‘China will grow old before she grows rich.’
—John Howard
‘They have lots of problems.’
—Donald Trump
If you’re an American or European manufacturer, make no mistake: China is your rival.
In two decades, China has become the world’s industrial powerhouse. To produce a consumer good at scale, China’s factories are likely to be the most ready, the most cost-effective, and the most able.
Yet if you’re an Australasian commodity producer — be that food or iron ore — China is not your rival. It’s probably your best customer.
But the numbers do not lie. The phenomenal rise of China is slowing. Perhaps its pinnacle is already behind us. America is accelerating again.
From here, we may face an economic and geopolitical turning point that has massive implications for investors.
They said Trump’s trade policy on China failed the US at the time. But rather different numbers seem to be coming through now…
The end of the Chinese boom?
State-sponsored capitalism, at the end of the day, is still communism.
Eventually, business — or something else like a virus — goes too far. The government steps in. And growth hits a systemic ceiling that free economies do not face.
China faces this conundrum on top of a demographic time bomb. That stems in part from the one child policy that ran from 1980 to 2015. And from the inevitable contraceptive of newfound prosperity.
Then there’s the question of the quality of the growth itself.
China’s factories have produced staggering export receipts over the past decade. They rely on core customers in the US and Europe.
But margins are now being squeezed.
Keeping labour costs low has relied on one of the biggest internal migrations in human history. Rural workers in China’s hinterland moving to cities to work. Since the pandemic, there are signs this trend is reversing.
It has been reported that many Chinese manufacturers are happy when they make 3% net margin on their sales.
A friend of mine visits China every few years. On his last visit, factory owners told him there was no profit left now. Increasing regulation, as well as input and labour costs, have taken a heavy toll.
Then there’s the issue of debt. China’s businesses are some of the most indebted in the world. They’ve relied on leverage to achieve the capital formation and growth they’ve had.
Corporate debt in China was 160% of GDP in 2021. In the US it was 85%.
The problem comes to the fore in a world of rising interest rates. China’s debt mountain threatens instability as the margins of debt-laden companies are further squeezed.
Over-investment in infrastructure is another problem. It creates illusionary growth.
A centrally planned government can drive growth by building infrastructure. But if that infrastructure is surplus to capacity or not used efficiently, the return on investment becomes negative.
With growth slowing, it seems the Chinese government wants to attempt to again drive up growth by accelerating infrastructure spend. But one study found that, for over half the infrastructure investments in China over the past 30 years, the costs have exceeded the benefits.
Often, these projects rely heavily on debt. If costs exceed benefits and interest rates rise, that debt can become a ticking time bomb.
As these chickens of debt and demographics come home to roost, China also faces a less amicable world.
Trump began a trade war in an attempt to address China’s huge trade surplus with the US. Those tariffs, for the most part, continue under Biden.
Average US tariffs on China’s exports today sit at 19.3%. Up from 3% in 2018. For some goods, it no longer makes sense to source them from China.
Then there’s the pandemic. In the early stages, this seemed to benefit China. It supplied a significant share of PPE. And it proved adept in controlling the spread.
But over the long run, things have been very different.
Beijing’s zero-Covid policy and aggressive lockdowns — alongside the other challenges mentioned — have likely contributed to key indicators moving in the wrong direction.
In April, we saw a stark comparison across the world’s two largest economies now moving in different directions:
|
|
China |
USA |
|
Industrial output |
Down -2.9% |
Up +5.8% |
|
Retail sales |
Down -11.1% |
Up +8.2% |
|
Unemployment — Mar to Apr |
Up 0.3% to 6.1% |
Unchanged at 3.6% |
|
Youth unemployment — Mar to Apr |
Up 2.2% to 18.2% |
Down 0.3% to 7.9% |
Perhaps Trump was right. Trade wars are easy to win. When you are the larger customer.
Of course, China may bounce back as lockdowns ease and stimulus flows.
For investors, a wider slowdown in China is not a matter of economic competition. It poses threats to global wealth.
In particular, investors need to consider the following:
- In recent years, China has provided significant financial inflow via migration and investment to Pacific Rim housing markets. Especially Australia, Canada, and New Zealand. I recently heard from someone working with investor migrants here in Auckland. The flow from China has largely dried up. This has implications for a struggling housing market.
- Over 30% of all exports from New Zealand and from Australia go to China. If this market is going to experience a slowdown over the next decade, it risks ending a 20-year bull run. Either Australasia will need to find new export markets. Or these countries, too, will be caught in the slowdown.
- Companies reliant on the Chinese market could face a reckoning. In 2021, 57.2% of Rio Tinto’s [LSE:RIO] revenue came from China. Can companies like Rio Tinto that sell iron ore and other commodities pivot to new markets? Or are they looking into a future of earnings decline — and hence share price downturn?
As an optimist, I believe well-managed companies and countries will pivot.
While Chinese growth is slowing, there’s another large population base that is showing all the signs of taking off. And that’s India, the world’s largest democracy.
While China may have an infrastructure surplus, India has a deficit. It also has a much younger population. India does have a long way to go on its development path, but any investment here could produce large returns.
Recently, in our Quantum Wealth Report, we looked at how investors are now accessing the opportunity India presents.
The world is changing fast. The most nimble and informed investors will capture the wealth that change generates.
Regards,
Simon Angelo
Editor, Wealth Morning
Important disclosures
Simon Angelo owns shares in Rio Tinto [LSE:RIO] via portfolio manager Vistafolio.
(This article is general in nature and should not be construed as any financial or investment advice. To obtain guidance for your specific situation, please seek independent financial advice.)