Practical analysis for investment professionals
23 March 2016

24 Charts: Chaotic China

24 Charts: Chaotic China

I bet you’ve been thinking about China more often than usual over the past few months.


Why focus there? The Shanghai Composite sits right around 3,000 today, which is quite a long way down from the 5,000 it was at three quarters ago. There are big questions to ponder. Think like a Chinese policymaker. With a slowing domestic economy and significant evidence of capital flight, do you focus on a stable currency or a stable monetary policy?

That question has, to put it mildly, some implications for the investment community.

It’s also helpful to note that, on at least one quantitative basis, systemic risk in China is the highest of any country in the world. That’s not much of a surprise to those who are paying attention. More than half of the CFA Institute Financial NewsBrief readers who we polled think that the economy will turn in less than 6% growth this year.

Investors looking for additional context have been studying the most recent report to the National People’s Congress (NPC), but it is also helpful to examine the fundamental differences that China has in terms of market structure. Some things do not look at all like they do elsewhere. For instance, credit analysis requires an investor to be, to some degree, an analyst of state policy.

I was eager to get some perspective on what’s happening and what to expect, so I enlisted the help of Gordon Chang, a peripatetic and knowledgeable observer of the region and a return guest to the Enterprising Investor. Chang is the author of two books and also writes for Forbes and World Affairs.

The format of what follows is relatively simple: The charts and questions come from me, and the answers come from him. Let’s jump in.

Chinese Equity Markets Have Grown Meaningfully in Market Capitalization

Chinese Equity Markets have Grown Meaningfully

Enterprising Investor: Looking just at the growth of China’s market capitalization, it’s an impressive track record. How would the Communist Party of China like us to see this?

Gordon Chang: They’d like you to look at the market as really being modern. Really as a rival to New York, and in some ways it is. For instance, before the collapse of the Chinese stock market last year, the Chinese stock index futures market was the largest in the world. The volume there is very, very big.

The problem is that although you have a lot of money sloshing around China, those markets are not modern. We saw that as the Communist Party tried to rescue stock prices beginning the first week of July. They directly intervened. They criminalized a lot of forms of trading. They prevented the institutions from selling. They directly bought up stock through the so-called “National Team.”

Despite the fact that these stock markets are now about 25 years old, they really haven’t reformed very much. There’s been relatively little progress because the government right now is just dominating the markets. China no longer has functioning equity markets.

As GDP Growth Slows
But GDP Growth is Slowing

We’ve all been told not to trust China’s GDP figures. Can you take us inside the statistics a little bit?

The National Bureau of Statistics reported 6.9% growth for 2015, but very few people now actually believe that. There’s a consensus forming around 4.0%. For instance, you have the Conference Board reporting 3.7% growth for last year.

Capital Economics in London is saying 4.3%. Although, you can make a case for 1% or 2%, especially when you look at electricity consumption, which is still by far the most reliable indicator of Chinese economic activity, and when you look at price data. For instance, for last year, when they were reporting 6.9% real, they were also reporting 6.4% nominal.

China’s officially in deflationary territory. Q4 was really ugly, because Q4, nominal was 5.8% and real was 6.8%. This is a situation going downward. It doesn’t really matter what China’s growth rate is, whether it’s 6.9% or 1%. The point right now is that Chinese leaders cannot change the downward trajectory. China’s growth has been slowing fast. It’s going to continue to do that.

Eventually, it’s going to go into contraction, and that’s a problem because China has accumulated all this debt in order to create growth. In some way, it’s got to pay this debt back. In one way or another, it’s got to retire these obligations. This means that China’s headed towards a debt crisis.

While Debt Grows Meaningfully

While Debt Grows Meaningfully

It sounds great, 50% year-on-year growth, until you realize we’re measuring debt. And again, that’s just as reported by the government, which we’re taught to suspect fudges numbers from time to time. What could the true number be?

Their debt, we don’t really know what it is. For instance, McKinsey Global Institute said, in the middle of 2014, that it was 282% debt to GDP. Soros, in Davos in January, said 350%. Some people are talking 400%, which I think is actually closer to the mark.

This is not a good story. There’s an enormous amount of debt out there. A lot has been stuffed away in corners. We don’t have a really good view of what it is. When you combine that with stalling growth, it means that there’s got to be an adjustment, and that adjustment’s probably going to look like 1929.

Are Domestic Borrowers Preparing for a Devaluation?
fx Are Borrowers Getting Ready For a Devaluation?

It seems like Chinese borrowers are maybe anticipating a currency move. If they were caught offsides with renminbi revenues and dollar debts, that would be really bad. Is that what’s going on here?

