The Chinese government just dodged a bullet. After weeks of stock market turmoil, the second largest economy in the world finally got some good news.
Official figures show China’s economy grew by an annual rate of 7% in the year to June. This figure came exactly in line with government expectations.
But the news comes as more of a relief than anything.
What’s important, in the eyes of the government, is that it didn’t fall below this level. The 7% growth is symbolically significant in that sense. Anything below would have been a failure, a sign that the economy was sinking.
That’s not an exaggeration either.
GDP growth of 7% is incredible by most standards. But this is China we’re talking about; the global economy looks to China for growth. The real question the world wants to know is whether China can sustain this.
On closer examination, the likelihood of a repeat performance is slim. Why?
Well, let’s look at how China arrived at its 7% growth rate in the first place.
China barely managed to scrape above the 7% threshold. It took a June rally to get them over the line. Growth for the June quarter was at 1.7%, revised up from an original 1.4%.
Retail sales and industrial output finished strongly. Sales were up 10.6% for the year, while industrial output rose by 6.8%.
Real estate, which struggled for much of the year, rebounded somewhat. There are early signs that property prices in the big cities are rising.
On the other hand, this might reflect the problem of weak housing construction.
I’d put the recovery in house prices down to three things.
One is the positive effect on demand stemming from slowing construction.
The second is that the central bank cut interest rates again last month, to 4.85%.
Finally, it’s only logical that investors are abandoning the stock market and going back to what they know best — housing.
The stock market’s contribution to GDP growth: good or bad?
Economists will say that growth of any kind is inherently good. But when growth stems from a volatile sector, it should raise some concerns.
China derives a growing percentage of its GDP growth from the performance of the stock market. I don’t know about you, but that strikes me as a worrying trend.
In the first quarter of 2015, the finance sector accounted for 1.3% of GDP expansion. That’s almost double the 0.7% contribution in last quarter of 2014. Brian Jackson, an economist at data provider IHS Inc, says that every sector outside finance slowed in the second quarter. That should make everyone nervous about the future of the Chinese economy.
As we’ve seen in the past month, the stock market is too volatile to be a reliable source of long term growth. How capable is China of maintaining 7% growth rates while reliant on traders? With the stock market in correction, not very.
The stock market has a knock on effect on retail investors who lose money trading. Many Chinese investors are worse off today than they were a month ago. A loss of wealth tends to affect things like consumption habits for the worse.
Some economists don’t think the 30% drop in share prices will cause long term damage to the economy. They argue that the relatively small number of Chinese retail investors minimises its impact.
Relative to what though? We shouldn’t forget there are over 90 million retail investors in China. The stock market correction will affect a large percentage of these people. And that’s before we even consider what the correction will do to long term company investments and growth prospects.
Demand slows, infrastructure spending falls
The outlook for China is made worse by the situations in the US and Europe. Demand has flopped as both regions struggle with their own economic slumps. Few economists see international demand for Chinese goods growing anytime soon.
Domestic demand has held up a little better by comparison. Rising retail sales and industrial output will ease immediate concerns over unemployment. But if unemployment rises from slowing growth, then it’s reasonable to expect consumption to fall as a result.
The other concern relates to a slowdown in infrastructure spending. Outlays on infrastructure projects have been one of the pillars of economic growth in China.
The reason why spending is down is because of excessive local government debt. Last year local government spending was responsible for 27% of China’s GDP. Investment bank Goldman Sachs estimates investments will fall by 1 trillion yuan. That could shave 0.7% off the growth rate by the end of this year.
The verdict on China’s economic future
We should maintain some perspective when talking about China. Growth rates of 7% are enviable the world over. But they come with risks attached to unpredictable asset classes like stocks. Yet we could say the same about Australia.
The difference between us and them is that they have more options available to them. Chinese policymakers have a lot of room to prop up the economy using various instruments.
The central bank has cut interest rates four times in the past seven months. The government too has lowered capital reserve requirements for certain lenders. The message they’re sending is clear: we’ll do whatever it takes to keep the economy above water.
Since they have leeway to inject money into the economy, the immediate dangers are less apparent.
That’s the reason why The Daily Reckoning’s editor, Phillip J. Anderson, is optimistic about China’s economy.
Phil disagrees with economists who say that slowing growth rates in China point to economic disaster. In fact, he thinks China’s boom is only beginning — and that it’s set to last another decade.
His timeframe is ambitious, but he’s probably right in that it will stay robust for a few years still.
Phil’s actually written a free report on China. In it, he argues that China still presents the perfect opportunity for investors. He does this by lifting the lid on China’s economic fundamentals. By equipping you with the right tools, Phil will show you how to invest confidently in China. To find out how to download his report, ‘The Cassandra Syndrome: After This Report, You Won’t Worry About China Again for Another Decade’, click here.