China is changing in a way that will soon make us forget about the old economy
Growth in the online economy is heating up, raising concerns of another capacity bubble in the making
There is an expression in investment circles that no one qualifies as a macro-trader until they have lost money shorting the Japanese bond market. The trade never worked even though it seemed obvious that Japan, with it combo of massive debt and anaemic growth, was heading for a bond market meltdown.
Given that definition, Kyle Bass, the Texas hedge fund manager, qualifies as a bona fide macro trader. He long predicted doom for Japanese bonds, a call that clearly didn’t reap him the gazillions he made with his bearish bets on US housing and euro-area debt.
Now his big bear call is Chinese banks. Will Bass make another killing, or will China turn out like Japan – an obvious disaster that is somehow always deferred?
The origin of China’s debt crisis has been endlessly dissected. After two decades of a rapid and stunning industrial build-out, the country became overly dependent on investment for growth, but was moving to correct those imbalances. Then the Global Financial Crisis hit and the leadership panicked. A massive credit expansion ensued, the type that history shows almost always ends in a financial sector crisis.
Yet strangely, betting on a financial crisis almost assumes China will do the right thing. Last year, for instance, Joyce Poon at Gavekal Dragonomics was hoping that Beijing would just face up to reality and write off bad debt, then start to rebuild by selling off state assets. Large-scale privatisation could then produce a burst of productivity gains and set China on a new path.
In recent research, however, Poon said she’d given up hope on radical policy solutions like this. Instead she expects Beijing to take the muddle-through approach, putting out fires in the sector as necessary.
Meanwhile, the property bubble and the debt-to-GDP ratio continue to inflate. This could set China for an even greater fall.
However the timing of a deferred disaster is famously hard to call. Bubbles are often talked about for years before they burst – remember when Warren Buffett gave up and pulled his money off the table during the long-enduring internet boom? The UK and Australian housing markets also seem crazily overvalued, yet refuse to blow, and Abenomics has chased Japanese bond bears high into the hills.
Despite heavy capital outflows and talk of a major devaluation, the Chinese central bank has managed, for now at least, to stabilise the currency. Meanwhile, the stock market has also settled into an uneasy normalcy after last year’s crash and confusing intervention.
If bad, China is still big. The country is seen as making up an expanding portion of a global equity universe in a world flush with excess savings and cheap money. Chinese companies still supply the world with the most initial public offerings, and this in turn has required that banks maintain a large infrastructure dedicated to Chinese securities.
On Wednesday MSCI will announce the results of its latest review on the inclusion of A-shares in its benchmark indexes, which are tracked by trillions of global investment dollars. So far MSCI has held off, citing concerns about closed shareholding structure and other “accessibility issues”, but this time around, analysts say the odds favour inclusion.
In a recent report that screened thousands of A-share company financials, Goldman Sachs reported that as a group, profits for domestically listed companies were flat in the first quarter. As in zero earnings growth. However, so-called “new China” sectors expanded profits by 26 per cent.
The chart, produced by Morgan Stanley equity analysts, illustrates the same dynamics. “Despite the recent slower growth environment, China’s economy is larger and more diversified towards consumption and services than is widely considered to be the case,” the bank said in a recent research report.
The hope for policymakers is that China’s new economy can take off robustly enough to offset losses in the old, industrial spheres. How to make that happen? Cheap money and new financing channels. Each new week, we learn of a new company that has just entered the sportswear sector, or acquired a mobile gaming company firm, or got funding for a digital food-delivery firm.
Which is why we may indeed be able to soon forget about the overcapacity in the old economy; if only because everyone will be too busy talking about overcapacity in the new.
Cathy Holcombe is a Hong Kong-based financial writer