Last year, there was $1 trillion of net capital outflow, according to Bloomberg. Other people say a little bit less. A large part of that net capital outflow were Chinese borrowers switching out of US dollar debt into renminbi debt, because they are concerned about the exposure. They don’t want to get caught on the wrong side of a declining renminbi, which is actually happening right now.

Of course, the central bank is trying to support it, but eventually they’re going to have to relent. They will have to capitulate. When they capitulate, it’s going to probably be at the last moment, because they’re going to hold on for as long as they can do so. When they can no longer do so, we’re going to see a run out of this currency.

Trading Volumes and Margin Balances Have Dropped Appreciably
Something Changed Recently

What’s going on with the plummeting volume and margin balances?

First of all, you’ve got to remember that one thing that’s happened since the first week of July, and that is the central government, through various state entities — the so‑called National Team — has been buying up stock. When the National Team buys out stock, it doesn’t trade them, so you’re going to have declining volume.

Also, this is a partial re-nationalization of state enterprises, so this is bad on two counts. That’s why you have volume declining. One thing that’s fascinating: Bloomberg reported that volume of the stock index futures market — which was the world’s largest prior to the mid‑June collapse — volume in the July-August-September time frame declined 99%.

This is an indication of how tough the central government has been, how determined it’s been to support stock prices. They’re going to do everything they possibly can to prevent the market values from tanking, but when they do that, they’re killing volume, and China no longer has a functioning stock market right now. It just doesn’t. It’s the government playing.

What we see in terms of changes in the Shanghai Composite, when they go up, it’s mostly the government. When they go down, it’s when the government isn’t looking.

Zooming Out, You Wonder: What Currency Volatility?

It Can't Just Be the Currency

The renminbi is this big specter that looms over any thought an investor might have regarding China. Recent currency moves have not been that big, if you look at them on a long time horizon.

There has been talk about further devaluation, but what range of values are we really talking about here?

The central bank has said that they’re not going to have a big one-time devaluation, which might make sense. They will continue to support it until they no longer have dollars and foreign currency to do so, which means that when it adjusts, it’s going to adjust sharp. It’s going to be sudden, and there’s no bottom to this market.

They will hold on until the very last moment. They can prevent large downward movements to the renminbi, but they really cannot, I think, do this for that much longer. There’s too much money coming out of the country.

One of the things that’s even worse: There was, in February, a much smaller decline in the foreign exchange reserves compared to January, when it was $99.5 billion. It declined to under $30, about $28 billion in February. That’s because basically no one’s allowed to remit money out of the country. Or, if they do so, it’s under very tight circumstances.

China’s essentially re-imposed very strict capital controls. A lot of these controls are off the books, so they’re not official. This works for a little while, but the problem is: Who’s going to put their money into a country when they may not be able to get it out?

The issue for China is going to be inward flows. Eventually those inward flows will stop, because of what they’re doing to prevent the outward flows.

Forex Reserves Seem to Have Been Spent to Support the Currency
ForEx Reserves are Being Spent to Support It

But Are They Just Replacing Outward Capital Flows?

Seemingly Directly Replacing Outward Capital Flows

The reported declines in foreign exchange reserves I think have been minimized. They give us a number. We can back check it, but it’s hard to do that.

Also, the one thing they’ve been doing is they’ve been engaging in forward transactions to hide the decline in the foreign reserves. They’re going with these derivatives. This is what Brazil did in 2013. It never ends well. Yes, China has a lot of firepower, but it’s declining fast.

Also, some of the funds in the reserves may not be liquid, so, therefore, they may not be available for defense of the currency. There’s a big black box there, and the global financial community just relies on the numbers that China has been giving us. I don’t know if we can actually do that.

Chaos Is Becoming Consensus

Chaos is Becoming The Consensus

This is definitely news. We were joking at the beginning of this. We titled our last conversation, “Is China Going Off the Rails?” At the time, that was not a question many were asking. Recently The New York Times ran a headline saying the answer was yes: “A New Economic Era for China as They Go Off the Rails.” Are enough people talking enough about this? Are too many?

I think that the global financial community understands that there are real problems in China, and they didn’t understand this, let’s say, eight or nine months ago.

For instance, you go back to August of 2015. You have relatively unimportant news coming out of the Chinese manufacturing sector causing big drops in equity markets in Asia, Europe, and the United States. For instance, we had six days in August when we lost $2.1 trillion in value because of inconsequential things happening in China.

Now, when you have bad news out of China, it doesn’t necessarily affect global markets. I think we’re becoming inured to that. Also, I think the global financial community, although it understands there are problems there, I don’t think they understand the dimension of the problems.

