The most important idea of ​​keeping China's economy together is being tested like never before

The most important idea of ​​keeping China's economy together is being tested like never before

With each passing day, it seems more likely that the US and China can not avert a trade war.

On the US side, President Donald Trump recently announced his willingness to impose tariffs on all Chinese exports to the US by January. Meanwhile, The South China Morning Post in Beijing reports that think tanks are struggling to keep honest discussions with legislators on how to handle trade negotiations. They fear that criticism of the Chinese economic model or the government's previous trade talks could get them into trouble.

From today's perspective, Frank Kommunikation seems to be in short supply everywhere. One day, Chinese President Xi Jinping and Trump seem to be chopping it out; The next moment the market slips off again.

This year has already been a difficult year for Chinese business leaders. After a solid start to 2018, the country's economy began to slow down dramatically in the second half of the year – a long-awaited outcome of the reform of the Chinese financial system, an attempt to free itself from the debt crisis that has fueled the economy ,

Analysts were expecting this type of hiccup. Beijing has been preparing the world for years for a more volatile, slow-growing Chinese economy, and has largely convinced the world that it can handle it.

However, they did not expect the additional pressure of a trade war – the drama of continued failed negotiations – to exacerbate the situation.

"For China, the signs of further growth slowdown and the threat of widening US tariffs are an unfortunate combination," noted Bloomberg chief economist Tom Orlik. "So far, Beijing has managed to find a policy that combines targeted incentives with reform steps, and as demand continues to deteriorate, it becomes harder to thread this needle."

Now, China's currency, the yuan, has fallen to the lowest level against the dollar for a decade, and Beijing has pledged to fight to keep it afloat. China's real estate market, the engine of its economy, is shaking as real estate sales fell 3.6% in September, and real estate investment – half of the country's total investment – is likely to follow. The stock market collapses – the Shanghai Composite has fallen more than 21% since the beginning of the year – and warning signs in industries such as automobiles and manufacturing are flashing.

This is a test for the brains behind China's economy. Since the late 1990s / early 2000s, it has not been so weak in the face of a potential disaster. The way that politics handles it could change the way the global financial community thinks about their ability to manage crises.

This could turn into a crisis of faith that challenges the main idea that holds China's economy together – I call it the theory of the "Chinese economy" they "have."

Chinese President Xi Jinping.
Lintao Zhang / Pool / Getty Images

Chill, they have

The theory of "they have this" of the Chinese economy is this: While democratic capitalism is beautiful, authoritarian state planning has advantages – and one of the benefits is that the brightest people with all the answers guide China's economy. They can guide it as they please, and so far they have adopted the right policy mix to avert all the little disasters that have been happening since the beginning of the true economic claim in 2015.

In the event that something big happens, do not worry, "they have that."

They hear this thesis in academic circles and at hedge fund conferences and thinkers in particular think tanks. Even the famous investor Ray Dalio – founder of the world's largest hedge fund Bridgewater Associates – is a proponent of this view. While in China last February, he preferred to avoid direct questions about the economy, The Wall Street Journal said. He said he was "very optimistic" about China, and that the problem was not the challenges, but the way they were treated.

And Beijing has the best dealers in the business, according to the theory.

On the other hand – and this post is very much about – what happens if they do not? This "they have this" type thinking was after all the reason why the USSR was such an economic success until it was not much. That may be the case for China.

Now that a highly destructive trade war has gotten into the mix with an already complicated reform agenda, the prospect of Chinese politicians losing the "they have this advantage" of doubt is very important.

In the Center for Strategic and International Studies, authors Logan Wright and Daniel Rosen examined the slow emergence (and potential destruction) of China's "they have this" narrative in an article entitled "Creditworthiness and Credibility, Risks to China's Resilience".

They explain it this way:

"Traditional explanations of China's financial stability underestimate the crucial importance of Beijing's credibility to ensure a sufficient government response to any financial stress, credibility was a strong political asset that strengthened financial stability, but it is not essential to China's system.

