For the past 10 days, the Greek debt drama has drawn media coverage and popular attention from important events on the other side of the globe. Today’s resounding “no” vote in Greece’s national referendum on whether to accept the terms of an international bailout only fuels that dynamic. Yet even if Greece exits the Euro, the global economic consequences are minor compared to the potential impact of events now unfolding in China. Indeed, focusing on Greece while a potentially larger crisis brews in Asia evokes a colorful, fitting Chinese idiom: “picking up sesame seeds but dropping the watermelon” (撿了芝麻, 丟了西瓜).
China’s economic story and political stability are now very much at stake in this challenging and uncertain time. Accordingly, it is worth revisiting what we consider to be three of China SignPost’s highest-impact reports. These analyses have anticipated, respectively: limitations in the implementation and efficacy of Xi Jinping-era reforms (#81), China’s recent stock market slump (#89), and a long-run S-curved slowdown in China’s economic growth rate and overall development trajectory (#44). We believe that they elucidate key short-term and longer-term dynamics and prospects for China’s economic conditions, its broader development trajectory, and the Party-State’s prospects for managing both effectively.
Stock Market Chaos
To begin, we recognize the reality of a Chinese stock market that completely decoupled from weak underlying economic fundamentals. The market rose meteorically, traded on easily available funds and massive leverage, and eschewed fundamental analysis of China’s rapidly slowing real economy and largely tepid consumer economy. On 14 June 2015, barely two days after the Shanghai Composite Index reached its recent peak, we offered the following assessments in China SignPost #89:
- China’s stock market rally is not underpinned by robust real economy activity.
- Real economy indicators suggest that China’s stock market is markedly decoupled from underlying economic reality.
- Specifically, the “Keqiang Index”—an aggregation of statistics concerning electricity consumption, rail cargo volume, and amount of loans disbursed reportedly advocated as a more accurate metric of real Chinese economic activity by Premier Li Keqiang himself—has suggested substantially lower GDP growth than have official figures.
- The massive speculative updraft in the Chinese stock market stands in marked contrast to weak electricity demand.
- The Shanghai Stock Exchange has risen approximately 150% over the past year, while electricity consumption has flat-lined for the past five months and counting.
- Given China’s industrially driven economic model, this reflects serious weakness.
- Many Chinese economic statistics remain “the mystery meat of emerging-market countries.”
- Even these official figures, which Premier Li reportedly denounced as “man-made,” have themselves been ebbing.
- The abovementioned factors underpin our concern that this stock market boom is unsustainable.
- President Xi is the ultimate margin trader in this market.
- His margin account is not just economic but political as well.
- Stock market downdrafts on the heels of euphoric upswings can be devastating to far more than pocketbooks.
- They sow fear and destroy confidence—the lifeblood of both economic growth and political stability.
- His margin account is not just economic but political as well.
Well-documented bureaucratic turf wars between the People’s Bank of China (PBOC) and China Banking Regulatory Commission (CBRC) helped sow the seeds of some of China’s most pressing current economic problems—such as ballooning debt and use of shadow banking. Such infighting continues impeding the Chinese government’s response to the current market downdraft. Unlike other major central banks, the PBOC is not politically independent. Indeed, in a Chinese political system where “de facto federalism” is the default modus operandi, banking is one of the few areas where policy authority is far more centralized, in part as a product of the pre-WTO reforms spearheaded by the Premier Zhu Rongji.
As such, the PBOC likely faces significant political pressure to continue pumping the stock market up, as this helps distract the populace from the fact that the market for residential real estate—the prior hot investment area—is flagging. For its part, the CBRC has likely been “captured” by the very banks it is supposed to regulate, further contributing to amplified systemic risk from shadow banking activities that are tougher to track and regulate than lending conducted through normal bank channels. Ultimately, conflicting bureaucratic priorities and infighting send contradictory messages to investors and likely fuel additional market instability.
China’s Leadership is Hesitant to Push Genuine Reforms
China SignPost #81 (23 October 2014) expressed our deep skepticism that China’s leadership was willing and able to implement reforms sufficient to maintain then-current levels of economic growth amid gathering challenges. We concluded that:
- President Xi Jinping’s vigorous promotion of new policy paths is colliding with powerful vested interests.
- China’s leaders appear to know what economic reforms are needed, but how, when, and to what degree can they actually implement them without assuming unacceptable political risks?
- This remains the problem, and it remains unanswered.
- Bottom line: China faces increasingly necessary reforms that its political power structure appears ill-suited to implement effectively.
- Accordingly, expect reforms to progress more slowly, and less successfully, than expected.
Fundamental Constraints on Growth Are Exerting Themselves
Approximately four years ago, we published what we consider to be China SignPost’s most significant—and prescient—macro analysis to date, “China’s S-Curve Trajectory: Structural factors will likely slow the growth of China’s economy and comprehensive national power,” No. 44 (15 August 2011). Looking forward, we maintain our view that the larger dynamics we articulated there will continue to place the growth of China’s economy, and its overall “comprehensive national power,” on an S-curve-shaped slowdown trajectory. Here’s our rationale:
- China faces costly internal and external challenges that are likely to shift the country onto a structurally constrained slower-growth trajectory.
- For all its policy navigation, efforts to guide national development, and claims of exceptionalism, China is not immune to larger patterns of economics and history.
- It will thus almost certainly experience an S-Curve-shaped growth slowdown like so many previous great powers have suffered, and the one that so many observers believe the United States is undergoing today.
- In fact, China is encountering such headwinds at a relatively much earlier stage in its development than did the U.S. and other great powers.
- This is due in part to China’s late start in modernization, its dramatic internal disparities, and its draconian one child policy and other political dynamics.
- Growth rates will therefore slow as key internal and external challenges—including pollution, corruption, chronic diseases, water shortages, growing internal security spending, and an aging population—feed off of one another and exact increasingly large costs.
China’s comprehensive global market moving power has become immense and spans equity, debt, and hard asset markets with trillions of USD in combined investor exposure. The corollary of this power is that China’s ability to transmit risk into global markets has become commensurately massive. Indeed, at present there are perhaps only three other individual countries to which global financial markets are so comprehensively exposed: the U.S., Japan, and Germany. While specific decisions by Chinese political actors are almost impossible to predict, we recommend that investors and policymakers focus on the structural factors we outline, as these provide the fundamental framework within which Chinese regulators will likely take their policy actions.