Opinion

John Hewson
Morrison can’t afford to ignore China’s economic woes

A British colleague of mine has drawn my attention to the folklore of sharemarkets, where October has always been considered a dangerous month. This year it may prove to be the case, due to a dangerous mix of short- and long-term factors that could spell the end of what has been an extended bull run.

These factors include “Pandexit”, where the overarching challenge is for central banks to decide just how long they should continue to pump money into economies that are already awash with cash and debt, and in some cases beginning to show signs of overheating. A recent crucial meeting of the governors of the Big Four central banks – from the United States, Japan, England and Europe – has left markets with plenty to think about.

In addition, there are the continuing concerns on at least four other fronts. The first is China and its economic challenges. Then there are US policy issues, including the fate of Biden’s large infrastructure package and whether the US will be able to meet the deadline of October 18 to increase the so-called “debt ceiling”. There is concern also about a possible global energy shortage. Finally, there are the continuing disruptions to supply chains that have resulted in acute global shortages of several key products.

I write this against the background of the Morrison government’s apparent complacency about our economic prospects, in what is a very uncertain global environment. It is a significant but largely ignored issue. The government seems to believe that China is strong and we are strong with it, but neither of these things is true.

Sharemarkets didn’t have a great month in September. The S&P was off by 5.1 per cent, the Dow by 4.5 per cent and the Nasdaq by 5.8 per cent. Europe was less negative, but the FTSE 100 was down 1.3 per cent, the CAC 40 down 2.5 per cent and the Xetra Dax down 3.4 per cent. It was a little better in Asia with the Nikkei down 1.2 per cent and the Shanghai Composite down just 0.8 per cent. Bond markets have also recently seen longer rates increase, reflecting growing concern about accelerating inflation.

The “miracle” growth rates in the Chinese economy have been slowing as the economy attempts some key transitions and tries to deal with important structural challenges. While the transition from an investment-dependent economy to one driven by consumers is clearly under way, it has been occurring more slowly than hoped. The declining and ageing population is a major constraint, as are the challenges of pollution – particularly its health consequences – and corruption.

All this is happening against the background of President Xi Jinping’s campaign to purge China of “capitalist excesses”. A recent editorial in The Economist describes Xi as seeing “surging debt as the poisonous fruit of financial speculation and billionaires as a mockery of Marxism”. This is difficult to reconcile with the country’s massive total debt levels, which some have estimated at 300 per cent of gross domestic product.

You can imagine the challenge for the Chinese government. It is in the process of confronting the collapse of Evergrande, one of the largest Chinese property developer groups, which has claimed 1300 projects in about 280 cities. The failed company also has several offshoots in electric vehicles, media, financial services, a sports team, health services and theme parks.

Evergrande is said to be the most indebted company in the world, with some $US300 billion borrowed in various forms. It has so far defaulted on several interest payments and the issue for the Chinese government is whether to bail it out.

Some see the Evergrande debacle as the beginning of a major Chinese property collapse, due to a tightening of government policy out of concern about the link between levels of debt and the real estate market. Evergrande had been pushed into a very tight liquidity position as the government increased restrictions on debt linked to real estate, the effect of which the company claimed in a Hong Kong sharemarket release was putting “tremendous pressure on the group’s cash flow and liquidity”. Subsequent media reports contributed to a drop in consumer confidence, making it difficult for Evergrande to sell down their stocks of unsold apartments, even at substantial discounts.

The potential of negative shockwaves from the collapse of Evergrande, across financial markets and the global economy, is obvious. These waves have begun, with key shareholders exiting and suppliers and those who had bought off the plan basically being abandoned. Some have referred to this as a Chinese Lehman Brothers event.

It is important to recognise that Evergrande is not the full extent of China’s debt problems. The traditional banking system also has a problem, with exposures to non-performing loans and a very significant problem with the debts of secondary non-bank finance or shadow banking sector. In addition, Goldman Sachs has recently warned of “hidden local government debt” – which it estimated at 50 per cent of China’s GDP – as another “serious drag on recovery”.

As a result, Goldman has cut its forecasts for Chinese growth this year from 8.2 per cent to 7.8 per cent, more in line with other private estimates. However, it is important to recognise Chinese official growth numbers are notoriously unreliable, as they are “manufactured”.

I recall that some years ago I was in China on a business trip when the Chinese government announced the growth rate for the September quarter. The problem was, it was only mid-September. The figure was for a quarter that hadn’t happened yet. In Australia, similar figures would usually be announced in the first week of December.

In considering Chinese growth for this year, it is important to note that the country has recently endured something of an energy crisis that has seriously restrained power supply to key sectors. There also has been an annoying side issue about Chinese growth prospects, with proven accusations that a World Bank “Doing Business” report was doctored to make China look better.

It is worth noting that American economist and New York Times columnist Paul Krugman has recently warned “of a potential Chinese financial meltdown”. He drew parallels between China today and Japan’s “bubble economy” of the 1980s and ’90s, which led to a protracted period of low or no real growth.

The recent meeting of the Big Four central banks, sponsored by the European Central Bank, also caused some disquieting of financial markets. It was agreed that the Covid-19 crisis was still the No. 1 priority and the chair of the US Federal Reserve, Jerome Powell, said vaccination was the main economic policy we have. Supply chain restrictions and disruptions are still significant and may be getting worse, but it is beyond monetary policy to address this issue.

The gloominess of the meeting was well summarised by Powell’s comment “that economic policymakers tend to underestimate economic damage, and undersupport economic recovery”.

The main takeaway was that central banks were most likely to sustain easy monetary conditions and low interest rates. This position is getting harder for the US Federal Reserve, with Powell needing to be reappointed and facing congressional scrutiny and debate.

The current and prospective health of the US economy is debatable. On face value some argue that it is going along nicely, with quarter two growth of 6.7 per cent this year, up from 6.3 per cent in the first quarter. However, recent partial indicators have been mixed at best, seeming to suggest that growth is now slowing and inflation accelerating.

The uncertainty of this situation is compounded by congressional complexities, particularly concerning infrastructure spending and the debt ceiling. Moreover, President Joe Biden’s star has waned in the run-up to the congressional midterm elections scheduled for November 2, threatening some resurgence of the Trump influence.

Biden’s overall approval ratings are bad enough post-Afghanistan. As reported in The Washington Post, only 45.1 per cent of Americans approve of his performance. “That alone makes Biden less popular at this stage of his presidency than any president in the past 40 years except for Donald Trump.”

On top of all this, the slowing growth in Europe and the pick-up in European inflation rates further complicate the global outlook. Much of the focus will be on Europe in coming months with the 2021 United Nations Climate Change Conference (COP 26) being held in Glasgow in early November. While the pressure will be on most nations to firm up their targets and transition policies, the backdrop will be a natural gas crisis in Europe and the US, and panic buying of petrol in Britain. These discussions may also include the possible introduction of carbon border taxes.

Clearly, Australia is particularly exposed in all this given our dependence on China and global trade. There is absolutely no justification for the Morrison government to be complacent and it should be challenged to detail how our economy is likely to perform given these global challenges.

This article was first published in the print edition of The Saturday Paper on Oct 9, 2021 as "Evergrande designs".

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John Hewson is a professor at the ANU Crawford School of Public Policy and former Liberal opposition leader.