China’s recent currency devaluation and market rout, sent a lot of investors panicking. Markets, rightly, began asking questions. Was this the beginning of the end for China? How would global stock markets react in the long run? And just what does it all mean for the Aussie economy?
These questions came with few clear cut answers. Some see the concerns as misplaced. Others, meanwhile, say that it bodes poorly for Chinese economy. But in the aftermath of the worst market retreat in years, it’s worth reconsidering some of these questions.
Does Australia have anything to fear then? Yes and no. As you’ll see, some of these concerns about China’s economy are overblown. But there’s also plenty of reason for alarm too.
China’s slowdown may not lead to a collapse anytime soon. But it could affect Australia’s economy even more so than its own.
Reports of China’s demise greatly exaggerated…or are they?
According to a leading China expert, Andrew Baston, fears over a Chinese economic collapse are misplaced. He doesn’t dispute that China’s economy is slowing. But he’s unconvinced that we’re witnessing the start of a collapse.
Why? Baston lists four key reasons for this. We’ll explore these in greater detail. And we’ll put them in the context of what it means for Australia.
The first of these factors relates to the recent Renminbi (yuan) devaluations. Over the past month, the yuan has declined by 3%. Markets got jittery on the back of this. They began wondering what Chines policymakers were playing at.
Fears arose that China was entering the global currency war. Aussie investors, meanwhile, fretted that it would devastate government budgets. All of a sudden the global economy found itself facing a potential foreign debt crisis. Or did it?
Mr Baston says the yuan’s devaluation isn’t likely to spark a foreign debt crisis soon. But it’s not altogether clear how that stacks up against the realities of devaluations. The questions over China’s participation in a currency war are irrelevant. All that matters is that they are devaluing the yuan. And the very act of doing so hurts global economies; not least Australia.
Why? Because it makes Aussie commodities exports more expensive. A cheaper yuan makes all imports more expensive in turn. And this comes at a time when Chinese demand for commodities is slowing.
This simple factor renders any debate over currency wars irrelevant. The facts speak for themselves. The yuan is weakening, and it’s making life difficult for Australia’s struggling exporting sector.
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Does the stock market collapse matter to the Chinese economy?
The next factor Mr Baston draws on is the stock market rout of the past several weeks.
Since June, the Shanghai Composite Index has shed 45% of its value. Calling it a correction would be putting it mildly. It’s a bloodbath, and a downright sobering one at that.
But does this actually matter for China’s broader economy? Mr Baston doesn’t think so. He believes the sell-offs will have a limited effect on the economy. That’s because the stock markets comprise less than 5% of household wealth. Baston explains:
‘Although a continued slump from current levels would generate plenty of hyperbolic headlines about a crashing China, even a further sell-off would have a limited spill over effect on the real economy’.
Baston says this is because China’s banking sector is less exposed to stock market turmoil. And, as long as that’s the case, swings on sharemarkets won’t affect the broader economy.
While that’s true for China, it’s not the same case with Australia.
Last week, the Aussie share market lost $70 billion in value amid the global rout. That’s $70 billion wiped off the ASX because of selloffs that started on Chinese markets.
Unlike China, banks dominate our stock market. The banking sector makes up almost half of the entire ASX index. Importantly, anything that shocks the ASX has implications for the broader economy too.
What’s more, there are underlying concerns here that aren’t immediately obvious. The relationship between stock markets and the economy is psychological too. Stock market routs create the perception of decline, whether in China and Australia.
From that perspective, China’s month from hell could frighten investors. And with so many regular Chinese investing in stocks, it could shape consumer spending. As consumers hold back, economic growth stalls. How can anyone think that’s an acceptable outcome for the Chinese economy? China’s economy may be less exposed to its stock market, but it’s not detached from its investors.
Is China’s property market heading for another bubble?
Mr Baston doesn’t believe China’s property market is under any immediate danger. In contrast to stocks, Chinese exposure to housing is high. That’s partly why the government promoted stocks in the first place. They saw it as an alternative to an overheating housing market.
