, the source of funds is expanding beyond banks, indicating an uptick in shadow activity. 

Yet fixed-asset investment is up only 6 percent from last year. 

That means loans aren’t heading into areas that will boost the real economy. 

Meanwhile, companies aren’t getting paid what they’re owed, and account receivables are building up.
The consumer side doesn’t look any better. 

Auto sales fell 11 percent in the first quarter from an already tepid 2018. 

Mobile-phone shipments slid 12 percent over the same period, compounding a 26 percent tumble a year earlier. 

Households are clearly feeling the pinch: They’re ordering less takeout from delivery apps and seeing fewer movies at the box office. 

Shoppers are using their credit cards more, with balances up 23 percent in the fourth quarter from a year earlier. 

And while surveys show household expenditure rose nearly 15 percent in 2018, there’s little left over in the budget for any extras. 

That helps explain why production of air conditioners is down 1 percent in the first two months of the year, while washing machine output dipped 7 percent.
Beijing has unveiled a standard buffet of fiscal stimulus, credit growth, debt restructuring and consumer-focused tax breaks to boost growth. 

It’s debatable whether any of that will work. 

Public finance doesn’t play out in a vacuum: A tax-cut recipient has the option of saving that money or spending it. 

Given high Chinese household debt levels, it’s quite likely that windfall will have a much smaller impact on consumption than hoped. 

The same thinking applies to firms and local governments.
The more pressing question might be how much new credit is flowing into financial markets given the rise in stocks and commodities prices. 

A long history of credit binges is a reminder that Beijing could end up spending a lot of money to accomplish very little.
With total inflation running at around 1 percent, compared with 2.9 percent at the end of 2018, the drop-off in nominal growth is going to push economy-wide leverage significantly higher in 2019. While Beijing has abandoned specific growth targets, it still aims for a range – and even that may not be feasible. 

Trying to maintain six percent-plus real growth in an economy already saddled with debt and excess capacity, one that can no longer depend on current account surpluses of 2 percent to 3 percent, is simply unrealistic. 

More than anything, Beijing may need to reset its own expectations.

China's growth could plummet to 2 percent in the next decade

• China's time as an emerging markets outperformer is ending
• Experts pointed to an array of risks as well as changing demographics for China
• That includes its debt problem, declining working population, and increasingly weaker drivers of productivity

By Weizhen Tan 

China has been a strong performer among emerging economies, even if its growth has been slowing. But that's set to end, according to research firm Capital Economics.
Growth in China could plummet to 2 percent over the next decade — from the expected 6.0 to 6.5 percent target this year, predicted Capital's Chief Asia Economist Mark Williams.
"China's time as an emerging markets outperformer is ending," said Williams, at the Capital Economics annual conference in Singapore on Tuesday. 

He added that the estimated 2 percent growth is a "long way" from the 5 to 6 percent expected by the International Monetary Fund for the next decade.
Speakers at the conference pointed to a number of risks, as well as changing demographics in the world's second largest economy. 

That includes its debt problem, declining work force, and increasingly weaker drivers of productivity, they said.
Those predictions come as Li Keqiang said at the annual National People's Congress on Tuesday that the official economic growth target this year will be 6.0 to 6.5 percent, slowing from last year.
Li also warned that there will be greater risks ahead for the Asian economy, saying: "We must be fully prepared for a tough struggle."

Risks ahead
China's debt problem will not go away, with the real concern being corporate debt and household debt — as opposed to government, said Julian Evans-Pritchard, Capital Economics' senior China economist, at the conference. 

He blamed rising debt levels on poor lending practices.
"Policymakers have been trying to shift lending away from state firms towards their more efficient private counterparts. But so far, the results have been underwhelming," Evans-Pritchard said.
Data also showed that state firms' capital spending is higher now compared to a few years ago, he added. 

"Servicing the existing stock of debt will be more difficult as China's economy continues to slow."
Evans-Pritchard noted that the real risk lies with property developers, who have borrowed the most to fund their land-buying spree.
Some analysts have said that Beijing might stimulate its slowing economy this year through more loans, but Williams warned that the "key headwind" on the Chinese economy so far has been the tightening on shadow lending.
Shadow banking refers to activities performed by financial firms outside the formal banking sector, and therefore subject to lower levels of regulatory oversight and higher risks. 

State-owned banks usually prefer lending to companies owned by the government, and as a result, private companies have turned to shadow banking.

Productivity and work force
Apart from the debt issue, Williams said the underlying engines of rapid growth in the country's economy are also fading. 

