Last week I went to hear fund manager Michael Riddell of M&G Investments talk about his views on emerging markets.
When it comes to the biggest of them all – the Chinese economy – his take is that “the question is not if, but when China’s bubble will burst”.
We don’t disagree with Riddell. In fact, we’d argue that the Chinese bubble has probably already burst. It’s now in the process of deflating.
One country that’s already feeling the pain is Australia.
China’s Economy Has Passed the ‘Lewis Turning Point’
M&G’s Michael Riddell is a big fan of the work of the economist Arthur Lewis. Lewis’s idea was that most growth occurs during the change from a rural subsistence economy to a modern urban one. During this period returns to capital are high, encouraging investment.
However, once all rural labour has been absorbed, growth quickly slows. Attempts to continue the pace of growth via ever-increasing levels of investment, simply lead to poor returns. It also risks creating a credit bubble.
This is the ‘Lewis Turning Point’. And Riddell believes that the Chinese economy has passed it. He also believes that the increase in private credit, which grew by more than 50% each year from 2009 to 2011, shows that there is a bubble.
Rising debt isn’t necessarily a bad sign in itself. Leverage usually increases as a country gets richer. However, Riddell points out that, despite its low per capita GDP, Chinese leverage is already on a par with much wealthier countries such as Hong Kong and Japan.
We’d be inclined to agree with Riddell’s take. Even if you’re not convinced, it’s certainly becoming clear that the Chinese economy has passed some sort of turning point.
As well as facing a fall in its long-term rate of growth, China’s economic short-term woes are mounting. April’s industrial production growth slowed down to 9.2% year on year, the lowest figure since mid-2009. GDP growth fell to 8.1%.
Although these figures both still sound impressive, you have to remember that – like every other government – China’s leaders aren’t above fiddling the data for propaganda purposes. This means that the trend, not the actual figures are key.
An even bigger hint of major problems is the latest trade data. Exports grew by 4.9%, compared with a year ago. This was much lower than the 8.5% expected. Imports effectively stayed the same, going up by only 0.3%. This suggests that China can neither export its way out of trouble nor rely on domestic demand.
The Impact of a China Slowdown on Australia
A slowdown in China should have a big impact on its ’51st state’ – Australia. While China’s massive demand for resources has shielded Australia from the global financial crash to a great extent, this is now set to go into reverse.
This would be bad enough even if Australia was in a hugely sound economic state. But it’s not. It has suffered a rampant housing bubble that has made it one of the most expensive places to live in the world. That bubble is already collapsing. According to the Australian Bureau of Statistics, average Australian house prices have now fallen for five straight quarters.
Meanwhile, the latest economic surveys show that both the manufacturing and service sectors are in deep trouble, with activity in both shrinking rapidly. No wonder the Aussie dollar has toppled back through parity with the US dollar.
Matthew Partridge
Contributing Editor, Money Morning
Publisher’s Note: This is an edited version of an article that originally appeared in MoneyWeek (UK)
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