The Middle in a Muddle – China’s Economic Growth Slows Down

With the Himalayas to the southwest, the Pacific Ocean on the east and the Gobi Desert in the north, China was relatively isolated from the rest of the world for thousands of years.

Surrounded by natural barriers, the Chinese people believed they lived in the middle of the world. The land become known as ‘Zhong Guo’…which translates to the Middle Kingdom.

The days of isolation for the people of Zhong Guo are well and truly over.

In the space of four decades, China’s transformation from a poor developing country into a major economic power has been nothing short of spectacular.

China’s GDP has soared to heights that even Chairman Mao Zedong (the architect of China’s Great Leap Forward) possibly never dreamed possible…a US$14 trillion giant.

Greg Canavan’s Top Two ASX Gold Stocks for 2019

China’s GDP - 1-08-19

Source: Trading Economics

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According to the World Bank (emphasis is mine), China has ‘experienced the fastest sustained expansion by a major economy in history—and has lifted more than 800 million people out of poverty.

In global rankings, China is narrowing the gap with the US and there’s daylight between the Middle Kingdom and third placegetter…Japan.

GDP (Nominal) Ranking 2019 - 1-08-19

Source: Statistics Times

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China surpassed Japan as the world’s second largest economy in 2010…a position Japan had held since 1968.

While China stagnated in the post-Second World War years, Japan surged ahead…it too experienced sustained expansion.

Figure 2. Comparison of Chinese and Japanese Per Capita GDP: 1950-1978 - 1-08-19

Source: Congressional Research Service

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According to ‘The Library of Economics and Liberty’, Japan’s growth was (emphasis is mine)…

the envy of most of the world…Following the end of the Allied occupation of Japan, real increases in GNP averaged 9.6 percent from 1952 to 1971. From 1972 to 1991, growth remained strong but less dramatic, averaging 4 percent per year.

By the end of the 1980s, such was Japan’s economic prowess, the country’s Ministry of Foreign Affairs released a policy document in 1989 titled ‘World Economic Situation and Japan’s Responsibilities’. Here’s an extract (emphasis is mine)…

Having grown to be an economic power, Japan has an important responsibility to assume for the stable development of the world economy.

Japan has achieved a rather high pace of economic growth through expansion of domestic demand for these years, thus contributing to the expansion of the world economy and the correction of external imbalances. A real economic growth rate of 4.0%, the highest among all developed countries, is projected for fiscal 1989 against the background of buoyant personal consumption and equipment investments.

That buoyancy for personal consumption and equipment investments came from one source…a rising tide of personal debt.

Japan Private Sector Debt - 1-08-19

Source: Wolf Street

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In December 1989, Japan’s miracle turned to mud.

The Nikkei 225 Index began a two decade long descent…ending in 2009. From peak to trough, the Nikkei 225 fell 80% in value.

The Nikkei 225 Index began a two decade long descent...ending in 2009 - 1-08-19

Source: Macro Trends

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Japan is a classic case of why GDP data is useless…it tells you nothing about where the money being spent is coming from.

Japan’s so-called economic power (sourced from debt-financed consumption) ultimately rendered successive governments powerless.

Try as they might, Japan cannot regain its economic mojo.

With the steady decline in Private Sector Debt, the projected real (after inflation) economic growth of 4% per annum in 1989 is but a distant memory for Japan.

This brings us to the world’s latest miracle economy…the Middle Kingdom.

The State of The Chinese Economy

According to a US Congressional Research Service paper published on 25 June 2019…

China’s growing global economic influence and the economic and trade policies it maintains have significant implications for the United States and hence are of major interest to Congress.

As reported in the Congressional Research paper, China is following the same slowing growth trend that Japan experienced…

As China’s economy has matured, its real GDP growth has slowed significantly, from 14.2% in 2007 to 6.6% in 2018, and that growth is projected by the International Monetary Fund (IMF) to fall to 5.5% by 2024.

According to Reuters on 15 July 2019, growth — as you would expect from China’s official data — is on a glide path to the forecast lower levels…

The second-largest economy in the world grew 6.2% in the second quarter of 2019, a drop from 6.4% in the first quarter, according to data released by the Chinese government.

The pace of growth in the second quarter was at its slowest since 1992.

But as we know, China’s GDP numbers are meaningless.