They see the Chinese government sort of rescuing things, but they don’t really look behind how that’s occurring and the sustainability of Beijing’s moves. Beijing’s moves: They can do this for a year or two, but the problem is that as they prevent the adjustment, the underlying imbalances are becoming bigger.

As the underlying imbalances become bigger, the inevitable adjustment has to be severe. Chinese leaders are continuing to do this stuff until they no longer have the ability to do that. When they no longer have the ability to do it, their economy will go into free fall. I don’t think the global financial community understands that.

China Seems to Be Moving from One Sort of Outlier to Another
Is This a Transition from One Sort of Outlier to Another?

How much of this is just demographics?

At the moment, they have a massive working-age population supporting a relatively small number of retirees, but World Bank estimates have us right at the inflection point where it heads the other way. By 2050, China will have more retirees than the rest of the world and perhaps a less dynamic population and economy, by extension.

A view that’s forming is that really this is the beginning of the end for them. Is it the case that there are a couple of reforms that they can enact, burn off some bad debt, and get back to business, or are we witnessing a structural decline?

There are structural economic reforms that if they were implemented could save China, but the problem is that those reforms are not possible within the context of the political system that China’s president, Xi Jinping, will not change. The answer is that we’re not going to see the reforms that are necessary.

Indeed, at Premier Li Keqiang’s work report at the ongoing National People’s Congress meeting, it’s clear that they’re prioritizing growth over reform. They’ve basically given up on reform. Yes, they talk about it, but they’re not implementing it.

That means that what we’re seeing is essentially a long, slow decline. Without reform, they aren’t going to be able to make the changes that are absolutely necessary. There’s just no political will to do that.

In fact, if we look at the changes in the economy since Xi Jinping became China’s general party secretary in November 2012, he’s taken China backwards. He’s recombining already large-state enterprises back into monopolies.

We’re seeing the partial re-nationalization of the Chinese economy as more and more state ownership of state enterprises. More state money going to favored market participants. Foreign companies are losing market share, because they’re being attacked by the state.

These are all things that are regressive, so Deng Xiaoping’s policy of reform and opening up is over. We’re going back to a Maoist-inspired economy. That may sound a little harsh, but indeed what Xi Jinping is doing is very reminiscent of what we saw in the 1950s. This is a bad story for China.

Yes, they can stave off problems while they have more and more state control, but eventually this whole thing just fails, as it did before.

You say the recipe is similar to Mao’s in terms of centralizing control. What are some other major points of concordance between what Xi Jinping has been doing and the 1950s period in China?

When we look at it, I think the most telling thing is the re-creation of state monopolies, which is absolutely the wrong way to go. China created growth in the 1990s when they went the other way, when they were breaking up state monopolies, allowing state enterprises to compete with each other.

Now, we’re about a year and a half, two years into a reversal process. That means there’s more and more of these recombinations. That means less and less competition. That can’t be good for the competitiveness of these enterprises except for competitiveness at home.

Of course, the bigger they get with no competitors, yes, they will be able to maximize profits. Only in China, though. Around the world, they’re going to get beaten, because they are losing those qualities of competitiveness that are absolutely necessary to compete in global markets.

Growth in Energy Consumption Has Stalled
Slowing Growth in Electricity Usage

Analysts love to look at electricity usage in China, under a theory that you can’t really trust GDP that much.

For 2015, electricity consumption increased by 0.5%. Generally speaking, GDP growth has been about 85% of the growth of electricity. We’re talking a pretty low GDP number.

Of course, electricity’s only one indicator, but there are others that corroborate, essentially, a no‑growth environment. If we go back to the last downturn at the end of the 1990s, a lot of people were saying electricity was no longer so indicative. Afterwards, after that downturn passed, people went back and realized electricity was indeed still the best indicator.

Now, people are saying there’s a move away from manufacturing to services, so therefore electricity is not as important as it once was. There may be a little bit of truth in that, but nonetheless, when you look at all the range of indicators that we have, electricity, I believe, is still number one.

We’re seeing so many other signs of minimal growth that I think electricity still is telling us what the Chinese economy is doing.

And Rail Volume Has Fallen
And There's Less Stuff Moving Around

How relevant is rail freight volume?

Rail freight was one of the three indicators that Premier Li Keqiang mentioned as the things that he looked at when he was a provincial party secretary. This is going back to 2007, when he was talking to the American ambassador.

This was in a WikiLeaks cable. The three things he mentioned were electricity consumption, rail freight volume, and bank lending. Rail freight volume is something we can measure. It’s something that is easy to verify, and we see it going down.

