How quickly is China growing?
Over the past 30 years, faster than any country ever, according to The Economist. The average annual growth rate has been above 10% since 1978. This has been mirrored in a rampant stockmarket, where prices have surged around 80% this year, following a rise of 130% in 2006.
Mind-boggling numbers now dominate the world’s fourth-largest economy – the newly-listed PetroChina has become the world’s first $1trn company, while China’s reserves of US dollars have passed $1.33trn. Give China another 20 years, says Graham Birch at BlackRock, and it may become the world’s largest economy, overtaking even the US in the process.
So what’s got some pundits worried?
Japan. There are concerning parallels between where China is now and where the world’s second-largest economy was in the 1980s. Like China, Japan was once hailed for its “miracle” economy. In the 40 years after the end of World War II, Japan held the title of Asia’s fastest-growing economy, due to a massive export boom made possible by a combination of cheap labour, low interest rates and a weak currency. This attracted a tidal wave of capital investment and kept Japanese goods, priced in yen, cheap for consumers across the world.
During the 1980s, the Nikkei 225 index rose fourfold in just seven years, while land prices in the big cities tripled, resulting briefly in Tokyo’s real estate being valued more highly than California’s. All of which should sound very familiar to China watchers today.
How did Japan’s boom end?
Horribly. In a bid to curb the overheating economy, the era of cheap money was brought abruptly to a close in the late 1980s by a government worried that the rapidly-appreciating yen (set on an ever-rising path against the US dollar by the 1985 G5 “Plaza agreement”) would destroy exports.
The property and share-price booms, which had relied heavily on cheap credit, stalled and went into reverse. Japan’s banks, often poorly managed and mired in corruption, were stuck with vast unrecoverable bad debts and stopped lending – some even went bust. Consumers, faced with falling house prices and rising borrowing costs, stopped spending. Many Japanese firms, depressed by spiralling wage costs and poor productivity, relocated overseas, triggering widespread unemployment. The 40-year boom evaporated and growth has been sluggish ever since.
Could China go the same way?
The Bank of International Settlements is certainly worried. The Chinese too have an export-driven economy pumping cheap goods into America, triggering concerns about a return to protectionism. “If you don’t buy US today, your kids will be speaking Mandarin tomorrow”, warns Madeintheus.com, for example.
Lehman Brothers argues that the balance of payment pressures created by a cheap yuan – China’s current-account surplus of 9.5% of national income in 2006 is more than double that of Japan in 1985 – are “more severe than those faced by Japan”. Meanwhile, international hot money continues to pour into China, buoying property and share prices, as speculators bet on the yuan rising further following a modest rise of around 7% over the last two years.
Domestic inflation is at an 11-year high of 6.5% and “non-performing loans” are already an issue for a relatively immature banking system. The underlying fear is that the Chinese government will soon attempt to rein in the economy, as did its Japanese counterpart, and the result could be equally ugly.
Is that outcome inevitable?
Maybe not, thanks to a few crucial differences between today’s China and yesterday’s Japan. Although the US could try to stifle Chinese exports by pushing for a currency revaluation similar to Japan’s following the 1985 Plaza accord, it probably won’t.
Technologically, China just isn’t yet as big a threat to the US as Japan was 20 years ago. Despite gripes from US manufacturers, higher levels of foreign direct investment reflect the fact that China’s trading relationship with the US is more open than Japan’s was. Moreover, China provides many of the cheap goods that have kept American inflation tame, a fact the US government will be keenly aware of and may be reluctant to threaten.
On top of this, as The Economist points out, there is debate over how much impact an asset-price crash would actually have – equities account for only 20% of net household financial assets, compared with 180% in America at the height of the dotcom boom. Plus, at a national average growth rate of 8%, Chinese house-price growth has so far been much tamer than that seen in 1980s Japan. There may well be trouble ahead (see below for how to profit), but China doesn’t look like turning into Japan just yet.
What should an investor do?
Despite this reasonably healthy longer-term outlook, share prices could be in the danger zone. Alan Greenspan recently repeated his “irrational exuberance” warning, and a near-20% drop in the Shanghai composite index from an October peak of 6,124 supports his view.
One way to profit from further falls is to buy the Ultrashort FTSE/Xinhua China 25 Proshare (AMEX:FXP) exchange-traded fund, which tracks 25 listed Chinese firms and aims to offer twice their inverse daily performance.
If the index falls 1%, the ETF should rise by 2% and vice versa. At 0.95%, charges are high for an ETF, and the product is also priced in ailing US dollars – so it is most suited to those who expect big drops in the Chinese index.