China’s 6.5% surge in the last quarter of 2020 epically trolled outgoing US President Donald Trump in the final three days of his presidency.
As the US economy slows amid exploding Covid-19 infections, China is surging in the other direction – and leading the globe in the process. In fact, China in 2021 will play the “oasis of prosperity” role that the US did in the late 1990s during the Asian financial crisis.
The phrase was Alan Greenspan’s. In September 1998, the then-Federal Reserve chairman detailed – correctly, as it turned out – how the US would be the sole growth engine for the foreseeable future.
This, remember, was the traumatic year after Thailand’s devaluation unleashed a wave of financial instability across the region. It toppled the economies of Indonesia and South Korea, pushed Japan’s banking system to the brink and slammed China.
Just as heady US demand back then bailed out Asia, it now falls to China to assume the role of global stabilizer. It’s hardly what Trump envisioned four years ago when he launched an ever-expanding trade war with the world’s second-largest economy.
But is China ready for its big moment as the world ‘s economic oasis? Yes and no.
The “yes” owes much to China’s relative success in containing the coronavirus. Along with South Korea and Taiwan, President Xi Jinping’s government proved that curbing the pandemic is a necessary precondition to revival. And China’s fourth-quarter surge, following the biggest slump on record, is the closest thing the globe has seen recently to a “V-shaped” recovery.
The 2.3% annualized growth China produced in 2020, meantime, made things everywhere look just a touch better. This growth, says International Monetary Fund (IMF) economist Gita Gopinath, raised the global average markedly.
“With the exception of China, all advanced economies and emerging and developing economies,” Gopinath reckons, will see output “below 2019 levels well into 2021. Therefore, we see that the recovery from this catastrophic collapse will likely be long and even highly uncertain.”
Against that dire backdrop, China’s growth is a good thing to have.
And it’s a testament to the success Beijing had in deploying fiscal and monetary stimulus. Juxtaposed with the US, Japan and Europe, all of which are seeing growth slow amid new waves of Covid-19 infections, China is well-poised to expand its soft power and economic footprint in line with Xi’s ambitions.
To Gene Ma, head of China research at the Institute for International Finance, the real headline is that Asia’s biggest economy just grew at the strongest pace in two years. “The economy,” he stresses, “recovered even with some services still in lockdown.”
What’s more, says Mohamed El-Erian, economic adviser at Allianz, “manufacturing held up relatively well.” It’s promising, too, he says, that the service sector “rebounded with the country managing better through Covid.”
In fact, China proved pretty nimble as coronavirus fallout slammed global business confidence.
China’s factories revved up to meet surging demand for medical equipment and work-from-home devices, sparking a much-needed export boom. China shipped roughly 224 billion masks from March through December. That, Bloomberg calculates, equates to almost 40 for every human on the planet outside of China.
In December alone, industrial output rose 7.3% from a year earlier – and increased by 2.8% for 2020 as a whole. Fixed-asset investment was 2.9% higher in 2020 than in 2019. That sets China up for roughly 8% growth in 2021, economists predict.
Nomura Holdings now predicts China will surpass US GDP by 2028, two years ahead of most predictions.
That is a stark challenge for Joe Biden – who may well be the man who will oversee the US becoming the globe’s number two economy – and a stark reminder of how Trump’s four-year effort to slow China’s ascent failed spectacularly.
Downside risks looming
It’s not all roses in China, however. Recent data suggest that the growth China is experiencing is of an unbalanced and somewhat hollow variety. One concern is that wage growth remains below pre-pandemic levels, complicating the outlook for domestic demand.
True, China’s jobless rate was 5.2% at the end of December. But wage trends remain disappointing and are indicative of growth driven more by top-down fiscal loosening than organic demand from the ground up. Overall, “data from December tells us that demand-side growth is not as great as supply-side still,” says economist Trinh Nguyen of Natixis.
The cost of 8% growth in 2021, in other words, is likely to be a new surge in debt and credit at a moment when Beijing claims to be clamping down on financial leverage. At a December meeting to devise 2021 priorities, China’s ruling Communist Party cautioned against any “sharp turns” in policy. The bottom line is the stimulus spigot remains open.
The bill for 2020, warns economist Michael Pettis of Peking University, could be bigger than many investors realize. Looked at in a broader context, he says, “these numbers aren’t especially good, and they certainly shouldn’t have been surprising.”
It was predictable, Pettis notes, that Chinese policymakers would respond to “worsening of the healthy parts of its economy by unleashing enough of the unhealthy, non-productive growth it has long tried to constrain – basically real estate and infrastructure investment – in order to achieve as much economic activity as it needed for domestic political ends. And that’s exactly what happened.”
Yet Pettis finds it troubling that retail sales, the best proxy for mainland consumption, rose only 4.6% in December from November after being down 3.9% overall in 2020. That may be good for macro figures but is a bad signal for 2021.
“That’s pretty bad,” he argues. “Not only did the imbalances get worse in 2020, in other words, they even got worse in the fourth quarter when we were expecting a partial consumption rebound.”
Put differently, Pettis says, the consumption share of China’s GDP will have probably dropped 3 to 4 percentage points in 2020, driving it almost back to its nadir in the 2010 to 2011 period.
“There’s no way that this can be seen as good news, and it’s confirmed by the fact that while exports were up 3.6% in 2020, imports were down 1.1%.”
Pettis is stark on what all this means.
“China’s recovery was driven by supply-side measures. The economy is now more unbalanced than ever.”
More downside risks? Fiscal stress among local governments is becoming more acute at the same time private-sector investment is slowing. That could lead to increased default risk.
This has two important implications. First, China’s debt burden is worsening significantly. In 2020, for example, China’s debt-to-GDP ratio rose by about 25 percentage points, roughly three times the level in 2019. Second, China’s trade surplus will continue to soar, perhaps increasing tensions with the incoming Biden administration in Washington.
Among the longer-term costs of 2020 was a widening gap between China’s rich and poor.
Data from the National Bureau of Statistics is clear: The wealthiest 20% had an average of roughly $12,000 of disposable income last year, more than 10 times the poorest 20% and more than three times the median.
As in many developed or near-middle-income nations, the negative income effects of coronavirus lockdowns have been far less severe for salaried workers or those who can operate remotely. Many rural migrant workers don’t have that luxury.
All this could mean an increase in social frictions in 2021.
This divide matters as China experiences its own new wave of Covid-19 infection, largely clustered in Hebei province, roughly 270 kilometers from Beijing. Should new lockdowns become necessary, China’s 2021 GDP trajectory would quickly shift downward.
Productivity is yet another worry. A recent IMF report warns that the surge in state investment is exacerbating a worker inefficiency problem that’s dogged China since the 2008 global financial crisis.
On various common measures, the IMF finds, many parts of China Inc are about 30% as productive as Germany, Japan or the US. That could complicate efforts to increase Chinese competitiveness heading toward 2025.
Because China has already done most of the public investment it can, says Helge Berger, the IMF’s China mission chief, productivity growth is the best way to expand incomes. “Government support for basic research and development, if prudently deployed to limit interfering with markets, can help foster innovation and boost productivity,” he says.
Regardless of this long list of risk factors, investors betting against China in recent decades haven’t done particularly well.
Xi’s government, too, is staffed by some extraordinarily skilled crisis managers determined to keep the globe’s “growth oasis” in the economic plus column.
It’s equally important, though, that they get under the financial system’s hood. The need to recalibrate growth engines and address emerging new risks has rarely been greater.
China can do it but 2021 is sure to be the most challenging 12 months of Xi’s tenure. And he will be doing it under a microscope: The world is watching more closely than ever before.