Gareth Morgan says what China does with its surplus needs to change fast if it’s to stop fuelling capital flight

Gareth Morgan says what China does with its surplus needs to change fast if it’s to stop fuelling capital flight

By Gareth Morgan

Global stockmarkets are down 8% this year and China is fingered as the main cause of the drop.

People are rightly asking why.

Over the last 15 years I have started travelling to China frequently. In particular I went beyond the eastern seaboard and into central China and out to the western regions of the country. There’s been a constant takeaway from my trips: How do they continue to build highways, cities of apartments, airports and other infrastructure – that never appear to be busy or even utilised? The investment overhang has been a constant visible right through the super-cycle.

We always heard of patient capital, happy to invest for the long term; heard that because the State governments were the funders the rate of return wasn’t that important; heard that China’s huge investment/GDP ratio would be the key to its sustainability. But the reality surely is that even for a government, you can’t just keep building white elephants. At some stage all that outlay has to provide a return – somehow.

And so it is proving to be, in no uncertain terms. The finances of China’s various State governments are suffering from the type of debt overhang that characterised the global financial crisis in the West. Sure the central government can forgive the largesse and write off the loans, but unambiguously they couldn’t continue the building of empty monuments to economic progress.

China’s economic growth is still falling, signs of it stabilising remain hopeful. For all the countries that have banked their futures on China’s “engine room”, the economic chills remain very much in place. That is why Australia’s sharemarket is down 18% since April 2015, and why mining company BHP Billiton has lost $41b of value. Yes outward tourism, migration and capital flows from China’s super cycle will continue for a while, but without some stabilisation at home, they too must inevitably slow.

Economists have long talked about what needed – is a shift from investment to household consumption spending in the Chinese economy so the large investments of recent years can finally spit out some sort of return. But as layoffs of Chinese workers continue from all the infrastructure projects, quite the opposite is happening. Individual households – with the exception of those who made megabucks from doing the development projects – are tightening their belts. In Western economies the automatic stabiliser for such tough periods is welfare payments. China doesn’t have that mechanism – yet.

The official data says the economy grew over 2015 at 6.9%, a whisker below 2014’s 7.3%. Nobody believes the data of course, so we can expect ongoing official acknowledgement of the reality to reluctantly emerge over 2016. The data on orders, inventories and production just do not support the stats. Neither do the abandoned towns of the rust belt in China’s northeast.

My suggestion to people intent on getting a fix on the future of the Chinese economy is to go there. Travel beyond the eastern seaboard, see for yourselves the investment overhang. Then looks for signs that Chinese consumers are spending like nuts, instead of pulling back. Without that I doubt very much whether China can get up again – the old formula of “build and they will come” has failed. Ever the pragmatic people, I don’t see them trying to rekindle that formula again.

There is nothing like a crisis to galvanise action – at last 2016 may see more urgency given to stimulate household spending. The move to a two-child policy certainly won’t cut it in the short term, and raising wages is for now a mitigation only. More demand side measures are urgently required if households are not going to join further with the contracting spiral. That means putting money in the hands of households by any means necessary; more than just wage rises, they need to loosen access to credit, and create a welfare system. These things would help reduce the obsession of Chinese households with saving, and get them spending instead.

Rather than government and its agencies having all the access to the financial flows from China’s export success, households need to be able to express their confidence by direct access to credit on the same terms. So long as the central bank allocates credit with such a heavy hand, that just cannot happen. The formula isn’t hard, China still has massive foreign reserves, it still runs a surplus. It’s what it does with the surplus that matters – and that needs to change fast, if it’s not all going to just fuel capital flight.


This article was first published on his blog, Gareth's World. It is here with permission.

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Isn't your purported layoffs of construction workers the direct result of your suggested solution? ie Less white elephants.
To change the culture of the public from one of saving to one of spending is not something which would change appreciably in one generation. These sorts of behaviours are deeply ingrained, initiated at times when things were very uncertain. eg During/ after the war.
You can say that increased access to credit/ welfare would get people spending.
I myself wouldn't bank on it happening quickly. Their sharemarket greed/panic will not help.
As I say, in my view, major things like that would take multiple generations to change.

Like a giant super tanker takes time and distance to make a change of heading.....same applies to China, problem is during this redirecting process the water close by becomes very choppy and can sink small craft, furthermore the giant bow wave / wash flows out huge distances ......slip the life jacket on and grab for the emergency supply pack. Good luck.

Why aren't we getting a piece of this?

Arbitraging - buy it locally, ship it to China, 350% profit

Profitable business - where is the profit being made?

Baby Formula, Honey, Vitamins, Pet Food
http://www.smh.com.au/business/retail/government-powerless-to-stop-daigo...

Cherries and fresh fruit
http://www.theage.com.au/business/retail/chinas-daigou-army-plan-fresh-a...

I don't know: when I was in Shanghai recently, everyone and locals were filling restaurants and shops were busy until late at night.

Credit and welfare as solutions.. Solutions to dependence.

Is it a solution to 'move to a consumption economy' ? Why is that good ? Has Gareth taken to repeating an ill thought platitude?
Sounds like those caged rats on the treadmill. The wheel might look busy in a satisfying way, but what's the advantage to the rats or anybody else.

I believe the "consumption economy" is a myth - Manufacturing Matters, even in the US - Read more

On the other hand, Gareth talks a lot of sense about going to see for yourself. Nothing like walking around to test the reality.
In the movie, "The Big Short" the traders got on a plane and went to see some of the Florida housing which secured the debt. Found streets of empty houses, complete with alligator in an abandoned pool.

Both your points are valid. Much of the western worlds economies are based on established economic theory. Much of this theory is like a half truth. the problem is figuring out where the truth stops and the lie begins because the data can be confusing. Also much of it comes from vested interests -people too invested int eh current models to be able to admit that they may have got it partially or wholly wrong, hence the current mess of uncertainty and instability. It has also led to desperate, ill advised attempts to patch the holes in the leaking boat (QE, China trying to shore up its markets).

In essence, the PBOC has opted to synthetically shut down the banking system in China, as if the New Year holiday were to be started early and on central bank time. That provides us with the first clue as to the nature of what is taking place globally connected to China via “dollars” – if you have to shut down your banking, you are several steps beyond the ordinary.
http://www.alhambrapartners.com/2016/01/28/fundamental-and-finance-reall...

What Gareth ignores is that China (like his chums, the Kims next door) is ruled by murdering communist tyrants. And their greatest fear is that if enough chinamen are laid off building concrete things that nobody wants, get hungry and become militant, there will be another revolution to throw off their communist yoke to gain freedom and the Rule of Law. They are trapped in a ever tightening noose.

It is rather rare of a revolution to end in the rule of law Ergophobia, rather it typically culminates in chaos, bloodshed, and all manner of atrocities. The so-called American Revolution was a singular political event, and less a civil uprising, and more of an armed transfer of sovereignty from the British Crown, to the well-established independent colonial popular assemblies.

Chinese investment in other countries does little to improve the wealth of those countries. Nearly all Chinese money is invested in existing real estate, farms and businesses.
They do not start up new businesses or create jobs. Their capital is unproductive and they employ mostly Chinese workers.
In fact, their capital does a lot of damage to an economy by creating inflation in assets, something we do not need.