China sneezed and the world caught double pneumonia. So far in 2016, oil prices and global markets have taken a pounding as China’s economy slows. The Dow is down 6%, and the Shanghai Composite lost 24% in January. Plus, the yuan has plummeted to a five-year low. And now Donald Trump wants to whack Chinese exports with a 45% tariff. Is the Great Boom of China finally ending?
There’s certainly evidence to say yes: The Shanghai stock index is down 48% from its June peak. The World Bank recently cut its forecast for China GDP growth to less than 7%, the lowest since 1990. Corruption is rampant and the authoritarian instinct to shut down markets when they falter has spooked investors.
Meanwhile, the global commodity-price bloodbath—with oil at $32 a barrel—has been blamed on China’s slowdown. The recently reached Trans-Pacific Partnership trade agreement excludes China, with President Obama saying last fall that “we can’t let countries like China write the rules of the global economy.”
Ugly, for sure. But savvy investors see turbulence and search for waves they can surf to success. Look closely and it’s clear that China’s economy of 1.4 billion people is undergoing a seismic shift—from top-down infrastructure investment to a more consumer-driven economy, moving from concrete to cars, cellphones and other consumer goods enjoyed by developed economies. Over the next several years, investors would be wise to focus on Chinese consumers buying goods and especially services (insurance, car rides, vacations).
You have to go back to the Asian currency crisis of 1997-98 to understand today’s slowdown. China’s leaders knew they had to continue modernizing; even simple things like roads and sewer systems were still lacking. They had watched neighbors South Korea and Thailand and Malaysia go under and crash their currencies trying to pay back massive dollar-denominated debt used to upgrade their own infrastructure. So instead of borrowing from abroad, China’s leaders encouraged workers to emphasize saving over shopping, which helped build more housing, highways, airports and trains.
Sure enough, China’s savings rate rose from 32% of GDP in 1980 to 50% today. Investment followed a similar trend. Household consumption dropped from 70% of GDP in 1962 to 50% in 1980 to around 35% today (it is 70% in the U.S.). That’s how you self-fund a build-out.
And it worked. According to Canadian analyst Vaclav Smil, China churned out more concrete in three years (2011-14) than the U.S. did in the entire 20th century. Aging Hutong residences are disappearing, replaced by 50-story high-rise apartments—many of which stand empty. To fund all this, China is 106th globally in household consumption at $3,900 per capita, behind Swaziland but ahead of Algeria—and about 10% of the figure for the U.S.
Chinese leaders are trying desperately to steer spending in a new direction, but it isn’t easy to turn a $10 trillion economy on a dime. Yet there are ways to change course, hopefully without blowing up the global economy.
The first step is crack down on corruption, which would help slow down infrastructure spending. Make it harder to keep building four-lane highways to places no one visits. This process has already begun. Banks are being told not to continue funding dead-end projects. Since 2012, according to the China Daily, some 270,000 officials have been charged with corrupt activities—even a member of the Politburo Standing Committee, a position akin to the president’s cabinet.