He cited a declining work force — hit by its One Child Policy introduced in the 1970s — and weakening drivers of productivity.
In a January report, Capital Economics projected that a shrinking labor force may result in a decline of about 0.5 percent in GDP growth by 2030.
The research firm pointed to China's working population which is currently falling by about 0.2 percent per year. 

There were only 15 million babies born in China in 2018 — a 12 percent drop from the year before, and nearly a third below official forecasts made three years ago. 

In 2015, China started allowing couples to have two children.
But "the main drag on China will be coming from much weaker productivity growth," Williams added.
While many emerging markets rely on exports to drive productivity, China's share of the export market is already very large, and will need to rely more on domestic growth to drive productivity, he said.
"The only way to raise productivity, if you can't do it by investing and building more, is to raise the productivity in workers ... It means you want your companies to move closer to the technological frontier," Williams concluded.

China’s imperial growth delusion

Running the private sector dry has never helped Chinese emperors; this time won’t be any different
By Anjani Trivedi

The big state-owned Chinese enterprise is back. 

But this time, it isn’t looking sturdy enough to prop up the economy.
As growth stumbles, Beijing is falling back on a tried and trusted solution: using large, government-backed companies to spur activity. 

That’s squeezing out private and small firms.
The economy certainly merits concern. 

Trade frictions and Beijing’s crackdown on the underbelly of the financial system have combined to sap confidence. 

Higher borrowing costs, weak household spending and rising prices point to the beginnings of what could be a wider consumption downgrade. 

Meanwhile, fixed-asset investment growth is near record lows, and the fiscal situation is looking increasingly constrained.
A superficial reading suggests the renewed pulling of state levers is working: Chinese industrial-company profits are humming along, climbing 16% in July from a year earlier. 

Earnings at state-owned enterprises rose 24%, almost double the 13.4% rate for private companies.
A closer examination presents worrying signs. 

While upstream industries such as mining and energy posted gains of more than 100%, manufacturing sectors like machinery and equipment slowed sharply.
Drill down through other encouraging data and there’s a similarly mixed picture. 

A measure of Chinese companies’ ability to service their debt has improved, leverage levels have stopped rising, and their liquidity in the form of cash to short-term debt is at its highest level in a decade.
But for private companies, measures of debt are still broadly climbing. 

They also lack the preferential access to cheap credit of their state-owned counterparts. 

Operating conditions for small companies are getting worse, they’re holding inventory for longer, and the time it takes them to convert working capital into cash is increasing, Goldman Sachs Group Inc. found in an analysis of more than 4,000 Chinese companies.
Key to the resurgence of gargantuan national champions such as the China State Construction Engineering Corp. have been supply-side reforms, including strict curbs on environmentally unfriendly companies and factory closures in industries with overcapacity. 

Xi Jinping’s Belt and Road Initiative has also driven business their way.
These policies have pushed out marginal players. 

Meanwhile, the wide-ranging campaign to reduce debt has hurt demand and left private, smaller companies in the lurch. 

The number of money-losing private industrial companies jumped about 40% as of June from a year earlier, while the number of unprofitable state-backed firms stayed flat.
China has a long history of using state-owned behemoths to drive economic activity—dating back to imperial times. 

Such industrial giants first appeared during the Qing dynasty in 1864, as the government attempted to revive a weakened economy after the end of the Taiping Rebellion. 

What little industrialization resulted from the so-called Self-Strengthening Movement “was characterized by a focus on heavy industries’ serving the government’s military and defense purposes,” as historians William Goetzmann and Elisabeth Koll wrote in A History of Corporate Governance Around the World: Family Business Groups to Professional Managers.
One difference this time: Beijing has talked about bolstering small and medium enterprises through legal protections and providing more credit. 

Under former Premier Zhu Rongji in the 1990s, the plan was explicitly to “grasp the large, let go of the small.”
History shows that private companies have far higher productivity. 

Their average returns on assets have been 4-6 percentage points higher than SOEs over the past two decades. 

The more the state sector contributes to gross domestic product, the worse it is for the economy’s long-term efficiency and productivity. 

Given that state enterprises now account for almost a third of all Chinese profits, up from 15% in early 2016, that should be a concern.
Even over the past decade, repeated mergers and de-mergers of several national champions (some of which are now being recombined) haven’t produced any real victors. 

Efficiency, earnings and returns on equity have declined. 

Listed SOEs have traded at discounts to their private peers.
Effectively suppressing private companies—especially now, when the state’s purse is looking smaller and its ability to prop up state-backed giants is constrained—isn’t sustainable. 

State-owned companies depend on government spending rather than solely demand like their private-sector peers, but fiscal revenues are falling sharply. 

