China’s economy grew by 9.1% in the third quarter.
From here in the UK, the land that growth forgot, that looks pretty tasty. But in fact, it’s the slowest year-on-year growth China has seen since 2009, and it’s down from 9.8% in the last quarter of 2010. It was also lower than the expected 9.2%.
China is definitely slowing down – that’s been obvious for months now.
But will it have a ‘soft’ or ‘hard’ landing? And what would that mean for you?
Is China heading for a hard landing?
For some time now, China has been tightening up monetary policy. It’s been trying to tackle its inflation problem and let the air out of its property bubble. And judging by the slower growth figures, the measures are working.
Property prices are falling in some areas, while credit is getting tighter, although some sectors are being hit harder than others. My colleague Cris Sholto Heaton has just written a very clear explanation of China’s credit system, and how the slowing property market could hit economic growth for his weekly MoneyWeek Asia email. You can read the piece here: Could China’s banking problems derail the economy? (and if you don’t already get his email, you should sign up for it here – it’s free).
In short, tighter credit means that a lot of the projects funded by local governments and property developers will go bad. That means bad debts will start to pile up in the banking system. On top of that, the weak European and US economies are already making life hard for exporters.
That’s all quite worrying. But while Cris can see problems ahead, he doesn’t subscribe to the ‘China implosion’ theory of the hard landing. China has plenty of options to keep the economy rolling along: if they’re smart, they might even use the slowdown to push through much-needed changes that will improve China’s chances in the long run.
Central planning always fails in the long run
For me, the jury’s out on China. I’m not a bull (surprise, surprise, you say). There’s a lot of nonsense talked about how China’s ‘command’ economy means they can engineer whatever economic outcome they like. It’s the sort of thing you tend to hear from perma-bullish fund managers looking for a way to flog their wares, and it’s patently drivel.
Central planning is a wasteful way to run an economy, and it eventually fails. Our own crash of 2007/08 was due to the interference of central planners in the price of money. In the US, Alan Greenspan dictated and distorted the price of risk, while Japan’s zero-interest-rate policy gave the world the yen carry trade.
Those closest to the centre of power got the benefit of playing with a stacked deck, while investors on the edges were encouraged to take more and more outlandish risks in order to turn a profit. It’s still happening now – quantitative easing is just more of the same policy that got us into this mess.
The whole point of money is to provide a reliable scoring system to guide activity in an economy. You get points for allocating resources to where they are most needed. You lose points for wasting resources on projects that no one wants. If you interfere with that scoring system, then you increase the amount of waste, as resources are misallocated.
So the idea that a central authority can somehow create a functional, healthy economy by fiddling with the price of money and forcing banks to lend is ridiculous. It’s like saying you can change the physical location of a mountain range simply by redrawing the map.
However, that’s the long run. As Adam Smith said, there’s a lot of ruin in an economy. And as the otherwise bearish Stephanie Pomboy of MacroMavens told Fortune recently, “China may be a bubble, but… it’s a bubble that can go on longer than you can remain solvent by betting against it”.
Why a Chinese hard landing could be good news for Britain
Regardless of the eventual outcome, the one thing we can be sure of is that China’s economy is slowing. And chances are that the market hasn’t yet priced in just how big the slowdown may eventually be.
Lots of the more bullish pundits argue that the country will loosen monetary policy again. But inflation is still above 6%, and food price inflation – which is the biggest worry for most people – is much higher than that. So it may not be as easy as they think to balance these things out.
Even that small undershoot of third quarter GDP this morning has rattled investors. The Australian dollar slid against the US dollar for example. So even if a soft landing lies ahead for China, it would probably be bad news for stocks. That argues for sticking with the defensive stocks we’ve been tipping for a while – you can read our latest piece on this here: Central banks can’t stop the next Great Recession.
However, the horrible truth is that a hard landing in China might be the best thing that could happen to the UK economy. I’m not saying it wouldn’t have nasty repercussions – you could expect a big plunge in stocks for a start.
But it’d also drive commodity prices sharply lower. That would remove some of the inflationary pressure that is currently squeezing the life out of British consumers. Given that the consumer price index is now rising at 5.2% (!) a year – that’s hot off the presses – that would provide some much-needed relief all round.
Unfortunately, we can’t bet on that happening either. Who knows? Confronted with a hard landing in China, Mervyn King might just bang the ‘print’ button even harder. That’s why, even although gold might have a period of consolidation ahead of it, it’s still worth hanging onto, particularly for sterling investors.
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• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .