The Bear Case for China Sees PBOC Following Fed to Zero Rates

  • Fathom says authorities will have to weaken yuan by 25%
  • China's main rate seen falling to zero by former BOE economist

Danny Gabay “bows to nobody” in his pessimism about China’s economy.

Gabay, a former Bank of England economist, says the world’s second-biggest economy is barreling toward a hard landing. He and colleagues at Fathom Financial Consulting Ltd. reckon its growth rate has slowed to about 3 percent a year -- less than half the official estimate of 6.9 percent for the year to the third quarter and the 6.5 percent the government is aiming for over the next five years.

That means desperate measures are in store, he says. The People’s Bank of China will eventually follow its western counterparts by cutting its benchmark interest rate to zero from the current 4.35 percent and begin buying assets. Politicians will ease fiscal policy and step in to support banks.

By cutting so deeply, the PBOC’s main rate will next year fall below that of the Fed for the first time since 2001. It has already lowered its benchmark six times in a year and devalued the yuan by 3 percent against the dollar in August.

“They will try to do it stone by stone, step by step,” says Gabay, a director and co-founder of Fathom.

The authorities also will need to let the yuan slide further, probably by between 2 percent and 3 percent a quarter for the next two years and ultimately by about 25 percent overall to stop it from choking the economy even more.

“The rope the Chinese have is currently around their neck and they need to let it go,” said Gabay. “It’s going to hurt.”

Fathom’s case conflicts with that of Ma Jun, the PBOC’s chief economist. He said on Tuesday that some market participants are “too bearish” on the economy, where a recovery in property sales alongside recent stimulus should support expansion. The PBOC has repeatedly said it won’t need to do quantitative easing.

Underpinning Gabay’s pessimistic view is his argument that China is no special case and that its policy makers are no better equipped that those elsewhere to prop up a faltering economy. Like the U.S. and U.K. before it, China needs to face life with excess debt.

China’s total government, corporate and household debt load as of mid-2014 was equal to 282 percent of the country’s total annual economic output, according to McKinsey & Co.

“They will be no more adept at stopping an asset price bubble from bursting than the rest of us,” said Gabay.

Perilous Ground

Its banks are now on perilous ground with non-performing loans totaling more than 20 percent of gross domestic product, more than the level witnessed in Japan in the 1990s before its economy entered deflation, according to Gabay.

“We haven’t yet had the final shoe drop,” he said. “There could be a larger further fall in Chinese activity if we’re right and the banking system implodes.”

Gabay and Fathom have been repeatedly downbeat on economic outlooks since the global financial crisis of 2008. They correctly predicted in 2014 that the European Central Bank would resort to quantitative easing in 2015. They began this year bucking the consensus by saying the Bank of England would end it having not raised interest rates.

The idea that Beijing can rebalance its $10 trillion-plus economy from investment and export-led demand to consumer-led growth also draws short shrift. Fathom data from seven previous Asian investment booms show three years of stagnation followed as bubbles burst and other drivers of growth fail to materialize. By contrast, Nobel laureate Michael Spence said in a speech in Beijing on Wednesday that the baton is being passed from investment to consumption.

The good news is that China’s woes may not infect global demand, according to Gabay, who argues the world economy has soldiered on even with China’s growth rate halving and points out it did so in the 1990s even when Japan slumped. Where it might hurt is in adding another weight on international inflation.

— With assistance by Enda Curran

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