With stocks now on the backburner, does that bring housing back into the limelight? Potentially, yes. But does that mean that China risks a housing collapse?
According to Baston, there are two reasons why a future property collapse is overblown.
The first is that China still has a rising urban population. This helps keep demand high in China’s fast growing metropolises.
The second reason is that household incomes are still rising. Naturally, rising incomes go hand in hand with housing affordability, increasing demand in turn.
On top of this, Chinese policymakers have made it easier on borrowers to secure cheaper loans. They’ve done this by lowering interest rates and easing banking capital requirements. What’s more, they have room to ease borrowing conditions further.
As a result of these factors, Mr Baston doesn’t think a housing collapse is on the cards.
Yet there are signs that the market is reaching its ceiling. Mr Baston explains:
‘Fundamentals indicate that housing demand is close to its peak, and that the sector has gone from being a growth driver to a drag on growth, a shift with huge knock-on effects for the rest of the economy.
‘But the maturation and decline of housing demand is a very different thing from the unwinding of a massive speculative bubble’.
But what about Australia’s housing market? The truth is, this could have both positive and negative effects on the Aussie housing market.
Chinese investors are particularly enamoured with properties in Sydney and Melbourne. If investors refocus their energy on real estate, it could spill over into Australia too. We may see increasing demand for high-end properties coming from Chinese investors. In that event, local property prices should edge higher. That’s the upside for existing homeowners.
First time buyers, on the other hand, would lose out. Increasing Chinese investment could worsen housing affordability for many Australians.
Holding Chinese employment in check
Another concern surrounding China’s slowdown is that it’ll result in surging unemployment. That’s especially true of the industrial and commodity sectors. The worry is that such a scenario would add pressure to weaker consumer confidence and demand.
But Mr Baston says that alarms over this are unfounded. He says that, despite falling hours and wages, unemployment should remain stable.
Why? Because state-owned companies dominate these industries. And, being government-owned, they’re loath to unleash a wave of redundancies. That’s because the government worries deeply about social unrest. It prefers the masses remain employed, for obvious reasons. China has a history of social unrest. Steady employment is one of the ways it keeps protestors off the streets.
It’s no different in the private sector either. Wage cuts, reduced hours, and increasing holidays are the norm. That’s the preferred alternative to sackings in the private sector.
At the same time, this isn’t necessarily good for the Chinese economy. All it does is decreases China’s productivity. And it burdens the state with debts to keep unemployment low.
But with debts at 250% of GDP, Chinese policymakers have their hands tied. They don’t have the kind of space to manoeuvre that they did during the global financial crisis. Mr Baston explains:
‘Today, such a debt-fueled stimulus program is out of the question, given the high starting point. As things stand, the combination of very high total debt plus deteriorating economic growth will push up the level of bad debt’.
This isn’t promising for the Chinese economy in the long run by any stretch. If nothing else, it increases the debt load it has to take on keep the status quo in check. But it won’t help the Chinese economy at a time when its workforce is both declining, and ageing.
China might not be on the cusp of an economic meltdown, but its slowdown foreshadows a long term decline. That decline, however measured, has to weigh down the world economy.
Sadly, standing in the firing line of China’s slowdown are commodity-driven economies like Australia. Whichever way you look at it, China’s economy is the greatest threat to our way of life in living memory.
Contributor, The Daily Reckoning
PS: Chinese stock markets aren’t the only ones with clouds hanging over their future. The Aussie share market has a few dark clouds of its own.
The Daily Reckoning’s Vern Gowdie believes the ASX is set for a catastrophic crash.
Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s ranked as one of Australia’s Top 50 financial planners. Vern’s convinced the ASX could lose as much as 90% of its $1.8 trillion market cap. And that’s why he’s written ‘Five Fatal Stocks You Must Sell Now’ for you.
In this free report, Vern identifies the five companies which could destroy your wealth. It’ll surprise you to learn which blue chip stocks made his blacklist. And he’s identified one major commodity stock that could catch you by surprise. To find out how to download the report, click here.