It is the fastest-growing consumer of luxury goods in the world. It will have an economy bigger than the US by 2027 (or maybe 2030, depending on who you listen to). It has 70 big cities, all crammed with new-build apartment blocks. It is home to the world’s largest dam. It buys more cars than America and produces half the world’s steel. It has grown 8-10% every year for decades and can keep doing so. It is the world’s second-largest consumer of energy. It produces 60% of the world’s buttons in just one of its towns. It has a huge population with a growing middle class poised to gobble up every consumer good in sight.
Yes, it’s China – the world’s current miracle economy, the country that will dominate the decade, and the best possible home for your savings during that decade. That, at least, is the hype. But how much of it stands up to scrutiny?
At the end of last year, I wrote that, while I agreed with much of the China story, I wouldn’t touch its markets because they were far too expensive. But having looked at things in more depth, I’m beginning to doubt the status of the economic miracle itself.
Why? Because, right now, it rests on about the most unstable of foundations there is: rampant credit growth.
China has been growing fast – at around 10% a year – for about 30 years. That, says a note from Pivot Asset Management, combined with the fact that the growth has mostly been investment led, means that, “both in its duration and intensity”, China’s capital spending boom has now outstripped all other “previous great transformation periods”, such as those of postwar Japan and Germany.
The point? That China’s growth cycle is more mature than emerging: it has most of the infrastructure it needs already, and so should be slowing rather than accelerating its capital spending.
When you look at where capital spending is now going, that makes sense. On YouTube, you will find an amazing film from Al Jazeera on the city of Ordos.
It is newly built, and could be home to a million people. Instead, it’s empty. With property prices rising 50-60% a year in some areas, its houses have been bought by investors expecting to make a return without having to bother with pesky tenants. Think Manchester 2006.
And it isn’t just residential cities that are empty. China now has more ports, offices, airports and steel factories than it will know what to do with for many years to come. Commercial property vacancy rates in central Shanghai are said to be as high as 50%.
Yet far from pulling back on building, the Chinese are pushing on at speed. In the first three quarters of 2009, China’s industrial capacity expanded at more than 25%.
So what’s going on? It’s all about the global credit bubble. Its collapse was nasty for China; much of China’s expansion was based on exporting goods to Westerners buying them on credit, so vanishing credit quickly meant vanishing exports.
China’s response has been to try to keep its famous growth rate going (and head off social unrest and so on in the process) by replacing export demand with state-sponsored demand – $586bn worth of it in direct spending, and many billions more in unfettered bank lending.
The result? Its very own credit bubble. Today, far from being the miracle economy of the popular imagination, China looks to be caught in a nasty trap of artificial and unsustainable growth driven by rapid credit growth and bubble psychology (everyone thinks the authorities can and will stop asset prices falling).
In the first five working days of January alone, China’s commercial banks are said to have lent out the equivalent of more than $50bn. Not good.
Dylan Grice of Société Générale points to a recent study from the National Bureau of Economic Research that looked at 60 financial crises going back 140 years and asked if there was one good indicator of a coming crisis. There was: rapid credit growth.
Look at it like that, and the Chinese miracle begins to look like it might end in rather the same way as the Irish, Spanish and Japanese miracles.
Still, the state of an economy is rarely the best predictor of stock market returns; the price you pay is. I’ve just been reading John Cassidy’s latest book How Markets Fail, The Logic of Economic Calamities. In it, he reminds us that researchers have shown again and again that value stocks (those with a low price/earnings ratio or low price-to-book ratio, or dividend ratio) “systematically outperform” so-called growth stocks.
But look at the Chinese market now and there is, I think, one thing you can be pretty sure of: overall, you are not getting much value. As Peter Tasker pointed out in the FT earlier this week, the Shanghai market trades on a Graham and Dodd price/earnings ratio (which uses the ten-year average) of around 50 times. Hard to see how it could systematically outperform from that kind of starting point, isn’t it?
• This article first appeared in the Financial Times