‘How China fooled the world’ was the subject of an excellent BBC documentary early in 2014 by senior editor, Robert Peston. The BBC headline was as follows:
“Now, Peston reveals what has actually happened inside China since the economic collapse in the west in 2008. It is a story of spending and investment on a scale never seen before in human history – 30 new airports, 26,000 miles of motorways and a new skyscraper every five days have been built in China in the last five years. But, in a situation eerily reminiscent of what has happened in the west, the vast majority of it has been built on credit. This has now left the Chinese economy with huge debts and questions over whether much of the money can ever be paid back.”
My ‘Chart of the Year’ above highlights one key aspect of what happened:
- China’s auto sales had averaged 550k/month in 2008, up by two-thirds in the 4 years since 2005
- But the stimulus bubble meant they then rose almost 3-fold in the next 5 years, to average 1.5 million/month
The result was that suddenly the world became convinced that China had become ‘middle class’ overnight. Yet in fact, the boom was simply the product of China’s $10tn lending bubble – as I described in our February Research Note.
This Note also highlighted how new President Xi was already reversing this lending bubble. It forecast 7 major potential impacts from this change of course:
- ”Domino effect. US-centric observers have understandably but wrongly assumed that concern over the Federal Reserve’s taper is solely responsible for destabilising emerging economies in a wide arc from Argentina through India and Indonesia to Turkey. Historians, however, will almost certainly recognise these economic tremors as also being an early warning of the policy shift now underway in China
- “Double-digit growth. The leadership have already made clear they intend to bulldoze polluting factories, and devote major resource to cleaning up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth are unlikely to ever return
- “Deflation. Premier Li confirmed in October that maintaining employment was his key priority. China’s producer price index has been negative for 22 months, and it is likely exports will be a key focus for policy during the transition. This will effectively export deflation – as volume rather than profit will be the priority
- “Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, smartphones and relatively high-value chemicals into emerging and Western markets, based on the major new capacity installed in recent years
- “Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to begin to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- “Domestic Demand. Similarly, the focus of China’s domestic demand will change. Sales of high-end western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be on affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/day
- “Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings for use at home – potentially putting upward pressure on Western interest rates”
Today, it is clear that Xi is indeed determined to maintain his Great Unwinding of previous stimulus policies. And the cumulative effect of his new policies on the global economy is likely to be even greater in 2015.
As a result, the outlook for China’s auto industry is already weakening quite sharply:
- 70% of China’s auto dealers are currently unprofitable, according to the dealer’s association
- Dealers’ inventory is rising fast, and is currently equal to 1.83 months of sales, up from 1.46 months in October
- The Toyota Dealers Association has asked Toyota for $353m subsidy due to their inventory problem
- In Jiangsu, Bloomberg reports that some Toyota dealer inventories equal 10 months of sales
- Sales of high-end Western car imports are under great pressure
- The Wall Street Journal reports BMW dealers are currently selling cars at a loss for cash-flow reasons
The chart thus captures the peak of the auto sales bubble, just as it bursts. This is why it is my Chart of the Year.