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China slows: don’t lose your mind!

China’s economy is undoubtedly slowing but despite some fears of a debt bubble that could cause an outright crash, it seems that this is currently being managed in a different way to previous slowdowns. Let’s take a sober look at the situation.


Double digits to strong single digits


The first thing to remember is that China’s economy is in a transition from a fast growth developing economy to a global market influenced mature economy.


An opinion piece in Forbes suggested, “As the largest exporter in the world, however, China’s export cannot grow much faster than the global economy. To try to do so China will have to take market shares away from other exporters continuously, which will be economically challenging and politically disastrous.”


The same article pointed out, “China’s economic slowdown is therefore both natural and desirable. It is natural because most of the lower hanging fruits such as price liberalisation and low value-added labor-intensive exports have already been harvested. And it is desirable because the slowdown necessitates a transition to higher value-added production, rising wages, stronger domestic consumption, and a generally improving living standard.”


An opinion piece in Bloomberg reinforced this: “The broader point is that China has steadily slowed since the global financial crisis, regardless of the not-too-terrible data Monday. The kind of scorching numbers clocked through most of the aughts – growth ballooned to about 15 percent in 2007 – are gone. Large and mature economies can't keep doing that or anything remotely like it.” Bloomberg suggested that in years to come growth may well equal that of the US average growth of around 2%.


Regional slowdown


In real terms the amount that China’s economy currently grows by (6%) is still bigger than nearby economic giant India’s entire GDP. China is a major importer and exporter as its change in manufacturing types mature and it exports ever more complex items, requiring imports of components from neighbouring countries. This means that there will be some impact on the greater East Asian economy.


The Bloomberg article above showed that the slowdown is affecting economies like South Korea: “South Korea’s industrial production has been hit particularly hard, [Merrill Lynch] wrote last week.”


A new approach to managing the slowdown?


Unlike previous slowdowns, the Chinese government is taking slow but steady measures to soften the bump at the bottom. The South China Morning Post (SCMP) reported in October, “Beijing won’t revisit its past policy of pumping money into the economy at the expense of long-term sustainability. This time, it is using monetary tools more carefully and also restructuring the income tax system.”


The SCMP article looked at fiscal policies that are generally aimed at reducing the amount of bank debt owed while still encouraging the economy to grow such as reducing the debt reserve ratio in banks gently but also maintaining interest rates at a similar level to that before.


The debt bombshell


All economists seem to be in agreement that the overall bank debt burden in China is too high and this could cause serious problems down the line - ‘how far down that line’ is the debate rather than whether this is the case now. The SCMP article above covered these reforms: reforming its “income tax regime – which goes beyond cutting tax rates, towards a freer domestic financial system and lower trade barriers (for example, tariffs) for non-US imports.”


These could end up priming the debt bombshell though. The SCMP again: “every policy stimulus in the past decade has been followed by an acceleration in debt growth in subsequent years. Even though the authorities have tried to be less reliant on credit this time, the side effects could still be too powerful to overcome and the economic imbalance could deteriorate further.”


Economic bear thinkers believe that if bank debt reaches too high a level then there could be a crash thanks to banks calling in loans to preserve liquidity. This would resemble the 2007 Credit Crunch in the West, and with China the second biggest economy in the world the economic tsunami that occurs will affect the global economy - potentially to the same extent as the US crash did in 07.


Economic bull thinkers say that there is a way to go before this is probable. The Atlantic Council suggested, “Beijing has strong administrative control over economic actors, backed up by a long history of steady development. Its record is imperfect and small to moderate crises do occur, but China’s debt capacity does not suffer from a poor reputation for economic management like other emerging markets.” It also indicated that much of the debt in China is domestic and offset by much higher savings levels kept than in Western economies - in short domestic debtors are more likely to pay off those debts with personal liquidity than to have to have assets taken from them as occurred in 07.


As ever, economic forecasting is blighted by the unexpected in the interim - the next big shock to happen globally could be the UK’s Brexit and nothing at all to do with China. It does seem that the Chinese authorities are taking measured steps to manage the economic slowdown, and this slowdown is one that may have been forecasted a decade ago - it is not a cyclical issue but one of economic maturity.

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