It seems increasingly clear that China’s economic policy took a wrong turning 10 years ago, when it joined the World Trade Organisation.
2001 was also the year when the Western BabyBoomers (those born between 1946-70), began to leave the peak consumption age group of 25-54 years. As they entered the 55+ age range, and the children left home, they began to spend less and save more.
China, however, decided to use its WTO membership to become the ‘manufacturing capital of the world’.
10 years later, the bill for this mistake is becoming very large indeed:
• China has $500bn invested in the US housing agencies, Fannie Mae and Freddie Mac. This was a form of vendor finance, to support its export drive. Unless the US housing markets stage a strong recovery, which looks increasingly unlikely, writedowns are inevitable.
• China’s personal consumption as a percentage of GDP has halved to just 35%. As we describe in chapter 6 of ‘Boom, Gloom and the New Normal’, the government instead sponsored the building of export-related factories and the infrastructure support they required.
• More recently, the Q4 2008 crash left many of these factories without work. So the government was forced to sponsor a domestic lending binge, as incomes were too low to support increased consumption.
• It doubled bank lending to $1.4trn, a third of GDP, and held it at this level in 2010. And it added a $580bn subsidy to support sales of cars and electrical goods, especially in the poorer rural areas.
• Its lending boom also encouraged speculative home purchases, as a ‘quick fix’ for employment. Prices are now 10 times average annual household incomes, double their peak during the US housing boom.
As one ‘quick fix’ led to another, so the government’s problems have multiplied. High house prices, for example, make it difficult for young men to marry. 70% of China’s women regard “housing, a stable income and some savings” as vital for any man wanting to get married.
So over the past few months, the government has finally had to act. As the chart shows, bank lending is now down 29% (red square) versus the 2009 YTD total. And premier Wen has revealed the government is now targeting home price falls of 20% or more.
What happens next, is anyone’s guess. No country in history has ever lent out so much, so quickly, to so many people.
Credit bubbles need increasing amounts of debt to continue. China’s Minsky Moment is therefore approaching fast as lending gets cut back. Thus ratings agency Fitch worries that 30% of China’s loans could become non-performing.
This one statistic is alarming enough. It means $2.5trn of loans might not be repaid. Yet 2010’s GDP was only $5.9trn. Even if we halve Fitch’s estimate, this would still mean loans worth 21% of GDP will not be repaid. This is a big ‘haircut’, even by Eurozone standards.
And debt repayment is already becoming a major issue, as sources of new credit dry up.
• Operating cash flow at China’s listed firms fell 27% in the January-September period, despite 25% sales growth
• Whilst Bloomberg reports that loan sharks from China’s vast unofficial lending market cut off fingers if debts can’t be repaid.
China is thus paying an increasingly high price for its 2001 failure to recognise the importance of changing Western demographics. After all, if demographics don’t drive demand, it is hard to know what does.