Key highlights from our recent interview with Worth Wray, Chief Economist at Evergreen GaveKal. Log in and visit our Newshour page here for full audio.
China’s economy not collapsing
"The story in China has evolved pretty dramatically in the past few months...and what are the odds of where does China go from here? What's the risk of a hard landing vs a stagnation over time…? I think that those odds have shifted here. So, with the stock market collapsing—it's important to keep in mind that China's economy is not collapsing today—a lot of people have suggested that but I actually don't see it in the figures that I watch. A good friend of mine, Leland Miller [see interview with Leland here], runs a service called China Beige Book, it's about a hundred thousand dollar service and it's difficult to get your hands on but it's one of the primary services...to understand what's really happening in China. What we're seeing is that there is a slowdown, it's been happening for a while...it's becoming very disruptive in the emerging world. We're starting to see it have a big impact on commodity prices as well but China's overall growth level isn't collapsing.”
Real issue: Massive amount of bad loans made over the years
“The real issue here is that China has accumulated a large amount of debt in recent years. If you look at China's overall debt levels, it's still nothing like what you see in the United States, or Europe, or Japan for that matter, but the burst in credit growth that you've seen since 2008—one of the fastest periods of credit growth in the last 50-60 years anywhere in the world—what we know is that these quick bursts tend to lead to high levels of non-performing loans or bad debts—it's really difficult when you're talking about big fast credit booms to do the kind of underwriting you need to make sure that those loans are made wisely.”
China tried to solve debt problem by blowing a stock market bubble
“[W]ith what I think could be as much as 5 trillion dollars in bad debts in China in a 29 trillion dollar banking system that has expanded in a dramatic fashion, China needs to manage that debt problem and the equity bubble was an attempt to try to have their cake and eat it too. So rather than embrace a slowdown and allow widespread bankruptcies, to allow state owned enterprises where government officials had rather large financial stakes in their future to fail, what you saw is that the authorities in Beijing actually encouraged an equity bubble to form: they encouraged margin lending; they encouraged their own people to pile in; and it got to the point at the early summer where there were over 90 million people—Chinese citizens—investing in the market. That's a larger number than the size of the overall Chinese Communist party that comes in about 85 million. They certainly got widespread participation in the rally.”
Global investors didn’t participate
“The problem with [the stock market bubble] was that it was not sustainable unless foreign capital came in. There's a narrative that MSCI would soon include A-shares in its index and that capital would come pouring in from the rest of the world. We found out pretty quickly that the MSCI said it wasn't time and it didn't take long for the markets to crater.”
China’s response to market crash made matters worse
“I thought that Beijing would step in a more powerful way; I thought they might devalue their currency rather than let the market fall and I've got to tell you that I'm surprised as anybody to see the way that Beijing intervened over the summer. They showed their true colors. They showed that China is not a market-oriented economy. They showed that in China the markets are only decisive when they are going up and when they run parallel to Beijing interests but when markets are crumbling and working against Beijing's interest and eroding Beijing's credibility, Beijing is ultimately going to be decisive. We saw everything from banning of short selling to actually forcing outright sales to forcing firms to pull their assets together to intervene in the markets. It was really interesting how it went down and I think it did a dramatic amount to erode investor confidence in China. Not just in the China growth story but in the safety of assets going into those markets.”
China now running short of options
“I'm afraid that Beijing came in with their devaluation a little bit too late to boost the markets and instill any kind of confidence. Instead they ran money off. This is really important because if you think about it the equity market was a major element of Beijing’s restructuring plan. What they needed to do was blow this big equity bubble domestically, attract a lot of foreign capital in, that would allow their over-leveraged debt burdened companies to sell bad assets—spin bad assets off into the market by issuing equity—and be delevering those firms. With the stock market now crashed and Beijing's credibility now severely eroded, they don't have that avenue anymore and I'm afraid the options for Beijing are dwindling. Either they intervene in these markets overtime; ether they backstop the debt problems that are brewing or a crisis could be on the horizon.”
Long-term strategy: New Silk Road
“I'm in the camp that thinks that a crisis overall is unlikely because I think that overtime that Beijing will step in and will backstop it and that's why I think the chances of stagnation go up dramatically over the medium and over the long-term. The one thing that may get China out of this whole mess knowing that if they do everything internally that they can right that they still probably stagnate is the "One Belt, One Road"—building the new Silk Road connecting China to Europe, trying to develop all of the poor underdeveloped countries that lie in between those two vast markets and that may help their growth model overtime, it may boost their growth rates. But we're talking about something 10,15 years down the road if it works with Beijing having to do a lot of deficit spending along the way. So the important takeaway here is that China isn't collapsing but Beijing's credibility and their options are. The odds of stagnation are rising and I think rising pretty fast.”
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