People say, “Well, more stuff is being moved by truck.” Maybe, but nonetheless, the decline in rail freight volume is especially troubling because it is so large, these percentage decreases. I think that, essentially, we’re looking, again, at another factor showing basically the contraction of the manufacturing sector.

I think the manufacturing sector is contracting. It did last year, 2% or 3%, maybe a little bit more. There may be an increase in services, but not nearly enough to make up for the decline in manufacturing, especially because the central government devastated the financial services industry beginning in the middle of July, when they tried to rescue stock prices.

A lot of things are going in the wrong direction right now. Not everything, but a lot of them.

We’ll get to the stuff that’s going in the right direction in a little bit.

That’s a one‑minute discussion.

It seemed a bit that way when I started digging through the data. What is going in the right direction?

There are more retail sales, certainly not as much as the central government statistics indicate. The problem with the increase in consumption, I think, is that it’s basically a derivative of growth elsewhere, especially growth of investment.

Investment growth is completely unsustainable. It’s anti‑reform. When investment growth starts to choke even more than it is now, I think it’s going to take consumption with it. What we’re seeing from consumer products companies is some growth, but not very much.

A lot of people like to report, “Oh, say, well, the growth of volume over Alibaba’s platforms and, online retailers,” but they’re really taking away sales from bricks and mortar. When you start to look at companies that sell across both platforms, online and offline, there really is unimpressive growth or even some contraction in the earnings of these companies related to China.

There’s some positive story there, but it’s not enough to counteract the collapse of manufacturing.

The Export Picture Is Grim

A Grim Export Picture

Should we be taking the recent export numbers as an accurate signal?

There might be a little bit of distortion related to Chinese New Year, but when you combine January and February numbers for both imports and exports, they’re both down deep in the double digits. That eliminates entirely the New Year effect.

Trade is just disastrous. You notice that Premier Li Keqiang, in his work report, didn’t have a target for trade this year. That’s the first time, I think, ever. For the last four years, they have not met their target.

Last year, their target was 6% growth in exports and imports combined. It actually came out down 8%. They missed by 14 percentage points. It’s not getting any better, as we saw from January and February.

This is a real indication of problems in the Chinese economy. The import number, I think, is the more important one because that reflects manufacturing demand, and it also reflects consumer demand. You have some pretty atrocious‑looking numbers coming out of imports and exports.

Certainly, just looking at this chart, even if you take the 12‑month average, it’s negative. There’s a very senior person on Bloomberg saying, “Oh, no, it’s not that bad. It’s only down 4% on average all year,” which seems like a spurious argument.

Aluminum Consumption Fell Sharply
A Sharp Drop in Aluminum Consumption

Is there anything in particular to be made about of the drop-off in aluminum consumption?

That’s a reflection of contraction of manufacturing. You’re going to see that in steel and coal statistics as well. That’s pretty much across the board in the manufacturing sector.

It Appears China Is in an Industrial Recession

Industrial Recession

The satellite index is the most negative and, presumably, the most reliable.

It’s hard to hide from space. The satellite indices have been the most negative, but even traditional ones, the one done by Markit, the London‑based research firm, it’s just been continually negative in manufacturing.

Even their services indices, which are still above water, they’re heading towards the contraction point. This is an economy which is slowly grinding to a halt.

If they devalue their currency, presumably it makes their exports more competitive?

Yeah, but they can’t do that. The reason is they will trigger even worse capital outflow. They’re basically prevented from doing that. Donald Trump says, “Well, they’re manipulating their currency to help their exporters.”

Yes, they are manipulating their currency, but they’re keeping it at an artificially high value. They have to do that to prevent capital outflow. It’s basically our exporters are being helped by China’s currency manipulation now, which is a reversal, of course.

Traditionally, China kept its currency below its market value in order to help exporters. Now, it’s keeping it above market value.

Industrial Profits Aren’t Growing

Long-Lived Profit Recession

How does the government talk about the stagnation in industrial profits?

They don’t. I think earnings, as reported out of Chinese companies can be a little bit not as reliable because of the nature of the accounting profession and other things. Nonetheless, it’s more reliable than what comes out of the Bureau of National Statistics because some of those numbers are completely made up.

It’s just fantasy land. At least with the accountants, they’ve got to at least have some responsibilities to the market. Therefore, it does give us a better window into what’s actually happening.

This is true at the revenue level as well. If you look at the Shanghai Composite, revenues are not growing. This is also true of indices in the States. In many ways, it’s the elephant in the room for global equity markets. Is there a way out of this?

I don’t think there is a way out of it. I think that they’re heading to that adjustment as the Chinese economy continues to slow. Especially when it gets to that contraction point, where it’s very close already, then I think we’re going to see a lot of things happen very quickly.

