The dark side of China’s latest rebound

China shares something more in common with Donald Trump than fighting a trade war. The shared interest: avoiding a meltdown in 2020. 

The US president’s focus on next year is well understood. He’s so obsessed with spinning himself as a winner, no matter the facts, that he’d sooner burn America down than concede defeat. So, winning the 2020 election is everything.

China’s 2020 challenge also concerns a fear of losing. That is, control of its economy. 

The fates of both Trump and China became closely linked when the former bet his foreign policy legacy on tackling the latter. Yet China’s ability to maintain growth and stability in 2020 is greatly complicated by Trump’s tariffs in 2018. And, it’s important to acknowledge, its own actions since then. 

Something else must be acknowledged – there’s just as much bad news as good in China’s most recent economic rebound. 

A raft of data released Wednesday cheered world markets. It included a better-than-expected 6.4% first-quarter growth rate year-on-year. The more “high-frequency” monthly data series look better, too. They include industrial production and improved demand for everything from cars to phones to cement to crude steel. 

As Chen Long of Gavekal Research puts it: “The world’s second-largest economy is proving more responsive than expected to the authorities’ supportive policy measures.” 

Stabilization, for now

Exports jumped 14.2% year-on-year in March after plunging 20.8% In February. This stabilization is a welcome development for the global economy. For now.  

Though good news for 2019, it comes at a high cost: total social financing is up an eye-popping 40% so far this year. There’s been an uptick in the shadow-banking activity Xi Jinping promised to curb. Loans aren’t heading into productive sectors, a state of affairs hinted at by the paltry 6% increase in fixed-asset investment. 

Account receivables are building up, a sign many companies aren’t getting paid what they’re owed. Credit cards, meantime, are getting quite a workout. While data lag, household balances rose 23% in the fourth quarter year-on-year. It means that a not-inconsequential driver of consumption comes at a high cost. 

The bigger question, though, is what happens when Beijing tabulates the bill for today’s 6.4% growth rate? Or, for that matter, the broader tab for generating rapid growth in the decade since the Lehman Brothers crisis. 

Last year, even before Trump’s tariffs on US$250 billion of Chinese goods began to bite, Beijing’s pile of public and private debt had reached $34 trillion. Add to that the tens of trillions of dollars of credit the state pumped into the economy, including fresh waves of liquidity in 2018 and early 2019. 

Lack of political will?

Those waves are keeping China Inc afloat. But they suggest a lack of political will on the part of President Xi. He’s still putting short-term stimulus over reform. 

“We have our doubts,” says Diana Choyleva of Enodo Economics. “The Chinese leadership has said it’s prepared to tolerate slower growth and it understands that it needs to drive supply-side reform. But the credit-fueled pump priming evident in first-quarter official data highlights the pressure the Communist Party is under to maintain expansion this year as it marks the 70th anniversary of the founding of the People’s Republic.” 

Xi’s team, it follows, may be setting China up for a rocky 2020. The concern is that Beijing is getting closer to a “Minsky moment,” or when a debt-and-credit-driven boom ends badly. 

It happened in Japan in 1990, Southeast Asia and Russia in 1997 and 1998 and then Wall Street in 2008. Of course, Asia’s biggest economy with $14 trillion of output hitting a wall would make previous market dislocations look like mere ripples. 

China has a remarkable knack for confounding skeptics. In 2001, Gordon Chang made a plausible argument for why Beijing’s luck was running out in “The Coming Collapse of China.” But no collapse. More recently, well-known short-sellers Kyle Bass of Hayman Capital Management and David Einhorn of Greenlight Capital bet on a falling yuan. They, too, made a good argument that crushing debt would wreak havoc in Beijing. The yuan crash never came. 

True, investors don’t tend to get wealthier betting against Chinese policymakers. But Chang, Bass and Einhorn are right on one thing: no developing economy has ever avoided a debt reckoning. No one beats the system, if you will. Skilled as Xi’s team is, crises tend to come out of nowhere and do far more damage than policymakers thought possible. 

Officials in Bangkok in July 1997 had no idea what they were unleashing when they devalued the baht. Nor did US Treasury officials appear 11 years later to understand how letting Lehman fail would shoulder-check the financial system. 

The dark side of China’s rebound is that it’s fueled by new bubbles to keep earlier ones from deflating. That poses short-term challenges that China bulls have yet to internalize.  

“All political signals from Beijing indicate continued concern with regards to a reemergence of speculative price rises,” says economist Andrew Coflan of Eurasia Group. “If real estate price inflation accelerates, policymakers will put in place further controls, even if growth has not fully rebounded.” 

The longer-term risks are the real concern. Granted, Trump’s assault on China’s foundations necessitated drastic measures. Yet those measures are setting China up for a rough 2020. The global economy, too.