The rise (and rise?) of China – part one

Prevailing wisdom says the Chinese economic juggernaut will inevitably overtake the US as the world's economic superpower – a position it already claims according to 57 per cent of Australians1. Last month's stock market crash, however, served to remind us that China's rise to the economic preeminence, if inevitable, will not be smooth.

In June 2015, even as the weakest corporate profits since 2009 and a slump in copper and iron ore prices foreshadowed difficult times for the Chinese stock exchanges, China's legions of momentum investors were taking advantage of loose margin lending regulations to leverage up their stock market investments to around 9 per cent, or $320 billion, of the market capitalisation of the Shanghai and Shenzhen exchanges2.

One month later the Shanghai Composite had lost more than 30 per cent, or around US$3.4 trillion, leaving thousands of investors facing devastating margin calls.

Focusing on the value of the market slump however risks losing sight of the fact that in the 12 months to mid-June, the market had risen by around 150 per cent, meaning that with the exception of those investors who came in in the last few months, handy profits had still been made.

Government intervention

Despite this, the Chinese Government threw everything but the kitchen sink at arresting the stock market slide, which is less surprising when you consider the Government 'owns' hundreds of the listed companies, including nine of the top ten3. Under Government directives, interest rates were cut, brokerages committed to buying billions in stocks, IPOs were blocked and ultimately trading was suspended on around half the stocks on the indices.

Despite weeks of declines through June, intervention finally came as the stock market crash threatened to realise a knock on effect for Chinese consumption – particularly in the fragile housing market. More significantly perhaps was the threat to Chinese corporations, many of whom use their own shares as collateral for loans. Furthermore, the Chinese Government also recognised the need to calm the nerves of its supply chain neighbours (such as Australia) whose economies have already been adversely affected by easing Chinese growth.

While the Chinese Government actions have been successful in propping up the market (for the most part), they have also highlighted the limitations of the Chinese Government and the pitfalls facing an economy which is adjusting to a 'new normal' growth rate well below the average 10 per cent annual growth over the last 35 years.

So what are the challenges ahead for China?

China's global influence

By some estimates, China has contributed more than 30 per cent to global economic growth in the last decade4, with 124 countries now considering China as their leading trade partner5. In 2014, China overtook the US, in purchasing power parity, as the world's largest economy.

It's an economic position with some extraordinary numbers:

  • Around 100 million Chinese are employed in manufacturing jobs with an average hourly pay of US$1.746
  • 50 per cent of cameras, 30 per cent of air conditioners and televisions, 25 per cent of washing machines, and 20 per cent of refrigerators are produced or assembled in China7
  • 20 per cent of Chinese urban homes are empty
  • $1.3 trillion, or 7 per cent, of US debt is owned by China
  • Foxconn, the electrical manufacturer that builds Apple's products, employs 140,000 people at its Longhua complex in Shenzhen, producing around 90 iPhones a minute8
  • In 2006, the equivalent of 3 new coal power plants were built every two weeks – though this has slowed in recent years
  • From 2011 to 2013, China used more cement than the US did in the entire 20th century9
  • According the IMF, China consumes around 47 per cent of the world's base metals (up from 13 per cent in 2000) 
  • Between 2010 and 2025 300 million people are predicted to move to cities.

With a burgeoning middle class consuming more and more global resources, China is expanding its influence far beyond its own borders. Whether it is ultimately successful or not, China's incredible plan to build a US$40 billion canal through Nicaragua underscores this determination to expand its economic influence, either for prestige or direct economic benefit, throughout the world. 

Other big ticket Chinese projects

  • A 5,300km rail link across South America to transport goods and commodities to the Chinese market
  • A 21st century 'silk road' – a 3,000km road project from China-Pakistan Economic Corridor
  • Two new nuclear power plants are to be built near Karachi in Pakistan in a $10 billion project
  • An $8.3 billion Nigerian railway modernisation project

China has also established itself as the future underwriter of Asian infrastructure projects with the launch of the Asian Investment and Infrastructure Bank (AIIB). With 57 countries signed up and a $100 billion capitalisation, the AIIB represents China's most direct challenge to US economic hegemony since WW2.

Despite embarking on domestic and international infrastructure projects with eye-watering price tags, the Chinese economy is facing headwinds as it struggles to maintain growth.

 

1 http://www.pewglobal.org/database/indicator/17/survey/17/response/China/
2 http://ww.marketwatch.com/story/the-worlds-worst-investment-bubble-will-burst-soon-2015-06-11?page=2
3 http://rogermontgomery.com/shanghai-composite-index-continues-to-disappoint/
4 http://www.investopedia.com/articles/investing/112614/chinas-economic-indicators-impact-markets.asp
5 http://rt.com/usa/china-us-trade-partner-169/
6 National Geographic, Economist Intelligence Unit, 27 April 2015
7 http://www.rgs.org/OurWork/Schools/Teaching+resources/Key+Stage+3+resources/China+Today/Made+in+China.htm
8 http://recode.net/2015/04/06/where-apple-products-are-born-a-rare-glimpse-inside-foxconns-factory-gates/
9 USGS cement statistics, Mineral Industry of China

Important
The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.