Friday, September 23, 2011

Will China’s bubble burst as global economy slides?

There are rising concerns that the global economy is heading for a down-slide and that implications will be far more wide reaching than already seen since the 2008 recession.

There is a particular focus on China's economy which is beginning to show signs of a decline. This week, the International Monetary Fund scaled back its projections for GDP growth in China, and an HSBC flash purchasing managers' index projection fell below 50 for a third-consecutive month, driving markets down and feeding fears that even the world's second-largest economic engine will not be able to help drive the global economy.


"China is a kind of barometer for the world economy, so [slowing] in the Chinese economy does spell, at least in the short term, a weakening of global demand," says Li Wei, a professor of economics with Beijing's Cheung Kong Graduate School of Business. "Countries [that were] largely pulled by the Chinese demand out of the last recession, with China weakening, cannot rely on China being the locomotive for growth any longer."

The IMF has cut its forecast for China's GDP growth slightly for this year, from 9.6% to 9.5%, and lowered its 2012 forecast from 9.5% to 9%. Although the numbers are still enviable, and above the 8% policy target outlined by Chinese leaders earlier this year, the slip coincides with evidence that China's manufacturing industry is slowing [Globe & Mail].

The preliminary HSBC China manufacturing purchasing managers index fell to 49.4 in September from a final reading of 49.9 in August, HSBC Holdings PLC said Thursday this week. A reading below 50 indicates contraction from the previous month, while a reading above 50 indicates expansion. Such a decline in the PMI could reignite some concerns over a sharp economic slowdown in China, due to weakening global demand for Chinese goods and various tightening measures at home [WSJ].


Such a decline could have wide ranging and far reaching effects. The Australian dollar, which is sensitive to Chinese demand for Australian commodities, slipped after the data were released, falling below parity to the US dollar for the first time since August 8th.

Asian stocks in turmoil

Stocks of Asian companies trading in the United States also fell sharply Thursday after the preliminary report on China's manufacturing activity. The BNY Mellon ADR was down 4.22%, while the BNY Mellon China Select ADR, which focuses on Chinese companies, was down 5.1%.

Shares of some individual Chinese companies that trade in the US also fell. Solar-module maker Trina Solar Ltd. saw its stock fall by 45 cents, or 5.8 percent, to $7.30. Shares of Internet search company Baidu Inc. fell $15.33, or 11.1%, to $123 and coal producer Yanzhou Coal Mining Co. Ltd. dropped $2.73, or 11.2%, to $21.61. Inc. also fell $1.56, or 9.6%, to $14.65.

Across the Asian stock indexes there was also a strong indication of uncertainty and concern. The Japan's Nikkei 225 closed down 2.1% while South Korea's Kospi slid 2.95 and the Hong Kong's Hang Seng falling 4.9%. And in mainland China, the Shanghai Composite Index fell 2.8% to close at 2443.06 [Business Week].

The reaction in Asia was not just down to the HSBC assessment of the Chinese manufacturing industry however. This week the Federal Reserve warned of major risks to economic growth which increased concern amongst investors around the world. US stocks suffered their worst drop in a month overnight after the Fed's cautious comments [CNN], driving investors to buy the US dollar as a safe haven. And a weaker euro dragged down export-related shares, with Honda Motor leading the losses, falling 3.9% [RTT News].

While the US and European economic situation was a major factor affecting financial markets, China was a focus of many analysts. "Further indication of contraction in China's manufacturing sector is clearly not helping," Deutsche Bank analyst Colin Tan said [CNN]. 

John Higgins, senior markets economist for Capital Economics, said that the slowdown in manufacturing in China was a worry given the importance of China's role as the engine of global growth as the world came out of the 2008 recession. "There is a broad brush concern that even if the Chinese economy is not shrinking, it is slowing, and that slowing is bad news for the rest of the world," Higgins said [CNN].

But the long term effects may be even worse than some are predicting. A paper published last year points to China's economic bubble bursting with dire consequences, not only for China but for the rest of the world.

Risks of a China bubble burst

In a Symposium of Views [PDF], a report compiled by International Economy based in Washington, experts across a wide field aired their views on how such an economic decline in China might affect both China and the world.

The opinions are mixed, but there was a general consensus that such a scenario would not only affect China. Maya Bhandari, Head of Emerging Markets Analysis at Lombard Street Research, said that surrounding export hubs would be affected, with global growth hit significantly.

Tadashi Nakamae, the President of Nakamae International Economic Research, also painted a bleak picture saying that many foreign investors would be particularly hard hit. "China has created a bubble in its productive capacity that is even more dangerous than its asset price bubble. The former is the inevitable result of over- investment in capital expenditure and building an export-led economy," Nakamae says. "When capital investment is booming, say, when steel factories are being built, this itself creates extra demand for steel that cannot be sustained, especially once the factories become operational and become units of supply rather than demand. China is a typical case of a capital investment-led boom-and-bust economy."

"Expansion of investment is mainly supported by exports. Once exports start deteriorating, economic growth halts. Exports decline, as does capital investment, leading to a sharp drop in overall demand. It becomes increasingly clear that the country [China] has huge over-supply in capacity. Prices decline and a deflationary recession develops," Nakamae suggests.

