Investors across the globe are increasingly worried about the state of the world’s second-largest economy after the United States, China. According to legendary investor George Soros, the slowdown in gross domestic product (GDP) growth coupled with rising credit levels has become so unmanageable that China’s economy resembles the pre-crisis economy of the United States. The nation's economy grew 6.5% year-over-year in the third quarter of 2018, which is the lowest growth rate since 2009 and reflects a growing trade war with the United States.
Accelerating Credit Growth
Wei Yao and Claire Huang of Societe Generale S.A. (EPA: GLE) consider that much of the growth in China's economy is due to credit expansion. In an attempt to shift from an investment-based to a consumption-based economy and buck the 25-year trend of slowing economic growth, the Chinese government has taken on an accommodative monetary policy. From 2008 to 2018, China’s overall debt jumped from 164 to 300% of GDP. In an attempt to alleviate its supply of debt, China has tried to increase demand by easing restrictions on market entrance for foreign investors but has had little success. According to Credit Suisse Group AG (NYSE:CS), more accessible bond markets should increase foreign investor demand; however, recent data shows investors are not that interested in Chinese bonds.
In addition to its credit woes, China is also facing a possible currency crisis. Through excessive debt creation and money printing, the People’s Bank of China (PBOC) has created the largest money supply and total banking system assets of any country. Thanks to an unprecedented and aggressively accommodative monetary policy, China’s total banking system assets stand at $39.9 trillion as of 2017, increasing by over 200% over the past seven years. These factors have helped create an absurdly overvalued yuan, which has propelled China’s M2 money supply to a 75% greater value than the entire U.S. M2, despite China’s GDP being more than 50% smaller than that of the United States. Perhaps even more concerning is China’s M3 money supply known as total social financing (TSF). TSF in 2017 increased by 1.6 trillion yuan year on year to 19.4 trillion yuan, which indicates that debt growth is accelerating via China’s shadow banking system. Some analysts suggest that the PBOC may have to worry about a negative credit impulse, which would further weaken the Purchasing Managers’ Index (PMI) and investment growth.
Frothy Real Estate Market
After the $3.2 trillion lost during China’s stock market crash in 2015, the PBOC wants to encourage potential equity investors. Compared to Americans, the Chinese have historically invested more of their capital in real estate than in the financial markets. The latest stock market crash reinforced that trend as Chinese direct investment in the United States hit a record $15.7 billion in 2015. From June 2015 through the end of 2017, the 100 City Price Index, published by SouFun Holdings Ltd., increased by over 30% to close to $202 per square foot. To put this in perspective, according to Bloomberg, "this is almost 40% higher than the median price per square foot in the United States, where per-capita income is 700% percent higher than in China."
The housing data indicate that some of the Chinese are building real estate for growth. Moreover, some investors are putting their resources in other countries, such as Australia, where the demand for housing has helped increase the household debt-to-income ratio to almost 200%.
China’s economic situation is difficult to assess. While China has made steps toward a more transparent financial sector, there is still a tradition of cooking the books. Chinese stocks typically sell at discounts of at least 10 to 20% of their American counterparts, and this implies that China’s economy is underperforming compared to government reports. Analysts question to what extent the data are being manipulated. As China's bad debt reaches a decade high, China is struggling to manage its credit situation. In 2018, the China Banking and Insurance Regulatory Commission reported a nonperforming loan ratio of 1.9%, while Charlene Chu of Autonomous Research believes that number is closer to 25%.