Monday, June 1, 2015

The Next Global Economic Recession Will Be Made-In-China

In the past, global economic recessions were Made-In-The-USA. The next one will be Made-In-China. That is something I am willing to bet on. The reason: China's credit growth, including off-balance-sheet credit, and shadow banking has grown way out of proportion compared with the growth of its real economy. 

Ruchir  Sharma, author of 2012 non-fiction bestseller "Breakout Nations"and now Head of Global Macro at Morgan Stanley Investment Manager says that every time a nation goes on a credit binge in excess of its real economic growth, an economic slowdown inevitably follows. He cites historical instances ranging from the Tulip Mania and South Seas Bubble of the 19th century, to the 1994 Asian Financial crisis, and Japan's decades-long recession as well as the 2008 US sub-prime mortgage crisis. . 

What is "excessive" to him? He say's if credit as a proportion of GDP grows 14 % over 5-years, that is one standard deviation above the Mean. 28% is two standard deviations and 42% is three standard deviations. 

China's credit has grown 62% over 5 years as a proportion of GDP. And this flush of money which includes all sorts of off-balance-sheet instruments and shadow banking is fueling the China stock market. Margin financing is rife, and Chinese authorities can't quite make up their mind whether to clamp down and let go, alternating between clamping down on and expanding credit facilities. As a % of GDP, China's credit is currently 200 %.  The first chart above is only to 2013, but already shows the craziness of Chinese credit growth. Compare China's credit as a proportion of GDP for USA, Eurozone and other emerging markets. 

By all other economic indicators from industrial production to home prices to retail sales and freight rates, the Chinese economy is experiencing an indisputable economic slowdown and yet the stock market is roaring. [See other charts above]. The current corruption probe with its wide net cast over whole sectors, and family, friends, relatives and business partners  of the person under probe, has also had an effect that is not publicised. Already many of the China projects and joint-ventures of Singapore companies are 'frozen' in fear of implication, or their partners cannot even get a visa to travel out of the country.

How bad will the effect of a Chinese recession be on emerging markets? Mr Sharma says that every 1% decrease in Chinese GDP growth brings about 0.7% to 0.8 % decrease in Emerging Markets GDP growth. The Chinese recession will be triggered by a stock market crash. 

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