Streetwise Professor

July 6, 2015

China: Catching a Falling Knife

Filed under: China,Economics — The Professor @ 6:13 pm

The People’s Bank of China is effectively funding an effort by a group of brokers to buy equity (to the tune of about $20 billion) in an attempt to stem the massive selloff in Chinese stocks. The news barely checked the relentless decline, which I will expect will resume with a vengeance.

In other words, China is panicking, and attempting to catch a falling knife, as the phrase goes. And that almost never works out well.

Actually, I don’t think that the equity market decline is China’s big problem, except to the extent that it is a harbinger of a dramatic slowing of the growth in the economy, or perhaps an absolute decline in the economy. Countries survive equity market meltdowns. It is the leveraged sector that is the concern. In China, that includes not just banks, but the plethora of shadow banks, trusts, and local government funding vehicles, all with murky interconnections with the banks.

There are pronounced signs of economic stagnation besides the shuddering equity market. The lack of growth in electricity generation is one. The sharp declines in China-sensitive commodities, notably oil, iron ore, and copper are another: oil was down 8 plus percent today. (Cheers, Vlad!) If it was oil alone, one could write it off to the market deciding that a generous Iran deal was imminent. The broad fall suggests that it is China, China, China.

The equity market, and the government’s response to it, is therefore a symptom of this broader economic problem. What the Chinese (and those long energy and metals production) need to be especially concerned about is if a decline in growth sets off a banking or shadow banking crisis. Then the Chinese central bank and government will be in the unenviable position of catching a barrage of plummeting arrows.

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  1. Rising powers always have some kind of equity bubble at some point as euphoria over their rise and new wealth causes people to forget economic fundamentals and reality. In China, this is accompanied by an autocratic party that required ongoing economic growth for political stability, and therefore willing to eat seed corn to keep the party going.

    China could have had a soft landing years ago that liquidated bad public sector debt and allowed them to regain healthy growth later. Instead, they choose to keep leveraging in order to avoid temporary public dissent.

    I think there is a very good chance China is headed into some economic crisis in the next year. How well China comes out afterwards will depend on the wisdom of the government’s reaction to it. China could either resume growth or enter economic stagnation. There are some very smart people in power in China right now and very foolish ones so it’s a mystery to me.

    This has been coming for several years now, so China has kept the bus rolling for longer than I thought possible. I’d be very surprised if it doesn’t stop in the next 12 months, perhaps a lot sooner.

    Comment by Chris — July 7, 2015 @ 1:31 pm

  2. I was watching the British Grand Prix and saw ads on the track for Cheniere.

    Not sure if the ads were at the track or only posted for TV viewers, but advertising anyway.

    Comment by TomHend — July 7, 2015 @ 5:57 pm

  3. Actually, the problem is worse than you describe. The size of the “other” in the provision of credit in China dwarfs anything in the US or OECD shadow banking system. This is the scary bit. Not only is the PBC trying to stop a stock market crash but is also trying to deal with a much, much bigger problem. It is as if the house is on fire and you try to put it out by extinguishing the secondary blaze in the garage.

    Today, the market fell again significantly. I guess this will become one of those “cases” of bursting bubble we can add to the literature 🙂

    Comment by Peter Moles — July 8, 2015 @ 2:43 am

  4. […] southern Europe.  The dollar volume of the Greek market isn’t that big. The Chinese market is down over 17 Greek markets.  What I mean is, the drop in value of the Chinese market is equal to over […]

    Pingback by Capitalism Hits The China Market Points and Figures — July 8, 2015 @ 6:44 am

  5. China has lost 17 Greece’s. Communism doesn’t build long term wealth.

    Comment by @pointsnfigures — July 8, 2015 @ 6:46 am

  6. What interests me about the possible extended slowdown in the Chinese economy is the demographic aspect. China’s one-child policy always had the massive risk that China will grow old before it grows rich. The longer the period of slow growth, the greater the hit on national wealth and the greater the risk that China does grow old before it grows rich.

    The median age in China is roughly 34.5. In the U.S. it is roughly 36.9, but China’s population is aging much more rapidly than that of the U.S. As the Chinese workforce ages, the only way to maintain a current surplus sufficient to support its pensioners is to massively increase productivity. Otherwise, the pensioners will drain from savings and that will reduce investment necessary to generate future growth.

    China needs to build national wealth to get past the demographic bubble created by the one-child policy. By 2050, China is projected to have half the number of individuals aged 20-24 as it does today (the U.S. is projected to have 12% more). By 2050, the Chinese median age is projected to be 48.7 (vs 40 for the U.S.). If the fall in the stock market is a cyclical phenomenon that causes an economic dip and helps strengthen their economy by wringing out excess and promoting structural reforms, no problem. However, if the stock market fall is a result of structural problems (much like Japan’s in the early 1990s), then an extended period of slow economic growth creates problems that will compound.

    The other problem for the Chinese is that the hit on national wealth raises the question whether the lost wealth is restored by maintaining a high savings rate to replace lost savings, or by encouraging greater domestic consumption to promote economic growth.

    Can the Chinese stabilize their capital markets, bring about badly needed reforms in their banking sector, wring out excesses, massively increase productivity and promote economic growth by encouraging domestic consumption while their population ages, all without threatening the control of the Central Committee? lol.

    Comment by Charles — July 8, 2015 @ 8:31 am

  7. @Charles-All good points. Another reason why I’ve long been a China bear. Massive social and economic engineering always ends up badly. Japan got rich before it got old, but it has been wheezing along: it’s now in the 25th year of its Lost Decade. China has worse fundamentals and greater imbalances, hasn’t come close to where Japan was in 1990, and faces a worse demographic problem.

    The ProfessorComment by The Professor — July 10, 2015 @ 8:22 am

  8. @TomHend-Cheniere was a sponsor. The ads were at the track.

    The ProfessorComment by The Professor — July 10, 2015 @ 8:23 am

  9. @Chris-I agree with all that. I too have been surprised how long they’ve been able to keep the balloon aloft. My take is that the longer they do so, the worse the reckoning will be when the inevitable comes.

    I’ve long called China the Michael Jackson economy, kept going by a toxic mixture of economic drugs. As MJ showed, this does not end well.

    The ProfessorComment by The Professor — July 10, 2015 @ 8:25 am

  10. What is really terrifying is what will China do if growth does halt for a significant amount of time? Will it be consumed by inner turmoil, and its neighbors benefit from a less aggressive foreign policy? Or does the government attempt to rally support by increasing its foreign policy aggression? Either is plausible. A third option – dissent is quelled by opening up politics – is not realistic given the priorities of the CCP.

    Comment by Chris — July 10, 2015 @ 11:15 am

  11. @charles-Apropos your demography point, here’s a sunnier take on the issue. Seems like a lot of happy talk to me. I am not convinced. Particularly if there is a substantial slowdown, or worse, those demographic problems will bite hard.

    The ProfessorComment by The Professor — July 12, 2015 @ 1:28 pm

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