'Malinvestment means China not growing fast enough to keep NZ, Australia immune from global stagnation, although NZ better placed due to food production'

By Alex Tarrant

China is not growing anywhere near the pace needed to keep New Zealand and Australia immune from the current economic quagmire as over-indebted economies deleverage and growth stagnates, one of the most outspoken "doomsters and gloomsters" leading up to the financial crisis says.

Satyajit Das, a former derivatives trader and now financial markets commentator based in Sydney, spoke to interest.co.nz's Alex Tarrant on TV3's The Nation programme on Saturday.

He believed New Zealand was in a better position than its Tasman cousin to stand up to global economic headwinds, as its economy was based primarily on food production as opposed to Australian reliance on minerals, demand for which was coming off the boil as Chinese demand slowed.

Malinvestment to the tune of 10% of Chinese GDP shaved most percentage points off China's headline growth of around 8% per annum. On top of that, a massive unwinding of European governments' debt-riddled balance sheets meant the global economy would be mired in a long period of no to low growth. That would make it difficult for those in power to hold together social structures which had been addicted to debt-fuelled growth, he said

Das also said the recent Libor scandal in the UK and US could be the catalyst for policy makers to finally move against the strong banking lobbies of Europe and the United States and re-regulate financial markets to force less risk-taking.

It was still difficult to tell what the full consequences and costs of the Libor scandal would be, although the likely vast size of the lawsuits to be brought against the banks involved would change investors' views on the banks, and would make it difficult for them to raise money, he said.

The problem

The global economy had tried to grow very quickly from the 1980s onwards using debt as an accelerant, Das said. While there was nothing wrong with using debt to grow the global economy, the problem was too much of it.

In the United States' economy from 2001 to 2007, half the growth was driven purely by debt, Das said.

“And today, China, on whom New Zealand and Australia and many other economies depend for their own growth, needs $6-8 of debt to create one dollar of growth," he said.

Global debt levels needed to be reduced over a long period of time. However, when policy makers realised the consequences of that in 2008 - "which is, you get locked into a period of economic stagnation with no growth, massive unemployment" - they blinked. Instead of the unwinding needed, debt was just switched from private balance sheets onto government balance sheets.

That unwinding had now begun in Europe, however.

“What you’re seeing in Europe now is a start of a massive unwinding of government debt, and I think what the world’s going to see is a period of deleveraging – a gradual run-off of this debt, which is going to take a very long time," Das said.

“The world is going to be mired, at best, in a period of very low, or no growth. And that’s going to have huge implications for investors, for companies, for governments, and basically the social structure. It’s very difficult for us to hold a society together which is addicted to growth to some degree, where we can’t grow anymore,” he said.

NZ not immune, but food production helps

Australia and New Zealand would not be immune from the global economic stagnation. Both countries had been very lucky in the first phase of the crisis when China inflated its economy with a massive stimulus package through 2008 and 2009.

“Now everybody thinks China’s growing, at say 8 or 9 percent. I’d question that. If you actually look at their growth, you have to look at how that growth is being created," Das said.

“To create that 8 to 9 percent, the government, through its state-controlled banks, is pumping in roughly 30-40 percent of what China produces every year in the form of debt. We all know something like a quarter of that is never going to come back," he said.

That was roughly 10% of China’s GDP disappearing due to malinvestment.

“Property’s part of it, but I’m not so worried about the property bubble. [It was building] bridges to nowhere, roads which go nowhere. That’s not going to produce. If you deduct the costs of those bad debts from the growth, they’re not growing anywhere near as quickly," Das said.

The world was relying on China continuing that level of investment and not having to unwind those burgeoning government balance sheets.

"I don’t think you can [rely on that]. I think we’re going to see the ripples from that storm in places like New Zealand and Australia," Das said.

“New Zealand less than Australia, because New Zealand isn’t a mineral producer. Australia relies on its iron ore and its coking coal, [New Zealand] relies on food stuffs, and people are still going to have to eat. It’s not all gloom and doom in that sense," he said.

European quagmire

Signs of stagnation were emerging in Europe that were going to be seen elsewhere.

“One is, it’s very difficult to solve a problem of debt with more debt. But more importantly, if you don’t have any money, what most people seem to miss in Europe is everybody’s shuffling the same money around in different ways. The only way you solve this problem is a massive injection of money, and there isn’t any," Das said.

While people were arguing that Germany and other well-off countries needed to take responsibility for keeping Europe's head above the water, "the fact of the matter is, defacto, all the debt has been mutualised and the Germans are going to suffer a catastrophic loss of wealth."

“Basically overall, Europe will have to muddle through. The best way to think about it is, it’s like a chronic disease now in Europe, and it’s going to be a chronic disease elsewhere. We can manage it, take a few aspirin, call [US Fed chairman] Dr Bernanke in the morning, and it basically just muddle along. But every once in a while you’re going to have a life-threatening emergency," Das said.

So what to do?

There needed to be some very controlled deflation of the debt bubble built up over the last couple of decades, Das said.

“But you’ve got to definancialise the system. We came to rely on financial engineering rather than real engineering to drive the economy. We’ve got to go back to the things that matter," he said.

Future growth had to come from innovation and productivity gains, rather than being based on debt.

“It’s not as if there’s a shortage of problems in the world to solve. You’ve got to solve the problem of feeding people, you’ve got to solve the problem of clean energy, you’ve got to solve the problem of things like water conservation. And one of the most important things that is neglected is essentially logistics. We actually have a lot of stuff which is wasted, because it can’t get to market. So there are a lot of problems to solve," Das said.

Finance had to be the hand-maiden, not the driver of that growth: “You cannot build a world on debt, and that’s what we’ve tried to do unsuccessfully."

De-risk

The problem was nobody seemed to want to address the need for change. Risk needed to be taken out of the financial system. In many cases risk wasn’t even the problem – it was outright fraud and manipulation of markets, as seen in the recent Libor scandal.

The banking lobby in the United States and Europe was so powerful they were preventing policy makers from acting, Das said.

“In the United States there’s a rule called the Volcker rule, which is designed to prevent banks from trading with their own money. But the problem is, the rule has been watered down and made so complex it’s 270 pages long. It’s got loopholes everywhere. I had a lovely conversation with a lawyer who said he’d be embarrassed if he couldn’t get his clients through at least one of the loopholes," Das said.

“So essentially we are not really making any progress. There’s a lot of activity, but I’m yet to see much achievement. Although recent events like the Libor scandal might actually galvanise people to do that. I live in hope," he said.

Das said he believed losses to the banking system, not from the fines, but the lawsuits over the Libor scandal would be colossal.

“If you actually look at it from the point of view of investing in banks, not so much New Zealand banks and Australian banks who are at the peripheries of this, but European and American banks, one of the fundamental problems you have is you don’t know how big these loses are going to be," he said.

“And at the same time they need obviously to raise money in different forms. It’s going to become very difficult and perhaps this will be the catalyst for what we call the de-financialisation, because people start to realise there’s not much point in running the banks the way they have been run in the past.”