A peaceful, slumbering dragon? Think again, economist and commentator George Magnus tells Merryn Somerset Webb.
What should we worry about today? Sometimes, there are so many possibilities, it’s hard to choose. That said, we have a few things we like to keep top of the list. One is China, something people seem bizarrely less worried about now than they were only a few months ago.
Why’s that, I asked this week’s interviewee, China expert George Magnus? Because, to the untrained eye, it looks like it has stabilised, he says. At the start of this year, China was registering its worst year-on-year growth since 2010. But now there are signs of life all over the place – particularly in the property sector. Prices are rising in all the major cities, and inventories of unsold apartments – “one of the bugbears of the bears” – have been falling.
So everything’s fine? Far from it, says Magnus. It’s “important to understand the reason this is happening”. China is in the midst of a credit boom even bigger than the one it created in 2008/2009, in an attempt to steer clear of the Western financial crisis. Most readers will remember that boom – it was the time when hedge-fund managers such as Hugh Hendry and Jim Chanos went to China and made terrifying videos of brand new “ghost” cities and empty shopping malls. Credit growth slowed after that. But now it is surging again – at about 14% a year (double GDP on official numbers) and around 30%, if you add in everything else.
Why? It might be that China is “substituting credit expansion to get desired growth rates at whatever cost”. But if “this continues, China is going to have a huge financial problem”. It is unlikely to erupt in the next three to six months. “But it can’t last ten to 15 years. There is a day of reckoning there.” When? I ask (we need to know when to really start worrying). “It could happen towards the end of 2016, but more likely, I think, in 2017/2018.”
So Magnus wouldn’t be that keen on investing in the Chinese stockmarket right now? He would not. And not just because of the coming crisis. He also reckons it is “not really a market in the way that we understand it” – it is very much still an emerging market and a “manipulated” one at that. There’s something for readers who have followed some of MoneyWeek’s advice to tiptoe into China to worry about.
What of the currency? Will investors lose more money there? Not too much, says Magnus. If the renminbi was free-floating, it would of course fall substantially – most economists now feel it is overvalued. But it isn’t (it was linked only to the US dollar, but is moving to be linked more to a basket of the currencies of its trading partners) and right now there isn’t a strong case for the Chinese to devalue: if they do it once it would simply raise expectations that it would do it again.
Would that be a bad thing? If the currency is overvalued and everyone knows it is, it has to come down at some point. Perhaps, says Magnus – but “the one thing the world does not need right now” is that kind of deflationary shock out of China: a major devaluation would put at risk the sustainability not only of the Chinese financial system, but also the global economy. The system just isn’t strong enough for shocks right now.
Should we stay or should we go?
That leads us straight into the EU referendum (what doesn’t these days?). Magnus says that Brexit would be a major shock to the global economy. I demur (having just had Mervyn King in my office, saying rather the opposite). He accepts that the consequences are largely unmeasurable, but can’t see how they can’t be bad – “the thrust of what the Treasury says” is correct. He’s also concerned about the non-economic effects: the “political dynamic that a vote to leave might lead to in terms of copycat moves” – the possible disintegration of Europe.
Hmm. Would that be a bad thing, I ask (again). Polls in lots of countries show large minorities (and the odd majority) in favour of leaving the EU, or at least having a referendum on the matter. And while we clearly aren’t in the eurozone, isn’t it the case that if we – as a politically stable, rich democracy – show that it is possible to leave, we will make it easier for everyone else to do the same? Europe is going to disintegrate anyway – might not Brexit make that end less bad than it would be otherwise?
Magnus agrees that it would make other people leaving easier, but I’m not sure I’ve convinced him on the less bad bit: he falls into the “warts and all we are probably better off… trying to fix what we’ve got” camp. The EU’s “modus operandi is clearly a problem” but better to keep it under “continuous review” than burn our boats now. Given how badly the “continuous review” thing has worked out for the last 20 years, we agree to disagree on that one.
A problem for the next generation
We move on to investment. He’s happy to keep the EU but how does he feel about what’s going on at the European Central Bank – about negative interest rates? This is interesting. He is very, very bored of monetary policy: we are all far too obsessed with it, given that at this point it is “clearly ineffective”.
Very low rates don’t appear to do much for aggregate demand (would economies really look so different if they had never been cut to these levels?) but they do distort markets and incentives (“it sends wrong signals to people in terms of saving and spending decisions”) and they allow politicians to sit back and say “we don’t have to do anything because the central bank is doing the job for us –when it’s not”. So what should politicians be doing?
Magnus is a believer in more government spending – borrowing at today’s “ridiculous, generational lows” and building “sensible infrastructure”. Isn’t that just replacing a private debt problem with a public debt problem? Yes, says Magnus, but the government will at least be in a “better situation to reduce its debt burden in the future”. I’m not convinced: the UK doesn’t have much of a record of reducing debt in times of low inflation – so the whole borrowing-to-spend-on-infrastructure thing just seems to me to transfer our problems to later generations.
That seems a bad thing. It should only be part of a “general programme of stimulus”, says Magnus. There are other things that governments should be doing – addressing matters of intergenerational inequality, for example. We need to get rid of universal benefits for the old (I’ve asked him to make a start on this by sending me his winter fuel allowance), for example.
Hmm. If you look forward ten years, I ask, can you see the economy growing properly again? Yes. The discussion is about the state trying to push aggregate demand. But on a long-term view “have we reached the end of ingenuity? I don’t think so. Do we know the capacity of our new… technologies to spark a new round of… manufacturing growth? I don’t think we really know anything about this”.
Think about driverless cars: once they are good to go, we might not need many taxi drivers or petrol pump attendants, but there is “a whole new infrastructure that’s going to have to be rebuilt, because we won’t be able to use the existing one”. We have not reached the end of progress – on that we agree. Great I say, so where shall we invest? For long-term investors it is all about “the diffusion of technology and the revival of productivity growth”.
The short-to-medium term is trickier. The next 12-18 months might be good for emerging markets – equities debt and currencies, says Magnus. The “risk on” mood that has gripped the market since March isn’t likely to change in the next three to six months. After that? We aren’t out of the woods. The Federal Reserve will start to tighten again and the China problem will come back. Expect a correction after that. “I’m not optimistic about the way things are panning out.” And that, I think, should give all of us quite enough to worry about for now.
Fact file: George Magnus
George Magnus, 66, is an independent economist, consultant and author, with a long background in the financial services industry. His city career began in 1977, after he left academia to join Bank of America as head of economics for Europe, the Middle East and Africa.
He is probably best known for being one of the few economists to have warned in 2007 that the US subprime mortgage market posed a serious threat to the financial system. At the time he was UBS’s senior economic adviser (a post that he held from 1995 to 2012).
Magnus’s first book, 2008’s The Age of Aging, dealt with shifting demographics and their impact on the global economy. Following the financial crisis, he penned Uprising: Will Emerging Markets Shape or Shake the World Economy? (2010), in which he took a more sceptical look at the assumption that China will come to dominate the global economy.