They’re just hanging on right now, and they’re able to do that. They can slow the inevitable, but they can’t prevent it because they have not been able to repeal the laws of economics. That’s why they’ve now got this fight with Moody’s over their ratings.

That just shows, Moody’s said, “Look, you can’t have the impossible trinity.” China then gets outraged that Moody’s would ever say that. What China’s trying to do is say, “Well, oh, the laws of economics do not apply to China.” They do apply. They apply differently because of the degree of state control, which is becoming more and more state control, but nonetheless, they cannot prevent the inevitable.

Non-Performing Loans (NPLs) Are Booming

Booming NPLs

Does this headline increase in non-performing (NPLs) capture the reality?

The numbers have gone up, but the reported number is not nearly as high as they, in effect, are, because people are not applying international standards.

A lot of this stuff is being rolled over, and so, therefore, it’s being counted as good. It’s only good because banks have been ordered not to call in loans. This means we’ve seen a lot of credit growth, but we haven’t seen growth in the economy, which you would expect.

As interest builds up, you have to lend more and more just to roll over what exists. That’s what occurring now. If you were to actually apply international standards to the loan books of these banks, we’d be seeing NPL ratios of 20%–30%, easy.

Banking Assets Are Ballooning

Screen Shot 2016-03-22 at 11.24.11 AM

We’ve got overall banking assets that have slowed to “just” 40% growth year on year.

It’s crazy. It’s absolutely crazy. What they’re doing is they’re just throwing a lot of money. People say, “Well, look, they’ve got a relatively high reserve requirement ratio for the banks, and they’ve got relatively high interest rates.”

They say, “Therefore, they have a lot of ammunition.” No, they don’t, because you can throw more money into this economy, and it isn’t going to do any good because there’s a fundamental lack of demand for money.

Yes, the government will build infrastructure, and yes, technically that does create gross domestic product, but it’s only government directed. Private businesses just don’t have a need for money, unless it’s connected to some government infrastructure or other government program.

That means, essentially, that it isn’t going to work. You throw more money in this economy, you just have more money. You don’t have more growth.

It’s a sad state in the world, when you think about it, if people are sitting around going, “Oh, you know, I don’t need more money.” That says a lot.

That says a lot. China’s not the only country with that problem, but their problem is so much greater than our problem here in the States, for instance.

Did a Memo Go Out?

Did a Memo Go Out?

The all‑system financing aggregate hit an all‑time high, after having been trending downward. Is this just evidence that the government is opening a spigot somewhere?

Absolutely. They’ve done this before, and they say they’re not going to do it again, because Premier Wen Jiabao, who authorized the stimulus program in November 2008, he put too much money into the economy.

He created about as much credit in five years as the entire US banking system, even though in November 2008 the Chinese economy was less than a third the size of America’s. Everyone said, “Well, look, that’s not what we should be doing.”

They say, “Oh, no, no, no, no, we’ll never do that,” but of course, that’s exactly what they’re doing. A memo did go out. Everyone was told to lend, and this is what we got. We got a lot of money supply.

Real Estate: Supply Crunch?

A Supply Crunch in Real Estate?

If you look at the leading indicators of inventory, like land purchased and the actual amount of real estate that’s under construction, you see it trending down. Meanwhile, you see a 50% year-on-year increase in the price of one square meter in a Tier 1 city.

Tier 1 cities, there is still demand for real estate. There’s no question about that. When you start going to Tier 3 cities, there’s just enormous amount of supply, and there’s very little demand, so it’s a bifurcated market.

If you’re in Beijing and Shanghai, you have a relatively healthy real estate market, and prices are still going up. You start to get out of China’s major cities, and there are real problems. What they did to create growth in the past was just to build, build, and build, and now they don’t know what to do.

Even in places like Guangdong Province, which is a relatively prosperous, modern province, you now have calls for state enterprises to buy apartments, because that’s the only way they can do this to solve their problem, use one state entity to bail out another.

There’s a real problem once you get out of Beijing, and Shanghai, and Guangzhou.

Where I live in Brooklyn, a million bucks buys you a fixer‑upper, but travel 500 miles in any direction and you can have almost whatever you want for that price. Is that the analogy?

That’s the same thing, yeah.

A Retail-Driven Bubble?
A Retail-Driven Bubble?

I want to ask you about retail investors and the domestic stock market. One of the things you notice when you look into it is there’s this incredible boom in the number of trading accounts that were opened in the mainland. Then, the government discontinued the statistics on it.

