Superhero has issues of its own
As China's focus shifts inwards, the embattled West cannot expect a get-out-of-crisis-free card this time, writes David Potts.
As China's focus shifts inwards, the embattled West cannot expect a get-out-of-crisis-free card this time, writes David Potts. As the world veers closer to recession, China is warning that this time it can't save it.All boiled down, that's why the markets are so jittery about the European debt problem and the repercussions of a default by Greece.It's just as well the ratings agencies don't rate the world or we'd all be rooned."China's growth has slowed down a bit," the managing director of funds management at Dixon Advisory, Alex MacLachlan, says."It will be less able to single-handedly drag the world out of recession. In 2007 it was the only bright spot. They're better placed [than the West] but the ability to do a Superman is not as clear-cut as before."Just as our biggest trading partner has mothballed the Superman suit, there will be no economic superhero in our second-best friend, either. Ageing Japan is in a debt quagmire of its own though, unlike Greece, luckily the money is owed to itself. But it's more susceptible to a downturn in Europe or the US, let alone both, than almost anyone."There is considerable uncertainty over the future of Japan's economy," the managing director of strategic consultancy at IMA Asia, Richard Martin, says. "The outlook for export manufacturing, the main engine of growth over the last decade, has deteriorated, with cuts to forecast global growth and the yen's appreciation."A global slowdown isn't just inevitable but is happening before our eyes.Unknown is how severe it will become and whether it will morph into a recession. There are "significant downside risks" to the US economy, in the words of the US Federal Reserve Board chairman, Ben Bernanke.Economic growth in Europe is even more sluggish as confidence is sapped by the imminent default by Greece - where the yields on two-year bonds have soared to 65 per cent - which would roll through the European banks like a tsunami. They're already loath to lend to each other, as happened in the GFC three years ago.Instead, bank funds are pouring into the US dollar and US government bonds, which are seen as a safe haven because they are so liquid, despite the ailing US economy and political deadlock over budgetary policy.As deadlocks go, though, that's nothing on the conflict within the EU between the central bank and politicians, and among each other. Our problem is that commodity prices are lined up like ducks in a row whether there's a global slowdown, the US dollar strengthens or, worse, both.Hang on, a slowdown must be bad but what's with the US dollar?Glad I asked. The more money pouring into US dollars, the less going into commodities. In fact, part of the commodity price boom has been fuelled by a weakening US dollar. But back to the recession or, more likely, long slow burn. Our best customerOur dependence on China is indisputable and, by the way, Wayne Swan should be sharing his treasurer-of-the-year award with his Chinese counterpart who threw more at its economy to avert recession than even he did.But can China go it alone?In the last crisis it stopped us sliding into a recession by putting a floor under commodity prices. The government's cash splash, Pink Batts and new school halls building wouldn't have been enough if they'd crashed. Incidentally, China recently had its own Pink Batt moment in the fast train wreck at Wenzhou that killed 39 people, also the result of shoddy supervision.That China's economy is slowing is indisputable and, indeed, is official policy. While it could reverse this, the fact is it would be going into the next crisis with a decelerating economy.The official Chinese news agency says inflation is "alarming", so interest rates have been increasing along with the percentage of bank funds frozen at the central bank that can't be lent as a result.The official target for GDP growth this year is "around 8 per cent", one-third less than the rate it was running at for most of last year or when China rescued the world last time. The annual target for the 2011-2015 five-year plan is 7 per cent, compared with growth of 11.2 per cent a year over the past five years.But it may have been a bit too successful in slowing the economy. Like everybody else, China has fired all its budget bullets, although it does have the luxury of being able to lower interest rates when needed, just as Australia has.There are two rival measures of manufacturing output and neither is comforting for us.Known as the Purchasing Managers Index, the official version has been falling, ever so slightly, for seven months.Then there's the rival HSBC "flash" version, which is supposed to be a preview of the official one and has contracted by more for the third consecutive month.When it comes to statistics in China, the preview can tell you more than the main show.So take your pick - soft or hard landing.Either way, investment in infrastructure is slowing and, due to its earlier stock-building buying spree, China has raw materials coming out of its ears.The new Chinese economyThe worrying thing for us is not just the lower growth rate but where it's coming from. Or rather won't be coming from.China wants to reduce its reliance on exports - the way Europe and the US are looking, so would you - and spend more on its standard of living.That is, make more consumer stuff such as fridges, improve government services and boost the services sector.To build factories and infrastructure so it can export takes a lot of steel, which needs iron ore, nickel and coking coal. But they won't figure prominently when Mr and Mrs Lee use their recent tax cuts and pay rises to go shopping, dine out, take out health insurance or go on a holiday.This re-structuring will be on a scale never tried before.No country has spent as much as 70 per cent a year of its GDP on investment - that is, building plants, equipment and infrastructure.Not even with our mining investment mega-boom will Australia come within cooee of that. But the more pressing problem is that China is as caught up in the global financial mess as the US and Europe.It has a budget deficit, too, though an altogether different kind of debt burden in that it's holding other people's. That is, Uncle Sam's, mostly.China is the biggest buyer by far of US government bonds, which are in an even bigger bubble than commodity prices.Not that it wants to be but it's a victim of its own policy in holding down its exchange rate against the US dollar.So it's had to buy more US dollars, investing the proceeds in US bonds, which are the safe haven of the global financial system.Having bought them it's trapped. If it tried to dump them, it would bring the global financial system down with it, which would be neither good for its exports or Mr and Mrs Lee.But if it allows the renminbi to rise, it'll lose billions from the bonds. Either way, it's going to be wary of buying more.Hidden debtNor is China as debt-free as its $US3 trillion of foreign exchange reserves might suggest.Officially debt is low, standing at about 27 per cent of GDP, but economists suspect it could be as high as 90 per cent because so much has been run up by municipal authorities using land as collateral that doesn't appear in the official accounts.As you'd expect when a local council is allowed to run wild, many of the loans have been wasted on uneconomic projects.But rising land prices also enabled local governments to build steel, concrete and consumer-goods plants.Chinese local media are already reporting municipal authorities in some areas can't meet their interest repayments.Since the Chinese owe the debt to each other, it's just a question of shuffling it from one arm of government to another.But if there are insolvent banks that have to sell land to meet their repayments, the situation could get nasty.Fingers crossed."There's a nagging feeling China will implode, which has very little chance of ever becoming a reality," the chief investment officer of Asia Pacific Asset Management, James Chirnside, says. "It has enough momentum to withstand a significant slowdown in North America and Europe."Continuing growth indicates steady returns from AsiaOUR neighbours to the north are renowned for their holiday and shopping bargains but check out the cheap shares, too.The rout in their markets and currencies in the past two weeks has made them cut-priced, fund managers say.Prices are unusually cheap, even more so compared with growth-challenged Europe and the US.The three biggest economies of south-east Asia Indonesia, Thailand and Vietnam tend to be considered on the economic periphery of China.That makes them sound as if they're dependent on China and potentially as shaky as those peripherals in Europe such as Greece.No way. They're less economic satellites of China than we are. Vietnam, if anything, is a direct competitor for manufacturing.They're growing in their own right at 6 per cent or 7 per cent a year and although Europe is one of their biggest export markets, they're not as dependent on it as is China."They're much more domestically oriented, tending to be a little more insulated," says Alex MacLachlan, the managing director of funds management at Dixon Advisory, which runs the listed Asian Masters Fund. "It's counter-intuitive because you'd think they would be more exposed. We're more of a satellite of China because we are more leveraged than countries like Indonesia."Indonesia and Thailand are well endowed with natural resources "but it's not like the resources sector in Australia. Their economies are far broader," says Singapore-based Hugh Young, managing director of Aberdeen Asset Management Asia.Its Asian Opportunities Fund has returned an average 9.1 per cent a year over the past seven years. "Indonesia and Thailand are in relatively rude health," Young says. "Their companies have strong balance sheets and their consumers are not heavily indebted."Indonesia is especially attractive for foreign investors because some of the largest multinationals such as Unilever and Heineken have subsidiaries listed on the Jakarta exchange, which, until last week, had been one of the best-performing sharemarkets and still leaves ours for dead so far this year."We expect Asia to enter 2012 with a mild loss in growth due to weaker EU and US demand but without signs of contagion from the Euro area or a spike in local risks," the managing director of strategic consultancy IMA Asia, Richard Martin, says.While exports to the West will fall, stable interest rates and intra-region trade will mostly compensate.Growth next year is still expected to range from 4 per cent in Malaysia to 6 per cent for Indonesia."Increasingly there is fast and rapid development of intra-regional trade which will cushion the effects of negative growth in Europe and slow growth in the US," the chief investment officer of Asia Pacific Asset Management, James Chirnside, says. Its Absolute Equity Asia Fund invests in different Asian funds.Despite being "fundamentally in much better shape than the European countries or North America, [share] valuations are much cheaper. Stocks are at a massive discount to developed markets," he says."They're starting to look pretty good again from our point of view."Unless you want to wade into each sharemarket yourself, there are no funds catering for Indonesia, Thailand or Vietnam.Some of the Asian funds have small investments in Indonesia and Thailand. The biggest are Invesco's Asian Share Fund with an 8 per cent allocation to Indonesia and 4.7 per cent to Thailand, or Platinum Asia with 14.6 per cent to Thailand and 2.2 per cent to Indonesia.The best-performing Asian fund in the year to August was 8IP's Asia Pacific Partners Fund, which grew 2 per cent despite the stronger dollar, the same amount the Australian market dropped.