By John Richardson
WHEN the Americans and the Europeans come back from their summer holidays in September it seems quite possible that they will see history repeat itself.
It was of course from September 2014 onwards that commodities prices started to decline from their all-time record highs, largely because of a belated understand that credit growth was slowing down in China. The collapse in prices then led to lower global economic growth.
To understand where I am coming from, first of all take a look at the extraordinary above chart, from Autonomous Research analyst Charlene Chu.
This chart doesn’t measure just China’s official bank lending and the shadow lending or private credit that can be measured by the government. It also includes an estimate of off-balance sheet shadow lending the scale of which nobody is entirely sure.
As you can see, the chart is a further illustration of the huge acceleration in lending that took place after 2008 in China. Remember that in 2009 alone, looking at only the official data, China increased lending by $10 trillion when its nominal GDP was only $5 trillion.
And crucially for what happens next, Chu estimates that lending jumped by 19% in 2016 over 2015. This year she expects a 13% increase over 2016.
The Reformers Back In Control
This is still a big increase in lending, but you of course need to pump more and more air into any investment bubble in order to keep it inflated. Pump-in less air and any bubble deflates, which was what happened from January 2014 until the end of 2015 during Beijing’s previous attempt to tackle excessive lending. Again based on the official lending data only, new lending was down by $5 trillion by the end of 2015 compared with end-2013.
Then came last year’s renewed credit boom as the populist political faction, led by Prime Minister Li Keqiang, took control of the economy. Hence, Chu’s estimate that 2016 credit growth was 19% over the previous year.
But now President Xi Jinping and his princeling faction have regained firm and perhaps permanent control of the economy, and it is possible that Li could be demoted following this autumn’s crucial 19th National Congress political meeting.
Chu worries that even though the rate at which credit is expanding is being slowed down, not enough is being done to deal with what she believes is a huge potential bad debt crisis. Her estimate of nonperforming loans is 25% of total lending compared with the official estimate of a bad-loan ratio of just 1.74%.
But recent signs of a major policy shift include:
- China’s credit impulse declined by 17.5% year-on-year in Q1, according to William Sterling, chief investment officer at Trilogy Global Advisors. Credit impulses are a measure of new credit issued as a percentage of GDP, and are thus widely viewed as a more reliable measure of the strength of new lending than headline lending data.
- Money supply growth is expected to have remained at a record low of 9.4% in July. In May, the growth of money supply fell to 9.6%, marking the first time the reading had dipped below 10% in 22 years.
- Bond issuance by Local Government Financing Vehicles (LGFV) fell by 54% year-on-year in January-May 2017 because of new government restrictions on local government financing.
- A plethora of new restrictions in the housing sector led to new-home sales measured by floor space dropping by 46% year-on-year in July the first-tier cities — Beijing, Shanghai, Guangzhou and Shenzhen – and by 23% in 16 key second-tier cities, which include, for example, including Hangzhou and Nanjing.
This all runs counter to the conventional view that Beijing would do very little to rein-in the credit bubble ahead of the 19th National Congress meeting. The thinking was the government would want to keep the economy booming in order to create a stable social and so political environment ahead of and during the congress.
But Beijing has been able to put its foot down on the lending brake because of the lag effect of last year’s credit boom. So much money is still flowing through the economy that GDP growth was an unexpectedly strong 6.9% in H1. Exports and imports are also booming and the Caixin Purchasing Manager’s index bounced back in June and July, into firm expansionary territory.
The political calculation seems likely to have been that any pain the Chinese population would feel ahead of the autumn meeting would be soothed by the strength of H1, and possibly Q1-Q3, growth. This looks like it might well have been a correct calculation.
Globally, though, the impact of the China credit slowdown is likely to be more immediate and a lot more painful.
Better world trade mainly down to China and commodities
John Kemp, in an important article in Reuters, says that world trade grew by 5% in the three months to May compared with the same period a year earlier.
“Trade growth came close to a standstill in the first quarter of 2016 but has been accelerating gradually since then, especially from the fourth quarter onwards,” he writes.
He is correct to link this recovery to the rebound in commodities demand and prices that has replenished the coffers of countries heavily dependent on commodities for their economic growth. And he is also right to argue that better world trade in general is the result of the rebound in commodities.
What has driven the commodities rebound? It is of course China. Take iron ore as just one of many examples. In 2016, its iron-ore imports rose by 7.5% over 2015 to 1.024bn. China imported US$57.1n worth of iron ore last year – 67.8% of the global total.
This China-driven boom has also benefited the west. A return to mild reflationary conditions has forced purchasing managers up and down all the manufacturing chains in Europe and the US to buy raw materials ahead of their immediate needs. They have been trying to hedge against further price rises.
At times like this it feels like demand is actually strong as no company has complete visibility all the way to the end of their particular manufacturing chain or chains. They never know to what extent final consumer demand has improved because of better economic fundamental, versus the final consumers also responding to stronger inflationary signals.
What better fundamentals? The US is in a political crisis as it faces longer-term lower growth because of its ageing populations.
The EU has rebounded slightly, but you have to question whether this is largely the result of Germany’s success in export markets. And China is a major export destination for Germany. The EU also confronts the drain on demand caused by an ageing population.
As for the UK, it faces both an ageing population and the economic damage resulting from Brexit. The remaining EU countries will also be hurt to a lesser extent by Brexit.
I believe the recovery in the west has thus been largely the result of a return to mild reflation – and that mild reflation has been down to the latest Chinese credit bubble’s impact on commodities demand and pricing.
Hence, my argument that history could repeat itself as September arrives. By later in this quarter, the effect of China’s slowdown in lending growth could start to feed through to significantly lower commodities demand and pricing. Oil prices may, for instance, be heading very quickly towards $35/bbl.
Might this then combine with tighter lending conditions in the west? Another global economic crisis is also possible.