Michael Pettis — a finance professor at Peking University’s Guanghua School of Management, where he specialises in Chinese financial markets — said in a June 2019 interview with The Market…

Remember, in China, the GDP growth numbers tell us nothing about the economy. If Beijing wants 7% growth, they get 7%, if they want 5%, they get 5%. That is not real growth, it’s just economic activity. The real growth in China, if you were to write down all non-productive investment, would be much lower.

Non-productive investment is money that’s been borrowed to build things for the sake of building things…factories, roads, bridges, towns.

When you take this useless use of funds out of the GDP equation, the numbers are far from rosy.

According to Michael Pettis…

‘I think the real economic growth rate in China is already below 3%. The economy is not doing very well, and the trade war is making it worse.’

The reason China’s economic growth is slowing is the same as it was in Japan and is in the rest of the developed world.

More and more debt (spent on consumption and non-productive investment) is required to move the GDP needle. Here’s how Michael Pettis describes it…

‘It takes more and more of this fake growth, this building of useless things, to keep the official GDP growth high. What the economy is really doing, the amount of wealth that it’s generating, is much lower than the reported GDP growth number.’

There’s that problem again…artificially inflated GDP data masking the real economy. Showing strength when there’s weakness.

This chart tells you all you need to know about China’s spectacular transformation and why it has surged into second place in world rankings.

Chinas Banking Asset Growth Dwarfs All Others - 1-08-19

Source: Crescat Capital

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With the banks unleashed, China’s total debt level has replicated that blue line.

In 2014 McKinsey & Co, China’s debt in 2007 was US$7 trillion.

This is the headline from the 17 July 2019 edition of the South China Morning Post:

Chinas total debt rises to over 300 per cent of GDP as Beijing loosens borrowing curbs to boost growth - 1-08-19

Source: South China Morning Post

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With GDP of US$14 trillion, China’s debt now exceeds US$42 trillion…a six-fold increase in just over a decade.

There’s your miracle. It’s the same path Japan, Ireland, Spain and all the other pin-up economies have been down. The trouble is the path leads to a cliff.

When questioned about the unsustainable debt level in China, Michael Pettis said…

‘Everyone here knows that there is a serious debt problem.’

But what can be done about the problem?

Not a lot.

There’s no easy way to quit a debt addiction of this magnitude. It usually ends badly, just ask Japan.

According to Michael Pettis…

If you do the math, it’s hard to imagine it [the unsustainable accumulation of debt] continuing for another two to four years…The real growth rate of the economy has slowed significantly…If you look at the private sector in China, you see that it’s contracting already. That is very worrying.

The private sector contraction is starting to hurt the banking sector.

The plight of Bank of Jinzhou, a Chinese bank with RMB 748 billion (US$112 billion) in assets was reported by Reuters on 28 July 2019 (emphasis is mine)…

China’s Bank of Jinzhou won government-backed reinforcement on Sunday as three state-controlled financial institutions said they would take at least 17.3% in the troubled lender, whose shares have been suspended since April.

Concern has been growing about the bank since the Hong Kong-listed lender suspended trading in its shares earlier this year and saw its auditor quit. It said on Thursday it was in talks with multiple parties for possible investments.

The Bank of Jinzhou isn’t the only bank feeling the pinch. Again from Reuters:

‘In May, a shock government-led takeover of little-known Baoshang Bank revived concern about the health of hundreds of small lenders as the slowing economy results in more sour loans, testing their capital buffers and draining their reserves.’

And China’s serious debt problem has authorities on high alert …

‘China’s banking and insurance regulator has told the country’s biggest distressed debt managers to prepare contingency plans to take over or invest in high-risk small and medium-sized Chinese banks, Reuters reported on Friday.’

China is no miracle.

When it’s all boiled down, its rapid expansion has been nothing more than a debt-fuelled Ponzi scheme…not all that different from the rest of us.

What does Michael Pettis think the future holds for China?

‘[he] warns of the significant debt overhang that is weighing on China’s economy. He thinks a long period of stagnation will be inevitable.’

According to Investopedia, the definition of stagflation is:

‘Stagflation is a condition of slow economic growth and relatively high unemployment, or economic stagnation, accompanied by rising prices, or inflation. It can also be defined as inflation and a decline in gross domestic product (GDP).’

The bottom line for Australia is that China won’t be able to save us from the next global debt crisis.

It’s somewhat ironic that the Middle Kingdom, with all its natural barriers to ward off barbarian invaders, will find its empire under siege from within…a financial system buckling under the strain of too much debt.

The Middle has gotten itself into a muddle all of its own doing.


Vern Gowdie,
Editor, The Rum Rebellion

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Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion