Cracks starting to appear in the China story: Gottliebsen

Taken on its own, the decision by China to clamp bank lending should not have caused such a big fall on Wall Street. But dig deeper and you see why there is underlying concern around the world. And for Australia, China’s decision underlines the dangers we face in the next few years.

For the past decade, China’s bank lending has been expanding at a much faster rate than its economy, but this coincided with its enormous infrastructure spending and a massive increase in exports, particularly to the US. Then came the global financial crisis and exports were slashed, while credit growth continued to surge ahead – many say that China’s credit growth is still around 35 per cent.

Any country that balloons credit growth much faster than its economy for a sustained period heads into dangerous waters. That’s what happened to Japan in the 1990s and the US in the past decade. Usually, political connections are part of the problem. In the US the connections between the banking lobby and the politicians remain so close that the banks are going back to their old speculative games.

In China the political problems are even worse, so we have experienced many reports of looming tough actions that have never reached the implementation stage because the political connections extend over wide areas of the economy and have simply blocked the moves to slow down.

Much of that infrastructure momentum, including the ownership of many smaller steel mills, is linked into the complex control structure that governs the Chinese Communist Party. But the long term dangers of excessive credit growth mean that it is essential, albeit painful, that those political forces are overcome.

There is no doubt that strains are appearing in the Chinese economy. Some of those strains are linked to asset speculation, which is currently rife, but they are also linked to the very high levels of investment that China has used to maintain high growth rates.

There is clear evidence that China is starting to fall into the Japanese trap of spending money on infrastructure for the sake of doing it and not selecting projects that achieve the most growth. China needs to increase consumer spending to open up a new growth source but that is not easy because of high unemployment, and consumer spending is only about a third of GDP. Lifting it to levels that cause consumers to drive the economy (as happens in the US) will be a slow process.

The world knows that in the long-term it will be healthier if China can adjust to the new circumstances. But any adjustment will be tough for countries like Australia.

The simple truth is that we are not going to see substantial growth in the US, Europe or Japan in the foreseeable future so our main exports are going to rely on China and to a lesser extent India for momentum. Any China slowdown will affect commodity prices and the Australian dollar.

Right now the Australian share market is priced on the basis that nothing will upset China’s high growth. And while that may well be right for the coming six to twelve months – China has, after all, made these sort of pronouncements before – the latest China bank credit announcement is a clear warning of underling fragility.

This article first appeared on Business Spectator.