About two or three months after they discontinued the statistics, the Shanghai Composite hit its recent high. Did we see recent inflows of retail investors who were basically gamblers? Is that what’s going on?

There was a lot of that, especially because when you start to go back to September 2014 or so. Keqiang’s policy was to talk up the stock market. You did have a lot of retail investors start to go into it, especially when prices started to move up. That created momentum.

That’s why you have a sharp increase in the number of retail accounts in the first part of 2015. Then, of course, June occurs. You have the beginnings of real problems. The markets start to turn down. Then you have retail investors start to leave, because they’ve been burned, lost their money.

I think that a lot of it was retail driven, but also, there’s Chinese institutional money in there. Even some foreign money’s starting to flood in when they saw the markets turn up. There’s a lot of stuff going in, but the real sensitive stuff was the Chinese retail investors. When they get burned, that becomes a social stability issue.

Why Do Vehicle Sales Keep Growing?
Why Are Vehicles Still Selling So Well?

Vehicle sales seem to be a bright point though.

Vehicle sales have done really well. Vehicle sales started to tail off last summer, but they’ve recovered. Right now, they’re starting to turn down again. This has been a real pillar industry, and we have seen state enterprises go out and buy vehicles in the hundreds. They then store them. That’s called lot rot. There’s been a certain amount of that.

Nonetheless, there’s no question that vehicle sales have held up well. Either you see the wealthy in Tier 1 cities buying cars at a pretty healthy clip. I don’t think that’s going to last, but, nonetheless, it is one of the bright spots.

So Bad It’s Good?
So Bad It's Good?

There’s some sense that we’re getting totally used to the negative economic surprises that are coming out. Our expectations are low. Maybe the news is so bad it’s good on China. I wonder how you’d react to that statement.

Apart from what we saw in August and September last year when it was, as I mentioned, unimportant news really triggered very big falls in equity markets around the world. Now, I think people are not focused on China. They’re focused on problems closer to home.

I think that’s what’s really driving markets right now much more so than that. When China starts to have real troubles, then again, we’re going to see the same phenomena that we saw last August and September. Again, I don’t think that bad China news has really been discounted.

A lot of people still say low sixes for growth. People are saying four, which the consensus is now at. If it really is closer to one or two, then clearly they haven’t discounted all the bad news. When it gets to zero and negative one, watch out.

Presumably there’s even a threat to the government’s ability to stay in power at that point.

People talk about that right now. I was on a panel for a bank with Asian connections in Boston [several] weeks ago. Afterwards, a young Chinese woman came up to my wife, and she’s the type who would come to the United States, get an education, work five years, and then go back to China for their career.

She told my wife, “I’m not going back. None of my friends are going back. My friends in China are saying this government might not last.” Yeah, there’s a lot of talk about that right now among Chinese themselves. There is a real issue about where this is going to go.

Can the Government Keep Growing Revenues?
Can The Government Keep Growing Revenues?

One potentially reassuring thing is that the government has done a decent job at actually growing its revenues, although it’s grown debt much faster.

Spending is growing much faster than revenue growth.

Yes, there was revenue growth in 2015, something on the order of, I forget exactly, like 7% or 8%. Fiscal spending last year, according to the government itself, was up 15.8%. There’s a pretty big gap there, and those are official numbers. Who knows what the real numbers are.

We know that a lot of central government spending is not disclosed in the central government’s budget. Military, for instance. A lot of military expenditures are not there.

There have been fantastic increases in fiscal spending. Last October, fiscal spending year on year up 36.1%. November it was up 15.9%. They didn’t disclose December, and I don’t blame them, probably because it was pretty bad. This is an out of control spending government.

While it’s good for them that they’ve got some revenues and they’re able to drive that line higher, they’re not able to drive it as fast as spending.

You’ve got to remember that in the work reports that we’ve been seeing at the National People’s Congress meeting, they’re increasing their deficit from 2.4% of GDP, which is what they claimed for 2015, to 3% this year.

Now, 3% is a psychological line, not just for the Chinese but for others. China is probably going to bust through 3% in reality, because they don’t disclose all their spending. Who knows what they’re going to be next year. This is not going in the right direction.

I realize I haven’t asked you at all about security. China’s neighbor and a critical part of the global security question is North Korea, who’s been testing their nuclear weapons . . .

And long‑range missiles.

. . . and threatening to use them preemptively. How should we be contextualizing that? Will China be an effective partner in working with the North, and what really can be done there?

I don’t think so, for a lot of reasons. First of all, the China and North Korea relation has eroded, especially after the execution of Jang Sung‑taek in December 2013, because Jang handled relations with Beijing.

