While it’s well known that I’m a “China Skeptic,” I always go out of my way to highlight China’s enormous – and historically unequalled – economic gains over the past three decades.
In 1980, China exported about as much in a year as it did in a day in 2015. Its economy was roughly the size of Taiwan’s or the Netherlands’ economy at that time.
But in 2014, China’s economy grew about as much as the entire size of Netherland’s gross domestic product (GDP).
Much of this growth has taken place along China’s east coast, and has transformed its leading cities, such as Shanghai. Just look at the remarkable images below:
Image source: The Atlantic
But China’s economic model, built on a foundation of exports and investment in manufacturing and infrastructure, is no longer working.
And this is no ordinary slowdown.
Trouble in the East
The China Beige Book is blinking red, non-performing loans are spiking, and former Fed chairman Alan Greenspan recently commented, “China is slowing quite dramatically.”
This sentiment is based on cold, hard numbers. Hong Kong home sales tumbled 70% year over year in February, representing a 25-year low. China’s exports fell 25.4% in February.
President Xi Jinping’s greatest concerns right now are growing labor strikes, protests, and layoffs.
In 2015, strikes and protests doubled over the previous year to reach 2,700 incidents. So far in 2016, they’re on track to surpass 6,000.
Earlier this month, hundreds – if not thousands – of angry employees of the state-owned LongMay Mining Group – the biggest coal company in northeastern China – staged one of the most politically daring protests over unpaid salaries. They publicly denounced the provincial governor even as he and other senior leaders gathered for an annual meeting in Beijing.
Hebei province is set to close 60% of its steel mills, lose 180 billion yuan in revenue, and lay off over a million workers as it weans itself off heavy, polluting industries in the next two years.
Keep in mind that China needs to produce 15 to 20 million new jobs just to keep treading water.
In addition to labor issues, President Xi’s and China’s greatest threat is its emerging debt crisis.
My sources confirm that the Communist Party is holding the passports of senior leaders, and is now limiting foreign trips to one to two per year – indicating that the party fears members fleeing the country.
Banking System in Danger
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China is under acute stress, as debt is rising twice as fast as economic growth, according to China watcher and Beijing-based economist Michael Pettis.
Chinese banks continue to practice “extend-and-pretend” loans. And sources estimate that China’s banking system could suffer write-offs four times larger than U.S. banks incurred during the subprime crisis.
China’s shadow banking system is especially worrisome. According to UBS AG, it’s grown more than 600% over the last three years, and has been using off-balance sheet trust products to hide losses.
Some analysts estimate that China’s troubled credit could exceed $5 trillion, a staggering number that’s equivalent to half the size of the country’s annual economic output.
China’s financial sector will have loans and other financial assets of $30 trillion at the end of this year, up from $9 trillion seven years ago, said Charlene Chu, an analyst in Hong Kong for Autonomous Research.
In her analysis, Ms. Chu estimates that at the end of 2016, as much as 22% of the Chinese financial system’s loans and assets will be “nonperforming.” In dollar terms, that works out to $6.6 trillion in troubled loans and assets.
The recent arrest of Wang Bao’an – the Chief of the National Bureau of Statistics, and the man responsible for China’s 2015 GDP growth statistics – casts an even darker shadow of doubt upon the reliability of these numbers. Some refer to the unreliability of China’s statistics as its “Enron problem.”
Our sources report that China’s true GDP growth for the coming fiscal year may be as low as 3%.
From July 2015 to February 2017, its reserves fell $600 billion and dropped by almost $200 billion in the first six weeks of 2016. In addition, it’s estimated that of China’s current foreign exchange reserves of $3.2 trillion, about $2.2 trillion are liquid.
What does all this mean for you as an investor?
First, it sure makes America’s economic challenges seem more manageable – even in the “political storm” that’s passing as a presidential election.
Second, while China may be able to steady its ship, investors need to hedge their portfolios for a worst-case scenario, as well.
It seems to me that the establishment financial media has missed this important point – China has gone from being the global economy’s leading growth engine to its leading global risk factor.