Why China Will Disappoint the Pessimists Yet Again
China’s eagerly anticipated “hard landing” hasn’t happened yet, and recent indicators make me wonder (not for the first time) if it ever will. In the past two months, the Chinese economy has actually shown signs of accelerating.
Constant pessimism in financial markets about the country’s prospects is only partly guided by economic analysis. There’s also the faith-based view that growth as rapid as China’s simply can’t go on -- and that a non-democratic country really shouldn’t expect to prosper. Many skeptics have been highlighting China’s impending collapse for almost as long as I have been following the country. Maybe the skeptics should be viewed a little more skeptically.
By the end of this year, China’s gross domestic product will be roughly $9 trillion, making its economy comfortably more than half the size of the U.S., and half as big again as Japan. I recall once projecting that China might be as big as Japan by 2015. The country’s far ahead of that optimistic schedule.
China’s economy is already more than three times the size of France or the U.K., and half as big again as Brazil, Russia and India combined. Of the four BRIC countries, China is the only one to have exceeded my expectations. The other three have done less well than I’d hoped.
As I mentioned in a previous column, China is in effect creating another India every two years -- making a mockery of those who’ve argued that India’s democratic model is more likely to deliver long-term economic success. China is already more than four times bigger than its southern neighbor. India’s economy won’t rival China’s for a very long time, if ever.
With GDP growth of 7.5 percent, inflation running about 3 percent, and a currency that’s rising gently against the dollar, China is adding about $1 trillion a year to global GDP, easily boosting its share of the total.
For many analysts, none of this is enough. According to a popular refrain, China might have staved off disaster in 2013 and papered over the cracks yet again in the short term -- but next year (or maybe the year after), the crunch will come. Supporting this notion is a question I’m asked all the time: If China’s doing so well, how come everyone always loses money investing there? Let me explore both issues a bit further.
It isn’t clear to me why China’s economy must deteriorate next year. China’s slowdown to its current 7.5 percent growth rate was well signposted by a sharp slowdown in leading indicators. Those measures, including monetary growth and electricity usage, are no longer flashing red. Coincident indicators such as the monthly purchasing managers’ index have picked up. Unless you believe that China is somehow doomed to fail, these signs are encouraging. They suggest that the rest of this year and the first part of 2014 might see slightly stronger growth.
The more resourceful pessimists next argue that the better growth signals are coming from parts of the economy where growth is unsustainable -- such as the urban housing market and government-directed investment -- from excessive growth of credit extended by shadow banks, and not from a broadly based expansion of consumer spending. If this were clearly the case, I’d be a pessimist, too, because a buoyant China needs consumers to take the lead.
Data for monthly retail sales suggest that consumption has held up well despite the fall in the trend of industrial production. I closely follow the trend of retail sales, adjusted for inflation and relative to the trend of industrial production, and though not moving in a straight line, this indicator has been generally rising for three years. This is a pretty good sign that the rebalancing China needs is happening. Another is the decline in the current-account surplus to about 3 percent of GDP.
Reducing the external surplus from more than 10 percent of GDP before 2008 to about 3 percent now -- while limiting the fall in growth from 10 percent to about 7.5 percent -- is quite an achievement. In my view, the “unsustainable” component of China’s economic prospects was the current-account surplus, not the growth rate, and the needed adjustment in the surplus has been achieved.
What about investors losing money in China? How can that be, if the economy is doing pretty well? It depends on how you measure investors’ returns. True, passive investors in the Shanghai index have suffered since 2007, despite a big rally from late 2008 through late 2009. But how many investors invest that way? More important, the Shanghai index is dominated by past winners in the China growth story. If China is rebalancing -- moving away from exports, improving the quality and sustainability of its growth, depending less on government-backed companies -- then the winning investments will be quite different than before.
It’s revealing that the Shenzhen index is performing much better than the Shanghai index, thanks to its greater exposure to newer, smaller, private companies. There’s a more general point here: When a country is embarking on a significant compositional change to its economy, stock-pickers rather than index-trackers have the upper hand. The same logic applies to foreign companies trying to benefit not just from China’s ongoing growth but also from its new drivers of growth. No doubt this is a little simplistic, but Apple Inc. (AAPL) or Procter & Gamble Co. (PG), say, are likely to benefit more in this economic environment than Caterpillar Inc. (CAT)
If you ask me, China’s economy hasn’t finished impressing the world with its strength. The changing foundations of that strength may make the prospects harder to read -- but the fact that the underpinnings of Chinese growth are indeed changing is all to the good.
(Jim O’Neill, former chairman of Goldman Sachs Asset Management, is a Bloomberg View columnist.)
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