In this report we discuss the outlook of the Chinese economy across a number of key parameters: re-balancing the economy, the current account/exchange rate and the risks stemming from rapid credit expansion.
The central thrust of our argument is that China will not conform to the world’s expectations of rebalancing; its demographics ensure this. China will only become increasingly dependent on exports and foreign asset income to achieve aggregate growth. China will not be able to run a sustainable external deficit to smooth out global imbalances. In the near term we are also wary of a brewing credit bubble. Official data are notoriously unreliable in China, but the explosion of debt used to kick-start the economy after the Great Financial Crisis in 2008 was unprecedented. As old debts mature, borrowers are struggling to repay them.
The stock of money measured by M2 stood at just shy of 180% of GDP in 2013. This is more than twice the comparable ratio in the US and paints a disturbing picture of the amount of credit that has been pumped into the Chinese economy. In a command economy, any credit bust will take time to play out, but the main risk in our view is that the Chinese government will allow some of the most vulnerable small and midcap financial companies to fail. In this report, we show who we think some of these companies will turn out to be.
Finally, we think the CNY is overvalued. The current account is likely overstated and China may not retain its balance of payments twin surplus forever. China may even become a net seller of US Treasuries to smooth currency fluctuations. This would have wide-reaching consequences for global asset markets.
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