The real problem is you’ve got a government in North Korea, a regime, where you have Kim Jung Un, the ruler, feuding with the military, which is still the most important institution in North Korean society. It’s unstable, and I don’t think the Chinese or anybody else can actually have much influence where you have intense infighting.

Plus, also, you’ve got intense infighting in Beijing. Not as bad as it looks like in Pyongyang, but, nonetheless, this is an unstable situation as well. You’ve got two governments right now that are starting to splinter, and that means that north Asia is exceedingly dangerous.

That’s not great news, but thank you so much, Gordon, for sharing your view and for spending time with us. I’m sure Enterprising Investor readers are quite pleased to have your perspective, as well.

Thanks so much, Sloane.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Sloane Ortel

Sloane Ortel is the founder of Invest Vegan, an ethics-first registered investment adviser that manages distinctive discretionary portfolios of public equities on behalf of aligned individuals and institutions. Before establishing her own firm, she joined CFA Institute’s staff as a sophomore at Fordham University and spent close to a decade helping members adapt to a changing investment landscape as a collaborator, curator, and commentator. She is also a co-host of Free Money, a podcast for sustainability-oriented investors with a sense of humor.

14 thoughts on “24 Charts: Chaotic China”

  1. Abdul Basit (level 2 candidate) says:

    Really liked the article. It was so comprehensive and simple. A few days back when i read that China’s economy is slowing down, i really wanted to know the reasons and possible outcomes. This really helped me.

    1. Will Ortel says:

      Abdul —

      I’m so glad it helped! Many thanks for reading.

      Cheers and all best —


  2. Arka Bose says:

    ‘Investment growth is completely unsustainable. It’s anti‑reform.’- Why does he say that? Does it applies elsewhere as well?

    1. Will Ortel says:

      Hi Arka —

      Whether investment growth is sustainable or not has everything to do with the intention of the person or entity that provided it. There are no hard and fast rules, but in general If the investment is made freely and in pursuit of a rationally achievable return it makes sense to view it as sustainable..

      In china’s case, nearly 50% of GDP comes from investment, and there is a solid argument that a significant portion of that capital is provided in one way or another by the government. That is not bad in and of itself, but the extent of it is certainly troubling.

      I’m not aware of any other countries with situations roughly analogous to China, but it’s always worth looking at where capital is coming from and asking whether that flow is sustainable.

      Cheers and all best —


  3. Pan says:


    I don’t think there’s agreement as to how quickly bank assets have grown. Your chart shows them more than quadrupling since early 2012. The time frame seems too short, which is why the annual asset growth is so astronomical. Other charts show that assets have indeed quadrupled, but that’s going further back to the financial crisis and the post-crisis stimulus of early 2009:

    Banking assets, also, aren’t entirely loans. A better gauge of the country’s debt situation is from McKinsey’s global debt report below, page 10:

    It has China’s total debt quadrupling from $7 to $28 trillion, or from 158 to 282 percent of GDP, from 2007 to mid-2014.

    Granted, this growth is still staggering – China’s banking sector (not even including most of shadow banking) has grown by almost twice the entire US banking sector since before the crisis.

    Kyle Bass, in making his wager against the yuan, apparently is closer to your banking assets chart: he notes that the bank sector expanded 11.5-fold in a decade, from $3 to $34.5 trillion:

    That implies a roughly 7-fold increase since the onset of the financial crisis (Q3 2008).

    Additionally, you’ll note in the first Zero Hedge link above that the highest independent estimate of NPLs is 21 percent, so Gordon’s assertion of “easily 20-30 percent” is on the high end. (He’s been waiting for China to collapse for 15 years, so that’s his bias.) Chinese banks and bank investors typically use a 10 percent bad loan ratio when making lending and investing decisions, respectively.

    On the other hand, even an unsanctioned Chinese officials’ report estimates that the country wasted a whopping $6.9 TRILLION of investment:

    That would be anywhere from 33 to 40 percent of the total credit expansion post-crisis (post-stimulus).

    Last but not least, it’s simply incorrect to apply Western financial standards to what essentially remains a communist system. The very argument that people like Chang and Bass use to argue that a banking crisis is inevitable – that most lending is a political rather than commercial decision in China – is also the reason why it simply won’t blow up like the Western financial system in 2008. Were it not for all those trillions of capital misallocation, the communist party wouldn’t be in power, and the 60 million state workers which form the core of its economic support base won’t have survived.

