If China’s Economy Stumbles, The World Fails

I’m as interested in the Queen’s Speech as the next political obsessive. All that proposed legislation, and the window it provides on the soul of the new government, should be pondered by anyone interested in the trajectory of British policy-making over the next five years.

Last week’s Queen’s Speech committed the first majority Conservative administration in almost two decades to a referendum by the end of 2017 on European Union membership. Measures to freeze income tax and extend childcare are also on the agenda. We’ll almost certainly see more devolution for Scotland, Wales and Northern Ireland, along with “English votes for English laws” at Westminster.

While legislation is what it’s all about, the elaborate procedures associated with the State Opening of Parliament — of which Her Majesty’s “humble address” is the centerpiece — are also important. It’s easy to dismiss the ebony black rod, the ostentatious door-thumping and the “searching of the cellars” as outdated nonsense. But these rituals serve as crucial reminders of the struggles involved in establishing democracy and the supremacy of our elected Parliament.

Dismiss them as feathered flummery if you want to, but we forget such principles at our peril.
All that said, while the Queen’s Speech rightly received much media exposure, I saw little coverage regarding important events related to China. With US GDP having contracted during the first quarter of 2015, and maybe this quarter too, it’s hard to overstate the importance of the People’s Republic to the global economy. Having grown by 9.8pc a year since the late 1970s, the Chinese economy is now bigger than America on a purchasing power parity basis (adjusting for living standards).

While growth was 7.4pc in 2014, the slowest expansion for 24 years, and could drop below 7pc in 2015, with America yet to stage a convincing recovery China is now the world’s growth locomotive. If this Eastern giant stalls, the UK’s nascent recovery could easily reverse — which would, of course, upend British politics.
While still spectacular by Western standards, China’s economic performance is now raising some eyebrows. The prospect of Chinese markets crashing also ranks among the calamities that now threaten the world economy.
Fixed investment grew 12pc during the last quarter, while property investment rose 6pc.

These numbers sound buoyant, but represent the slowest rate of investment since the 2008 financial crisis. China’s export-focused factories meanwhile struggled to expand in April, as government steps to stimulate the economy failed to offset the slowdown in Western demand, with the US economy faltering and the eurozone still on the skids.

The official manufacturing Purchasing Managers’ Index was 50.1 in April. Given that values above 50 represent growth, this was a dire performance for China — and the May figure, to be published tomorrow, could be even worse. Non-official survey data released last week actually show activity in small and mid-sized factories, those with far less state support, contracting in March, April and May.

This month, the People’s Bank of China slashed its benchmark interest rate to 5.1pc, the third cut in six months. Reserve ratios have also been reduced twice, at the fastest pace since 2008, in a bid to reverse a property downturn and boost domestic and corporate lending. Unusually, the Chinese central bank admitted to “relatively big downward pressure” on the economy, pointing to “fluctuations in external demand”.

The biggest clouds hanging over the economy, though, are local equity markets that look extremely overvalued. The Hang Seng index of leading stocks has doubled in the past year. The Shenzhen Composite Index, meanwhile, dominated by tech companies, has nearly tripled — with some stocks trading at 50, 100 or even 150 times annual earnings (shares historically trade at between 10 and 20 times).

Local brokers point to a price-earnings ratio of around 25 on the Shanghai Composite Index, which includes the biggest companies — similar to the valuation of the main US share indices. But that ignores the big overweight of Chinese bank equities, the prices of which have failed to rally (not least due to a preponderance of non-performing loans). Stripped of the banks, the main Chinese market is trading at 30 or even 40 times earnings, with the vast majority of shares now with price-earnings ratios well above those they displayed in 2007 at the height of the stock market bubble and prior to the 2008 crash.

Were Chinese stocks to plunge, that would weigh heavily on the economy — and, in turn, the rest of the world. It’s worrying, then, the Shanghai Composite fell by almost 7pc on Thursday, one of its steepest single-day drops for 15 years.

Despite these concerns, there was a slew of other news last week pointing to China’s growing economic and diplomatic power. Astonishingly, the International Monetary Fund declared that the Chinese yuan is “no longer undervalued”. For over a decade, as China has traded its way to its status as the world’s leading exporter, the IMF has accused Beijing of benefiting from an unfair advantage by keeping the Chinese currency low. Now, after a 25pc appreciation of the yuan against the dollar in 10 years, the IMF judges the valuation to be “fair”.

This is deeply significant as it paves the way for the yuan to be included among the world’s leading currencies — along with the dollar, yen, euro and sterling — when the IMF publishes its review of the Special Drawing Rights, the official currency basket used by central banks everywhere to denominate their reserves, by the end of this year. The yuan’s inclusion, if matched by a loosening of capital controls by Beijing, would mark China’s full integration into the global financial system.

Meanwhile, again despite economic concerns back home, a Chinese delegation toured Latin America, signing a string of trade deals. Bilateral trade with Brazil has skyrocketed from $6bn to $90bn over the past 10 years, with trade flows now going well beyond commodities and consumer goods. Chinese Premier Li Keqiang announced a further $50bn of Brazilian investment agreements – welcome news for Latin America’s largest economy, which has lately been flagging – including deals on oil, airlines, iron ore and infrastructure.
Mr Li then went on to Peru, where he unveiled Chinese plans to bankroll a 3,500km trans-Andean railway from the Brazilian port of Santos to the Peruvian Pacific port of Ilo. This is on top of news that a $50bn Chinese-owned and operated waterway is to be built across Nicaragua, to rival the US-operated Panama canal.

Then, of course, we saw an escalation last week of Sino-US tension in the Asia-Pacific region, as the war of words escalated. China accused the US of “threatening to sow chaos” by inciting countries whose territorial claims in the South China Sea clash with those of Beijing – not only Japan, but also Taiwan, the Philippines and Vietnam.

China meanwhile continues to orchestrate the rapid construction of artificial islands in disputed waters, causing US Defence Secretary Ashton Carter to demand an “immediate and lasting halt to land reclamation by any claimant”. Beijing responded by pointing out that, despite a slowdown, and a possible stock market crash, the People’s Republic is now calling the economic shots. “If the major powerhouse of world economic growth is thrown into chaos, will that serve the interests of the American side?” sniped Beijing’s Foreign Ministry.

The Queen’s speech was important and fascinating. We’re set for an extremely interesting Parliament, which could well see big changes to the composition of the UK and even Britain’s place in Europe. The shape and future direction of the global economy, though, is increasingly being determined elsewhere.

http://www.telegraph.co.uk/finance/comment/11640723/If-Chinas-economy-stumbles-the-world-falls.html

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