China: A New Level Of Concern – Rebalancing Is Not Working

As you know, printed above, the China’s transition to a more balanced economy has been one our major macro themes, as laid out in our 2016 Macro review. Success or failure on transition has implications for asset classes across the globe. Based on the latest information, it seems a successful rebalancing is in major jeopardy. Desperation is in the air, it seems.

Chinese leaders are adding more debt in attempt avoiding the pain of vital rebalancing of their economy. They are adding more risk, increasing the probability of a serious financial crisis, for the short-term benefit of keeping the existing growth model afloat.

“Bank loans are at a record high, monetary policy has shifted to a “slight easing bias”, reserve requirement ratios have been cut, eight government ministries have pledged to support the industrial sector and down payment ratios and taxes have been reduced in the real estate sector,” according to the Financial Times. 

We already knew about the massive overcapacity in a world of stagnant aggregate demand.  The new piece of information we didn’t know was the Chinese services sector—the place expected to pick-up the slack from the morbid capital investment growth model—is floundering.

Professor Michael Pettis has been way ahead of the analyst curve on China, pointing out growing enormous imbalances years before others starting recognizing the problem. Prof. Pettis has written books on the subject, I have read them. The risk flowing to the global economy if China’s transition goes right are real and many; but if the Chinese leadership gets it wrong, it likely means a severe financial crisis will be unavoidable.

Part and parcel to the success China making the much needed transition i.e. rebalancing to more domestic sourced growth, away from the capital investment-cum-export model, was predicated on the transfer of wealth from the government to the household sector no matter what GDP was reflecting. In other words, even a successful transition will push GDP growth down into low single digits, but as long as Chinese consumer income was growing, China could make this transition with minimal domestic unrest.