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Ronald Stoeferle

Ronald Stoeferle

Ronald is a metals analyst at Erste Group. Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4…

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A Chinese "Black Swan"

According to an old saying on the stock exchange, “if the USA sneezes, the rest of the world catches a cold”. But in the meantime it would seem as if this had become true for China. We remain critical vis-à-vis the unlimited China optimism that seems to be the current consensus. The Chinese economy has grown by almost 10% per year in the past ten years. According to Bloomberg, the consensus expects real growth of 7.7% p.a. for the next 20 years, which we regard as drastically over-optimistic. The extrapolation of historical growth rates is dangerous, as a look through history books shows. Sometimes this boundless optimism reminds us of Japan at the end of the 1980s. 20 years ago the Japanese GDP accounted for 18% of global GDP – today the share has fallen to 8%. The daily news reports about billions worth of takeovers and investments by the Chinese underpin this picture. An interesting detail: Hong Kong has passed Tokyo as most expensive office location.

The stimulus package in 2009 worth almost 14% of GDP helped repair the economic dent quickly yet superficially. Artificial stimulus of this sort naturally comes with quicker results in a centrally controlled economic system. State-held companies accounting for almost 30% of aggregate output can be forced to invest, as banks can be forced to lend. China is currently inflating its money supply by a more substantial degree than any other nation ; M2 increased by almost 20% in November y/y and at the moment amounts to 185% of GDP. On average M2 has increased by 18.8% p.a. in the past decade, while GDP has been growing at 10.9% annually. China currently has the highest M2/GDP ratio worldwide.

M1 money supply (left scale) vs. M2 growth in % (right scale)

M1 money supply vs. M2 growth
Sources: Datastream, Erste Group Research

Given the drastic rise in property prices and the record levels of the food prices, the PBoC now wants to tighten its monetary policy in order to facilitate a soft landing. Battling inflation is on top of the agenda . The minimum reserve requirement was raised to almost 20%. The situation is similar to the fourth quarter of 2007 where comparable steps were taken. But China remains miles behind the curve, and the massive overcapacities in key industries such as steel, aluminium, cement, and chemicals are ever more difficult to gloss over. Ironically, capacity utilisation is significantly lower than in 2008 (87.2%). In 2010 it averaged 82.4%.

The slowdown of Chinese credit growth substantiates our pessimism and will probably affect both the commodity prices as well as all asset prices generally on a global scale. While credit had been growing at an absurd rate of 34% in 2009, it slowed down to 18% in 2010 . The current estimate for 2011 is 12-13%.

S&P500 vs. Baltic Dry vs. Shanghai Composite

S&P500 vs. Baltic Dry vs. Shanghai Composite
Sources: Datastream, Erste Group Research

On a political level, the unrest in North Africa should worry Beijing. Seeing that in 2012 the 18th National Congress of the Communist Party will be held (where the government will go through the usual changing of the guard procedure), the fight against inflation seems to mainly serve the purpose of ensuring social stability. The Chinese inflation statistics euphemise the actual price increase. The massive discrepancies between the Chinese energy consumption and GDP growth lead us to deduce that China is currently in the phase of “low quality growth”, and this phase is coming to an end.

We do no expect the Chinese economy to collapse, but a profound market consolidation seems overdue. To an economy that has been growing at double-digit rates for years, a GDP growth rate of only 5% feels like a severe recession. The sooner China allows the necessary cuts to be made, the less deep they will go. However, the Chinese government is confronted with a difficult task. Due to the extremely high capital intensity of the Chinese economy (gross fixed capital formation > 40% of GDP) future growth will hinge on a higher propensity to consume of the Chinese population. But in order to boost China’s domestic consumption real wages would have to rise first. And currently it is precisely the low wages that represent China’s most important competitive advantage, which have facilitated the high growth rates in the past decade. It is therefore clear to see that the Chinese leaders are caught between a rock and a hard place.

History has often shown that what had been planned as “soft landing” ended up as abrupt crash. Following the teachings of Ludwig von Mises, a laissez-faire policy would be the only right answer to the recession. The massive interventions in the market delay the cleansing of the market and only make the following consolidation worse.

The China of today is somewhat similar to the USA of the 1920ies. Industrial growth was mainly fuelled by high exports, supported by an artificially low currency. China is also the world’s biggest creditor today, and the gearing of households and the corporate sector is equal to that of the USA in the 1920s. Back then the USA was hoarding almost 6% of global GDP in foreign exchange reserves in a period of extraordinary prosperity. Should the analogy continue, China would probably face a crisis similar to the one of the 1930s in the USA – i.e. a deep depression and a severe crisis of the banking sector. Due to the striking similarities we think such a development is possible. But in the long run, this would also mean that China would overcome this deep crisis and emerge from it as strongest political, economic, and financial power of the world. We consider this also a realistic scenario.


We are therefore sceptical about the – meanwhile generally accepted – belief in the Chinese economic miracle. The mere extrapolation of the past is devastating in the long run. The massive stimulus measures have so far helped avoid a dramatic economic slump. However, the overcapacities – considerable as they were even before – have further increased. The public share in the overall economic output has been gradually growing, with public infrastructure projects responsible for the majority of growth. Dubai seems to have granted the world a sneak preview into a classic boom-and-bust cycle, although the Chinese dimensions are disproportionately bigger. Since China is a centrally planned economy, it may remain on the growth path for longer. But in the long term, China, too, will not escape the basic principles of economics.

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.

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