And he drew analogy to past history. "Immediately after Lehman Brothers collapsed, China's nominal GDP growth rate fell from its peak of 24% in the fourth quarter of 2007 to a mere 3.6% in the first quarter of 2009. Its GDP deflator fell from 12.3% to a negative 3.7% in the same period. The Chinese government tried to deal with this by stimulating bank lending, mostly for infrastructure projects by regional governments. Banks also lent a considerable amount for speculative real estate investments. The problem with regional governments using bank lending rather than tax revenue to finance public works projects is that these do not create a return on investment. Servicing the debt is all but impossible, leaving banks holding potentially enormous bad loans on their books."

He also points to Beijing's inability to control the certain parts of the economy. "While China's asset price bubble is worth monitoring, its capital investment-led boom and bust is far more dangerous, and this looks to be already beyond the control of its central authorities," Nakamae warns. "This will have far- reaching negative effects globally, but the biggest victims will probably be foreign companies already invested in China. If the collapse is sudden, the Chinese government should guarantee the property and all other assets of foreign companies leaving China."

While Chinese authorities have accumulated vast reserves Chen Zhao, the Chief Global Strategist and Managing Editor for Global Investment Strategy at the BCA Research Group, warns that a bursting China bubble would be a "massive deflationary shock to the world economy."

Threat to Beijing

There are some who believe such a situation would also be devastating for the Chinese leadership. Marshall Goldman, a Senior Scholar at the Davis Centre for Russian and Eurasian Studies at Harvard University, suggests that the Chinese themselves would be the most affected. "Both domestic and foreign investment in China would suffer and result in a sharp drop in production and employment. That in turn might have domestic political consequences, possibly resulting in a governmental upheaval." It is an opinion held by Gary Hufbauer, a Senior Fellow at Reginald Jones of the Peterson Institute for International Economics.

"Collapsing Chinese asset values would devastate China and many millions beyond the Middle Kingdom," Hufbauer asserts. "Hardest hit would be party leaders in Beijing. It's questionable whether the technocrats could survive a 50% drop in property values."

But he too also warns of wider affects. "Beyond China's own borders, manufacturing supply chains across Southeast Asia and commodity producers from Australia to Brazil would all take a drubbing. A new aphorism is born: China sneezes, its partners catch pneumonia."

Others might benefit

However Hufbauer speculates that some economies might benefit if China floundered. "Perhaps the biggest beneficiary would be India. Lower oil and raw material prices, openings for its manufactured exports, and a burnished reputation for growth and stability."

Ernest H Preeg, a Senior Advisor for International Trade and Finance for the Manufacturers Alliance/MAPI, also believes India would be the biggest winner. "The biggest net gainer would be India, with relatively small exports of manufactures and business services to China at risk," Preeg says. "India would emerge touted as the new  number-one high-growth emerging market, with balanced and therefore sustainable 8–10% growth, which would attract increased foreign investment, in part at Chinese expense, to reinforce its new status."

US-China ties at risk

China might also see tensions in its relationships with other countries, should its bubble burst and its economy took a serious down slide. Bowman Cutter, a Senior Fellow and Director within the Economic Policy Initiative at the Roosevelt Institute, and former Managing Director of Warburg Pincus, says the United States' relationship with China could become particularly strained. "The most important consequence of a major "China Bust" would be an almost inevitable political and economic crisis in the China-U.S. relationship," Cutter says.

But he says such a major economic and financial crisis in China would have to be on a scale such as that seen in the US since 2008. Such a crisis is "extremely unlikely" Cutter maintains.

Nonetheless, it is clear that China is beginning to feel the affects of the economic problems that are increasing in Europe, Britain and the US. Some believe that if the situation worsens China could even become hostile [Financial Sense] though such prospects again are also highly speculative.

Interconnected world

IMF Managing Director Christine Lagarde today spoke of an "interconnected world" and called for countries to come together to solve the economic crisis and prevent contagion spreading from areas such as Greece and other vulnerable regions.

The G20 has vowed to tackle the economic crisis [Bloomberg] and leaders across Europe have called for action. But there seems to be little resolve nor a definitive response.

Uncertainty raises fears

Despite G20 assurances, shares once again took a battering in Friday's trading [BBC]. Negativity concerning weak global growth from the International Monetary Fund and the World Bank knocked sentiment further. On Thursday, IMF head Christine Lagarde said the global economic situation was entering a "dangerous place", while World Bank president Robert Zoellick said he thought the world was in a "danger zone".

British PM David Cameron has warned any failure to act swiftly over the Eurozone's debt problems would "lengthen the shadows of uncertainty" looming over the global economy. In a speech to the Canadian parliament, Cameron called on European nations to show they had the "political will" to "do what is necessary".

"Endlessly putting off what has to be done doesn't help, in fact it makes the problem worse, lengthening the shadows of uncertainty that looms over the world economy," Cameron said. "We are not quite staring down the barrel, but the pattern is clear, the recovery out of the recession for the advanced economies will be difficult," he added [Sky].

China's economy 'still strong'

There are those who think that China, despite its fall in productivity, is still in a position to bail out ailing economies [BBC]. For its own part China remains upbeat despite the International Monetary Fund lowering its estimate for China's growth for 2011 and 2012. Data from the People's Bank of China on Wednesday suggested financial institutions' yuan positions had a net gain of 376.94 billion yuan [$59 billion] in August, 72% more than in July and the biggest increase in five months. The numbers suggested a surge in flows of speculative capital into China as investors bet on the nation's growth and prospects for gains in the yuan an article, published by Xinhua, claims.

The uncertainty and pessimism over financial markets is likely to continue for many months to come, not only in the Eurozone, Britain and the US but also China and economies further afield.

tvnewswatch, London, UK

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