Even though industrial SOEs look to have improved, they still carry the bulk of stressed debt in the system.
In the latest example of the squeeze, Beijing is planning to extract more in tax from companies to replenish state coffers for an ageing population. 

China’s social security tax rate is the highest in the world at around 43%, versus 13.3% in the US and 30% in Japan, according to Nomura Holdings Inc. 

The tax changes could dent profits by 2.5% next year and cut investment by around 1.1%, the Japanese brokerage estimates. 

Private enterprises, or employers, are the biggest contributors to social security tax in urban areas, paying almost twice as much as SOEs.
Running the private sector dry has never helped Chinese emperors. 

This time won’t be any different. 

China: Soon the most visible victim of deglobalisation

China's exports are falling and millions of jobs are at risk.
By Salvatore Babones

Container boxes are seen at the Yangshan Deep Water Port, part of the Shanghai Free Trade Zone, in Shanghai.

When you buy anything, anywhere in the world, there is a good chance that it comes from China. 

We all know China as the great export powerhouse of the 21st century. 

But China's exports hit an all-time high in December, 2015 and (ignoring season fluctuations) have been declining ever since. 

China is increasingly turning inward for growth -- and having trouble finding it.
China accounts for about one-eighth of the world's merchandise exports, far more than any other country. 

Even this figure understates the true importance of China's export economy. 

Most other countries export intermediate goods that are just parts and components of the finished goods that consumers actually buy. 

China more often exports the finished goods.
When China's exporting juggernaut slows down, the world slows down. 

Or maybe it's the other way around: when the world slows down, China slows with it. 

Either way you look at it, both Chinese and global exports are falling.
Global exports as a percentage of global gross domestic product hit an all-time high of 30.8 percent in 2008. 

They fell precipitously during the global financial crisis of 2008-2009 and have since stabilised at just under 30 percent.

Global export volumes
These figures cap off a remarkable quarter-century of global export growth that began back in 1973. In that period global GDP roughly doubled, but global export volumes grew by a factor of 5.6 (based on inflation-adjusted data from the World Bank).

China played a leading role in that story, but it was the rise in international trade that pulled the Chinese economy along, not the other way around. 

China rode the coat-tails of a quarter-century of globalisation.
Most people think of globalisation as a process that began in the 1990s with the collapse of the Soviet Union in 1991 and the foundation of the World Trade Organization in 1995. 

But the roots of today's global economy really go back to 1973, when the United States went off the gold standard and most countries moved from fixed to floating exchange rates.
Floating exchange rates meant that the era of managed trade was over. 

The global economy moved into a new phase driven by market forces. 

The oil exporting countries of the Gulf were the first to benefit as the market price for oil quadrupled between 1973 and 1974. 

China came to the party just a few years later.
Since then the global economy has become more and more open. 

After the currency liberalisation of 1973 came a huge increase in international trade and then, in the 1990s, in foreign investment. 

Both trade and investment peaked in 2007-2008.
Since then international trade has declined by roughly half a percent. 

Foreign direct investment, or FDI, has fallen by half.
That is not half a percent. That is half. 

Annual global FDI is down roughly 50 percent from its 2007 peak of just over $3 trillion. 

It's still much larger than it was in the 1990s or earlier decades, but global FDI has stabilised at roughly the levels of the early 2000s.

Tourists browse through T-shirts for sale in a night bazaar in Temple Street, Hong Kong.

Unlike global FDI, foreign investment into China hasn't fallen in absolute terms. 

But it too has stabilised and is no longer rising. 

China is firmly on the world's shortlist for companies looking to invest, but it is no longer the only country on that list. 

These days China has to compete with India, Southeast Asia, Latin America and even Africa for scarce foreign investment dollars.
That's many more countries chasing fewer and fewer dollars. 

So far China has been very successful at holding its own against tough competition. 

But China is holding its own in a slowly declining market.

Exports and jobs
No one knows exactly how many people in China are dependent on foreign investment and export industries for their livelihood.
But by any count the numbers are huge. 

For example, China's export-oriented garment industry employs about 10 million people. 

These jobs are increasingly threatened as companies move production to lower-cost countries such as Vietnam.
The Taiwanese contract manufacturer Foxconn, once famous for for employing 1.2 million people in China, is now automating its Chinese plants. 

It has announced plans to move up to 1 million jobs to India. 

And Foxconn is just the tip of a very big, rapidly melting iceberg.
For the past quarter-century China has been the most visible beneficiary of the increasing globalisation of the global economy. 

Soon it may be the most visible victim of deglobalisation.
The global economy is still growing. 

But it is no longer globalising. 

Like everyone else, people in China will have to work much harder to capture growth in the next quarter-century than they did in the last.