After going sideways for five months, the Aussie market has been on a tear lately. At the same time, our largest trading partner, China, has been in the news — and not all of it is for positive reasons.
Last Wednesday saw the launch of the 19th National Congress of the Communist Party of China. They are held every five years and are an opportunity for the party leadership to consolidate power and reiterate both long and short term goals.
General Secretary and President of the country, Xi Xingping, kicked things off with a marathon speech. From an economic perspective, Xi stated China’s aim to become ‘a moderately prosperous society’ by 2020, which includes a goal to double 2010 GDP by that year.
Xi reaffirmed his view that ‘development is the foundation and key to addressing all problems.’ The challenge for China, as always, is to develop in ways that provide economic and social balance.
Xi’s Long Term Focus
To give you a sense of the long term focus of a one-party nation, Xi’s policies and reforms are working towards making China a ‘modern socialist economy by 2035 and a great socialist economy by 2050’.
Back here in Australia, we’re scrambling to keep the lights on in 2018…
But just because a one party system has the luxury of being able to plan for the long term, it’s not all bells and whistles.
On the sidelines of the party congress, Peoples Bank of China head Zhou Xiaochuan warned of potential financial instability:
‘If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.’
A ‘Minsky Moment’ refers to a scenario portrayed by famous US economist Hyman Minsky, who said that stability creates the conditions for instability. And if I’m remembering correctly, he also said that this path to instability goes through several stages, with the final stage being one of Ponzi finance.
When an economy gets to this point, the income streams that back asset values are only maintained by ongoing debt growth. Once the debt growth slows, the economic Ponzi scheme is exposed (the Minsky Moment) and asset values collapse. This in turns leads to impaired banking systems and a general economic debacle.
China’s Massive Debt Growth
Given China’s massive debt growth since the financial crisis nearly 10 years ago, this is not the first time worries of a Minsky Moment have surfaced.
Total debt as a percentage of GDP has gone from around 140% at the start of 2009 to nearly 260% today.
In other words, China’s unsustainable debt growth is behind its ongoing economic strength.
So for the central bank head to bring up the potential risk of China experiencing a Minsky Moment is a pretty big deal. Especially given that China’s state-owned banking system probably has a better chance of avoiding a meltdown than the private banking systems of the west.
What it suggests is that China might well tolerate lower growth targets in the future, and therefore slow its rapid accumulation of debt.
The China bears will no doubt jump on Zhou’s comments and point to the growing risks of a China bust. But I think it would be foolish to do so.
It’s a case of been there, done that. Back in 2011 and 2012, I was bearish on China’s economy thanks to its rapid debt build up. The timing was lucky, as that was when the post crisis resources boom (especially in iron ore prices) was peaking out.
And while China’s economy did subsequently shift to a slower growth phase, it didn’t blow up.
That doesn’t mean things can’t go pear shaped for the Middle Kingdom again. I’m just saying that it’s a complex situation and not at all like western economies, so you can’t just assume the rapid debt build up will end in tears.
If China is indeed getting into economic trouble, you should see it start to show up in the stock market, which is particularly sensitive to changes in liquidity conditions.
A ‘Minsky Moment’ is preceded by a tightening of liquidity, and this will manifest in falling stock prices. But as you can see in the weekly chart below, the Shanghai Composite stock index continues to recover nicely after the 2015 boom and bust.
In fact, the index recently traded at its highest levels since January 2016.
Another barometer of China and liquidity is an index of commodity prices — especially industrial commodities. And as the Thomson Reuters industrial metals index shows below, there are not yet any signs of concern.
And finally, consider that China’s capital flows are not the problem they once were. Remember the concern about capital fleeing China, leading to a devaluation of the yuan and general havoc for the global economy?
That hasn’t been an issue in 2017. As Reuters reported a few weeks ago:
‘A dramatic slowdown in capital flight — which had been seen as one of the biggest risks to China — has helped boost confidence in the world’s second-largest economy ahead of a key Communist Party meeting this month, at which President Xi Jinping is expected to consolidate his grip on power.
‘Forex reserves rose $17 billion in September to $3.109 trillion, compared with an increase of $10.5 billion in August, central bank data showed on Monday.’
While there are concerns about China’s debt load, there are few signs that it will pose immediate problems to economic growth or commodity prices in general. That may change, but for now the signs are telling you to remain bullish.
Editor, Secret Crypto Network