New York-based investment manager, formerly of Goldman Sachs. Each week Mr. Stirton examines a facet of the current economic situation
Two important questions concerning the Chinese economy are making the rounds:
Can China sustain its high growth rate and continue to offer solid returns on investments in the face of a massive recent slowdown in exports?
Can its positive growth help pull us out of our own economic black hole?
With the U.S. economy contracting in the fourth quarter of 2008 by -6.3 per cent, by a substantial amount in the first quarter of 2009, and with global GDP growth for the year expected to be slightly negative, many have been looking to China as the only bright light on the horizon. The rough consensus is that China's 1.3 billion people - and its hands-on government - will produce incremental GDP of somewhere between 5.5 per cent and 7 per cent in 2009, a remarkable feat given the conditions.
Some say China can achieve even more. Despite 700 million rural inhabitants and an average GDP per capita of just less than $6,000, they wonder whether China's positive growth trajectory could whisk us out of our doldrums. While there are reasonable debates about the first question, which nets to "affirmative," the second notion is a little far-fetched.
SUSTAINABILITY OF HIGH GROWTH
China boasts the second-largest economy after the United States in purchasing-power terms. For almost 15 years it has been growing more quickly than any other country. There is no question it has one of the strongest national balance sheets in the world, with net surpluses and a $2-trillion cache of foreign reserves. But in February of 2009, the exports of this export-driven country fell by some 26 per cent versus the previous year. So how can it grow so much in 2009, and by an expected greater amount in 2010?
In the Far Eastern Economic Review, Brian Klein of the Council on Foreign Relations writes: "Optimism for near-term China recovery, fuelled by the widely reported $587-billion two-year stimulus package, is running high. ... These hopes are unfortunately misplaced at the moment. The stimulus is neither large enough to stimulate demand lost from plummeting exports and declining investment, nor is it focused on addressing the concerns of the fragile middle class that might help China spend its way out of crisis."
This case against ongoing growth has numerous components, and invokes a host of supportive data: only $170-billion of the Chinese stimulus plan is new; its infrastructure and investment focus may be inappropriate if the idea is to get consumers spending; many Western banks and other companies are scaling back expansion and investment plans; foreign investment has tumbled for six months running; property prices are down as much as 25 per cent in some locales, and while loan quantity is up, loan quality is suspect. In other words, the Chinese economy is in real trouble, and won't be growing at anything close to its former rates.
Still, there is another interpretation of the situation.
The upside case has its own logic and factual basis, including work by World Bank economists who think a mid-single-digit rate of growth can be had this year in China.
The case works this way: Although down about 25 per cent in the early part of 2009, Chinese exports are not likely to remain at that level for long. Inventories in the West are close to being depleted, and the decline in U.S. consumer spending has already slowed. Exports form only one-third of China's overall economy, so growth in domestic industry and consumption can more than offset the declines there. Rural consumers have been offered targeted incentives to purchase household items, and that is occurring quite dramatically.
An affirming voice for this positive outlook, from a macro perspective, is Felix Chee, special adviser to the president and chief investment officer of the China Investment Corporation, the main investment arm of the Republic of China.
In an interview, Mr. Chee said: "The Chinese stimulus package can't in itself overcome the severe decline in exports, but it can materially offset it. Remember, the other two-thirds of the Chinese economy was growing double digits for years, so with an offset to exports, the stimulated domestic economy can still generate new jobs and get into meaningfully positive GDP territory. The stimulus package is a double-digit percentage-of-GDP-type program. Businesses are responding to it. The Chinese government has a high conviction that it can hit its targets."
Nicholas Lardy of the Peterson Institute for International Economics has similarly been taken with the amount of assistance the government is providing to families, and thinks it will help substantially.
"China has very substantially stepped up its social programs and its transfer-payment programs. The social programs are extremely important because they do contribute to rebalancing the economy, will reduce the precautionary demand for savings, and lead households to spend a larger share of their disposable income."
Yiting Liu, vice-president of China investments for Vision Capital Advisors, and Randolph Cohen, associate professor of finance at Harvard Business School, who advises Vision Capital on its China effort, echoed that upbeat macro theme from a business-specific and investment perspective.
Ms. Liu said: "Among companies focused on the domestic Chinese market, many with strong balance sheets are looking to take advantage of weakened competitors and want to expand. For example, one integrated bio-diesel energy producer we know is seeking to acquire underfunded and underutilized competitors who cannot operate profitably in the current economic environment. This is a productivity-enhancing phenomenon that is happening throughout the economy."
Prof. Cohen looks at the recent drop in Western investment in China as a strong buying signal, building on a positive view of Chinese growth prospects:
"The interesting thing about China is that it has the second-largest economy in the world, yet virtually every Western institution is significantly underweight in that marketplace in their investment portfolio, and the Chinese market capitalization as a percentage of their GDP is many times less than most others. This is quite rare, especially when you consider that growth is better there, the equity market appears reasonably priced, and the country's balance sheet is dramatically better than most. These sorts of skews are not likely to endure for long. Investors will figure that out and will reinvest in China. That should help drive growth again."
Representing 34 per cent of global economic growth just over one year ago, China is clearly a vital actor on the world stage. But even if China weighs in at 7 per cent of the global economy nominally (more in purchasing-power terms), and it grows 6 per cent, that would represent a positive addition to overall world economic activity of only .42 per cent. If the rest of the world's GDP declines by 2 per cent the same year, that converts to -1.9 per cent. Taking those two parts together, overall global growth would still be negative, by about 1.5 per cent. Certainly not enough to save the world.
China will not be augmenting its demand for Western output in any large way this year or next. But it will soon be buying some particular things from North America and Europe in larger numbers than it did the year before. The Chinese stimulus has prompted additional purchases of some commodities and raw materials again. And the very fact of growth in demand from one large customer - or any customer - is a good thing, something that companies can build positive stories around; a not inconsiderable variable in the psyche of a downtrodden economy.
As well, by being practically compelled to invest in U.S. Treasury securities, since it is still running a (smaller) trade surplus, Chinese growth allows the U.S. Treasury and Federal Reserve to do what they need to do, namely foster their own stimulus actions - through debt issuance, recapitalization of tottering banks and selective repairs to the mortgage and housing sectors. In these indirect ways, the growth of the Chinese economy assists well beyond the decline in some imports from Western economies.
Of course the hardest work, and the largest source of renewed economic activity, will have to come from the United States, Europe, Japan, Canada, Australia and Brazil. This is just how the balance of the numbers stacks up.
Folding these aspects together, Liming Wang, director of the UCD Institute for Chinese Studies, probably stated it best when he said: "China cannot save the world, but the world cannot now be saved without China."