    If you’re betting against the Chinese economy (i.e. its financial system or currency), you’re essentially betting that the communist dictatorship will lose power. Gordon Chang at least has never been unclear on this point. That’s where his argument is fundamentally flawed, IMHO. Even if things get much worse, the regime has the means to crush any credible opposition. Xi is willing to sacrifice the wealthy elites for the rural and working masses – he doesn’t mind seizing their assets to redistribute to the general population, since it’ll be perceived as part of the anti-corruption campaign. At worst, the elites and best and brightest will all flee abroad, but the party has always been prepared for this anyway: when the West urged them to democratize in the early years of reform and opening, they simply answered, “So, you want 200 million of our people landing on your shores?”

    I don’t think Americans and Canadians will be pleased to see more cities end up as unaffordable as Vancouver, what with all the influx of Chinese people and cash.

    1. Will Ortel says:

      Hi Pan —

      Thanks for reading, and also for sharing your thoughts!

      A few points:

      – I strenuously disagree that betting or thinking negatively about the Chinese economy necessarily implies a view that the government will lose power. It is possible to observe slowing trade and growth and simply incorporate that into the range of estimates one uses for other things, for instance. An analyst doing work on a Chinese company would be foolish to ignore signs that the economy is slowing.
      – The government appears competent and may well remain in power forever, but there are many ways to stay in power. I believe that the government will do all it can to support its domestic economy, but there are limits to government stimulus and the effectiveness of government interaction. I also question any investment thesis that relies on that degree of stability. History does not work that way. I suggest you read this from Harvard Business School professor Rawi Abedlal for some more color there.
      – I agree with you that there isn’t broad agreement about how large the Chinese financial system is. Where possible, all of my charts use official statistics provided by the Chinese government, which came straight from Bloomberg. Here is a 31 march 2015 SNL financial report which is undoubtedly derived from the same time series.
      – Whether Gordon’s estimate is on the high end or the low end for NPLs, the official statistics show an NPL ratio of .5%, which is somewhat on the low end 🙂

      I’m not sure I follow your conclusion, but I want to stress that I didn’t conduct this interview to exhort people to bet against China. The country is immensely significant to global investors and economic trends there are, on the surface, not good. Consider for a moment that an NPL ratio of 5% would be 10x the currently reported number, while still being a quarter of the aggressively negative estimate that you’ve found.

      The country is immensely dynamic and there are doubtless many great businesses that are being built there today.

      But in aggregate, its growth is slowing — there is no credible disagreement on that point.

      Cheers, all best, and thanks for reading —


  4. Kedarnath says:

    Well, China has always surprised the world. I am sure they will come out with some government measures. This article assumes that capitalism is penacca for all problems in world economy. I dont believe so. We are facing an unprecedented and uncertain future. Balance between Keynesian and free market economy seems essential at this stage. I think, China is good at that.

    1. Will Ortel says:

      Hi Kedarnath —

      Thanks for reading. I agree that china’s growth has been spectacular and surprising. I personally do not believe that any approximation of true free market capitalism is either in existence or desirable.

      Governments undoubtedly have a role to play in supporting their populations when the economy slows, and I expect the Chinese government to make quite a competent intervention within the limits of what is reasonable.

      I would caution against a belief in an unspecified positive action though. “They will do something” is likely true, but you owe it to yourself to tease out the nature of that something a bit more.

      Cheers and all best!


  5. Wilfried says:

    Great article! I liked the way that you explained each sections. I’ve studied in China for 4 years and I know how much it’s difficult for collecting Chinese data in economic field. That’s also one of the reasons why they will surprise always the world, because they don’t disclose all the informations for helping analysts to analyze the current situation and predict the Chinese economy future.

    1. Will Ortel says:

      Wilfried —

      Thank you for reading! I personally am skeptical of the notion that there is a substantial amount of undisclosed good information about the Chinese economy. In my experience, it’s usually a lot easier to find positive information than negative information when a significant apparatus exists to distribute and reinforce the positive.

      Cheers, and all best!


  6. John says:

    Hi all,

    A very critical piece indeed. What happens if China government is telling the truth? And everything turns out really well for China over the course of this century? I personally China is rising and will continue to do so even while analysts talk, talk and talk. How else are they supposed to fill their time? And make use of all the pent up critical thinking skills that need a good exercise.

    1. Will Ortel says:

      Hi John —

      Thank you for reading. I’ll surprise you by agreeing with you — over the course of this century, China and the rest of the world will likely do just fine.

      However, I would point out that the bulk of the data presented here in the charts comes directly from various Chinese state agencies via Bloomberg. So if you believe that they are accurate there is still a hard truth that bears acknowledgement: things are slowing down. Things can be fine for individuals people in an economy even as providers of capital suffer from a re-rating of their contribution during a slowdown in growth.

      Cheers, and best of luck!


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