In the last thirty-odd years, China’s economic growth has been
the fastest sustained improvement the world has ever seen. To be honest, I’m
not entirely sure how the statisticians can measure that, but I guess we can
all agree that it’s been an astonishing performance to go from the closed,
somewhat ramshackle product of war and revolution to today’s gleaming economic
superpower. The key change was probably brought about by the partial
introduction of so-called ‘free-market’ reforms during the 1980s, but the huge
increase in credit in the wake of the 2008 crisis has also had a major effect
in shaping what we can see today, most obviously on the eastern seaboard but
also in the glittering expansion of some of the other old industrial cities.
Everybody connected to the metals business is for sure aware
that the appetite this growth created for raw materials has been the most
significant driving force of the boom in commodity prices. Miners and traders
enjoyed a golden period, which, with little more than a hiccup, continued
despite the crisis in western economies caused by the credit crunch. It’s been
good for us all, but are the fault-lines becoming just a little more obvious?
Credit-Driven Boom
What’s been achieved, particularly post-2008, has been built
on the back of a soaring amount of credit. Seeing the crisis posed by western
bank problems and failures, the Chinese Government’s reaction was to use its
large state-owned banking sector to make loans to stimulate growth through
infrastructure and property development. That’s resulted in the construction of
lots of airports, lots of metros, lots of apartment blocks. Anybody who has
been there – in fact, anybody who has watched TV – has seen them. While the
credit taps remain open, it’s all systems go. Problems arise, though – at least
potentially, so far – because those taps actually can’t remain permanently
open. If the growth of credit year-on-year exceeds the growth of GDP, basic
economic logic would suggest that the position becomes untenable. And that’s
what has been happening. Despite seeming conspicuous consumption by Chinese
visitors to Europe and the US (think London property purchases), the domestic
Chinese economy remains still seemingly tied to its export-driven base; without
domestic consumption driving GDP to grow faster than credit, the lack of
balance remains. Credit has fuelled property speculation but that in itself
does not increase consumption in the economy. Neither is it by co-incidence
that so much gold has been sucked into China – gold is a solid store of
value, and its attractions are not lost on Chinese investors.
'Shadow' Finance
During 2013, the Government – who one has to believe do
understand what is happening – have several times tightened credit, with the
result that short-term interbank rates shot up. That’s a sign of fragility,
mitigated to an extent by the growth of the so-called ‘shadow’ banking sector.
That sector is now responsible for a growing share of the credit market in China,
facilitating some quite strange operations. We know there is a glut of steel
production in China,
and yet iron ore imports do not seem to be suffering commensurately. One reason
is the use of iron ore as collateral. The trade is to buy iron ore with a term
letter of credit, sell the ore spot and invest the proceeds in the property
market in the expectation that rising property prices will produce an
attractive return before the original loan (via the L/C) has to be repaid. Now,
I’m very cautious of criticising other peoples’ dealing strategies, but I don’t
think that’s a particularly smart trade. You begin by buying a raw material
whose end-product market is in over-supply, and you use the money you generate
from the loan to invest in a sector which is also suffering oversupply. Not
only is the property market showing signs of over supply, but anecdotal
evidence suggests that a disturbingly large proportion of the loans originally
taken against property are ‘non-performing’ – i.e., bad.
Bubble?
To me, this has all the signs of a fairly well-developed
bubble; the bit I’m not clever enough to see (sadly) is the time-scale over
which it will play out. It’s all there, though; huge indebtedness which a
Government tries to reign in, with credit nevertheless growing faster than GDP,
a shadow finance sector facilitating somewhat irrational investments (it’s not
only iron ore, that’s just my example), newly-built properties standing empty,
and conceivably not worth the loans outstanding on them, and a voracious
appetite for gold.
In the words of Blood, Sweat and Tears (‘Spinning Wheel’,
1969) "What goes up, must come down". And yes, I do know they were neither the
first nor the last to say that.