China’s economy is facing headwinds that could lead to a Chinese economic collapse in 2015. Economic growth forecasts say China will grow at a very slow pace this year, its slowest pace in a quarter-century and well below historical averages. With the recent turn of the Chinese calendar and onset of the year of the goat, investors need to ask themselves one simple question: will China’s economy collapse in 2015?
The data being released regarding the Chinese economy is not only worrisome, but it also suggests the worst is yet to come.
Factors Signaling China’s Economic Collapse in 2015
Industrial Production Slump
The old drivers of expansion are not there to support the economic plans of China’s government. In February, industrial production growth came in at just 6.8% year-over-year. (Source: National Bureau of Statistics of China, March 18, 2015.) This is down from a February 2007 pre-global recession growth rate of 18.5%.
Current industrial output is down, and this points to excess capacity in the Chinese economy. There is not enough demand and as a result, factories are not running at their full potential. For example, in the U.S., factories are running at roughly 80% of their capacity, while in China, it stands at 70%. (Source: Board of Governors of the Federal Reserve System web site, last accessed March 18, 2015.) This shouldn’t go unnoticed since China, not too long ago, was referred to as the manufacturing hub of the world.
With industrial production idling, you have to wonder if things are going to pick up.
Fixed-asset investment (the purchase of any physical asset) is a leading indicator of future manufacturing activity. These numbers are down as well, and we don’t have to look too far back. Asset investment growth in the Chinese economy is down four percent from last year and has declined a total of 7.6% from 2012.
Consumer Spending Severely Hurt
Industrial production isn’t the only issue. The Chinese government’s new aim is to transition the country from a manufacturer of goods for the rest of the world to a net consumer. China wants to lift its own consumption, get its own citizens spending, and reduce its reliance on exports.
Progress on this front is not going as fast as Chinese officials would like. In other words, the government is failing to boost consumer spending.
Just last month, retail sales in China grew 10.7% year-over-year. (Source: National Bureau of Statistics of China, March 18, 2015.) But isn’t 10% a strong growth rate? Nope; it was the slowest pace for China in the last nine years.
Chinese Housing Market Collapsing
The housing market in China is another cause for concern.
The latest home prices report for China’s largest cities shows that 61 out of the 70 major city centers experienced price declines. (Source: National Bureau of Statistics of China, March 18, 2015.) Since last year, prices in major cities like Beijing and Shanghai have declined six percent and five percent, respectively. I believe the price declines are in the early innings and are likely to accelerate.
The problem is that residential homes (mostly apartment buildings) in China’s rapidly growing cities were purchased by investors. With lending rates relatively low, wealthy investors were easily able to exceed their costs of financing. At the time, a rational response by these developers was to take out as many loans as possible to build more. In the process, real estate developers leveraged themselves up to their eyeballs.
The housing market in China makes up about 25% of the economy. If home prices go down, do you really think those who overleveraged themselves will be just fine? I believe they will default on what they have borrowed as scrutiny in the housing market grows.
This isn’t all…
China’s National Debt Soaring
Debt levels in China are extremely high. The “official” numbers point to a government debt-to-gross domestic product (GDP) ratio, a national annual output, of a mere 22%. In fact, it has declined from 33% in 2011. (Source: Trading Economics, March 18, 2015.) So what’s the problem? Isn’t that low?
Last month, Mckinsey & Company, a global consulting firm, released a report on global debt levels. The firm points out that seven years after the Great Recession, indebtedness has grown by $57.0 trillion worldwide. (Source: Mckinsey & Company, February 1, 2015.) It noted China’s debt-to-GDP ratio stands at 282%! These debt calculations not only include government balances, but also those of households and non-financial corporations. Mckinsey further states, “Half of all loans are linked, directly or indirectly, to China’s overheated real-estate market.” And this brings us full circle.
I repeat again, debt levels are way too high and this will limit the ability of the People’s Bank of China to stimulate its economy. Debts have to be repaid, and if borrowing isn’t put towards productive uses, it becomes harder to do so.
Chinese officials know all the money is flowing to real estate developers. Not only are they overextended, but also home prices are dropping quickly, and there is no wealth flowing down towards the real economy. This won’t help consumers spend more either.
People’s Bank of China Fights Back
The central bank of China is worried about all of this. As a result, it has cut its benchmark interest rates twice in the past four months and more cuts are expected.
While lowering interest rates is well within the norm, there are limits to this option, especially given China’s fragile economic condition. Yes, fragile.
Debt levels when compared to national output are extremely high and the all-important real estate market is in bubble territory. The declining real estate market will suppress growth in the short-term, while unsustainable debt levels must be reduced, limiting the long-run potential.
Economists predict a slower first half of 2015 for China, questioning the immediate real effects of interest rate cuts and other simulative measures. My outlook for China in 2015 and beyond is for a definite decline in headline growth rates. As I see it, China will face scrutiny going forward.
Underneath the headline numbers are major risks in the form of staggering debt levels and elevated housing prices. These can prove to have serious consequences for the Chinese economy. Slower growth for longer shouldn’t surprise investors.
Finally, understand this: if China faces economic misery, it will send ripple effects through the global economy.