China Outlook: 'Winter Is Coming'

 |  Includes: CYB, FXI, TAO
by: Patrick Chovanec

Last week, I appeared at The Economist China Summit in Beijing, on a “bulls vs. bears” panel, alongside Professor Li Daokui (a Tsinghua colleague and advisor to China’s central bank), Arthur Kroeber (founder of Dragonomics and highly respected China bull), and Huang Yiping (Peking University professor and economist at Barclays Capital). You can read a quick English summary of the panel discussion here, courtesy of Dezan Shira & Associates. The folks at Sina prepared a full transcript in Chinese, which you can check out here (or run the link through Google translator to read it in fairly decent English).

Although Arthur gamely agreed to play along as a “bear” for the morning, I don’t think his heart was really in it — which is totally understandably, given that he recently authored this thoughtful and well-argued presentation on “Why China bears are wrong.” That left me as the only real “bear” on the panel, if “bear” means accepting the possibility that China’s growth could drop below 7% in the next several years.

The main theme of my comments were “Winter is Coming.” The phrase, as I explained, is a reference to the popular HBO TV series Game of Thrones (and the novels by George R.R. Martin), which depicts a medieval fantasy world in which summers and winters last for many, many years, alternating not over the course of a single year, but a lifetime. After so many years of summer, many people begin to doubt whether winter will ever return, or remember what it is like. One family, whose task is to guard the North, have a watchword: “Winter is Coming.” It serves as a warning, and a reminder, to be prepared for difficult times ahead — and in China’s case, that the current drivers of growth are unsustainable and a correction is coming (and, by the looks of it, is already underway). I had already planned to introduce this theme when, a few days before the panel, I happened to come across this New York Times article on China’s real estate downturn, which concludes with a quote that capture this idea exactly:

But the real estate downturn has only just begun, Mr. Zhang said, adding, “We are on the cusp of winter, and we don’t know who will survive it and who will not.”

One of the areas of substantial disagreement on the panel was whether the recent rash of bankruptcies in Wenzhou are an atypical, localized phenomenon (as Arthur and the others argued) or signs of a broader breakdown. I argued that, if you look closely at what is happening in Wenzhou, what you see is highly representative of pressures and imbalances that are building across the Chinese economy and financial system (namely, the use of easy credit as a way of avoiding real economic adjustment, by fueling speculative growth). I don’t think the credit quality of Wenzhou shadow lending is any worse than in the formal banking sector. The only difference is, unlike China’s state-owned banks, entrepreneurs in Wenzhou don’t have the financial resources to roll over loans and pretend everything is fine when their loans go bad and they don’t get paid. They are, I said, the “canary in the goldmine” (I meant to say “coalmine,” but as Economist reporter Gady Epstein pointed out, “goldmine” is actually more appropriate, so I’m sticking with that). For anyone who wants to read more about Wenzhou’s recent problems, I highly suggest this article in TIME (“When Wenzhou Sneezes”) by Austin Ramzy.