If China were an equity, I would short it.
While this, at present, might come across as a bold statement, my stance on the nation is not entirely unfounded. There indeed are a number of issues with the Chinese economy, which might raise a few eyebrows.
Perhaps the most important concern for any investor looking to invest in the country is its demographics. Thanks to the one-child policy, the majority of the Chinese population is growing old. With fewer hands to work with, the world’s manufacturer has already started facing a labor shortage.
When I mentioned the same to a Chinese friend, he instantly rebutted by pointing out that the next chapter in the Chinese growth story was not manufacturing but consumption. He was of the view that a richer Chinese population had already transitioned from being the world’s manufacturer to the world’s consumer. He wasn’t wrong.
While I found his argument compelling at first, looking deeper exposed some glaring deficiencies. That which fuels China’s consumption is foreign investment- a staggering 48% of the GDP. The reasons for this investment are obvious- China’s manufacturing competence. But now that the economy has started showing signs of a slow-down the question to be asked is- will foreigners still keep on pouring the same amount of money in the economy? The answer is, no.
In light of the above observation, one thing is obvious. Less money being injected into the economy will translate into a fall in consumption. It seems that the Chinese will soon have to cut-down on their appetite for Rolls-Royces and Bentleys. Moreover, with a 3.2% inflation rate, it is implausible to hypothesize that QE would provide relief to the economy any time soon.
Ruchir Sharma, the head of emerging market equities at Morgan Stanley has a name for this phenomenon, “the middle income trap.”
The problem doesn’t end here. The Chinese owe a lot of money to their banks. When I say a lot, I mean an astonishing 16.454 trillion USD or 200% of their GDP! That is more than the Gross Domestic Product of the United States. With a slowing economy, how will the Chinese repay all this money?
Real estate prices do not provide much respite either. As prices keep on rising, the only door open to an average Chinese person is the bank’s.
Let me provide you with a glimpse of my perception of the future of China: relatively less young people having to cater to more old people, less investment, large debts, unsustainable property prices, health risks due to pollution, slowing foreign investment and a state-controlled media trumpeting the glory of the “Middle Empire!”
That said, I am optimistic about China in the short-term. There definitely are problems with the country, but China realizes this and is actively taking steps to remedy them. Just last week, the Chinese government announced its plans to relax the one-child policy. More such reforms are underway. Without doubt, the country has a very able leadership, which will steer the country in the best possible direction. Nonetheless, the country and its decisions warrant the attention of anyone interested in its future and the future of the world economy.
In my next blog, I shall deviate from my country-specific focus and discuss the future of Latin America.
Until then, stay tuned!