Credibility is a by-product of a track record of successful and meaningful interventions that defend the interests of investors. This credibility is being tested as China reforms its financial system and withdraws from widespread implicit and explicit guarantees for assets, companies and banks.

The credibility has helped Beijing cope with the typical effects of rapid credit expansion, but this credibility is temporary and will be taxed in the near future as financial reform progresses. "

Stop, you make too much

Now comes the trade war.

Current, unexpected circumstances are forcing policymakers to return to what they have done in this situation and undermining their credibility – credit conditions are being relaxed.

On the one hand, Chinese news agencies assure investors that the economy is still on the path of reform and that despite a dire situation they will stick to their weapons.

On the other hand, there are signs that politics may be heading in the opposite direction. Societe Generale analysts said local government bonds rose sharply in August and September. Earlier this week, the People & # 39; s Bank of China issued further guidance on increasing infrastructure investment. At about the same time, the Chinese Banking and Insurance Supervisor asked banks to increase their loans to unsecured or unsecured loans to private companies.

To be fair, private companies in China are now not in the same debt problem as their massive sovereigns (SOEs). Policymakers say that the stimulus efforts they have made so far (such as a recent tax cut) are targeting private companies and households. Therefore, they are not a return to old habits, and they will not strengthen "zombie" companies – profitless state-owned companies that need credit to survive.

China has a "whole-of-society" view of national interest in all areas and has set itself the goal of pooling all resources of its economy in the face of this debt crisis. For example, the government has urged sound private companies to acquire ownership of troubled state-owned enterprises in the past.

In any case, recent data from the private surveyor China Beige Book contradicts the government's line that only private companies receive credit assistance.

"The absorption of corporate bonds has not slipped – it exploded in the third quarter to the highest level since 2013," the company said in its last quarterly report.

"There was likely to be a rise in borrowing from small and medium-sized businesses, with PBOC appearing to be pushing so much each week, but in the quarter everyone has taken out more loans, and big companies have seen their loans skyrocket while the PBOCs are picking up Borrow real estate companies on a 5-year high. "

Perhaps this is the reason why Societe Generale analysts recently noted a "puzzling strength in manufacturing investment", although manufacturing output dropped from 6.7% in the second quarter to 6.0% in the third quarter and remains in one Downtrend is located. It also seemed strange to them that real estate investments were still resilient despite declining real estate values.

"They said the debt relief is irreversible, but they have already reversed it," Leland Miller, founder of China Beige Book, told Business Insider over the phone.

"They have come back to their old formula … it's not 2009, 2010, but it's remarkable to hear the narrative – which means that conditions are tight and companies do not get credit, they invest much more than what people do Official data is more negative than what we saw in China Beige Book Q3. "

Societe Generale

A downturn with Chinese characteristics

Obviously, what the government is doing has not been enough to overcome the economic slump in China, suggesting that the introduction of new lending to the economy is becoming less and less efficient as debt increases.

But what else to do? Things could go awry before the US and China come to any kind of agreement at this meeting with Xi and Trump at the G20 later this month.

For example, China's export figures looked good in part in September, as exporters were in front-loading orders ahead of further trade wars off the US. That is, we have not even seen the full impact of Trump's trade war measure in the data.

Meanwhile, we see personal consumption – something the Chinese authorities have been trying so hard to modernize.

From the Societe Generale:

"Third quarter data suggest that domestic demand – mainly consumer demand – slowed growth during the quarter and more than offset the improvement in net trade.

The past contribution of consumption (including households and governments) to overall GDP growth declined from 5.34 pp to 5.23 pp, while net trade increased from -0.67 pp to -0.66 pp. "

This is particularly troubling for China this week. On Monday, Xi launched a six-day exhibition in Shanghai to showcase the country as a buyer of international goods. Unfortunately, the event was badly visited, according to the New York Times. Large trading countries such as Germany, Japan and the USA did not show up. One participant, the president of Kenya, complained that his country's trade relations with Beijing were "heavily biased in favor of China."

China needs more than ever friends – more friends who still believe that they have.

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