Periodically, the market is rattled by a “China is slowing” narrative. As the accuracy of official Chinese statistics can be doubtful, the real-time market reaction indicates nervousness, but no panic. The performance of the equity markets of China and her major trading partners relative to MSCI All-Country World Index (ACWI) shows that their trends are all flat to down.
How concerned should investors be about a China slowdown and its contagion effects?
Assessing the damage
The economic news out of China is certainly concerning. Bloomberg columnist John Authers pointed out that the six-month average of Chinese growth rates in different categories have been significantly decelerating.
The bad news just keeps on coming. Large Chinese shadow bank Zhongzhi and its affiliate Zhongrong missed payments on several investment products as a result of China’s property slump. The move sparked rare protests in Beijing.
The PBOC unexpectedly announced a cut in the medium-term lending rate by 15 basis points, which unsettled markets. What does the PBOC know that the rest of us don’t?
The offshore yuan, or USDCNH rate, has been weakening and briefly breached the 7.35 level. The yuan exchange rate was not helped by the ultra-dovish policies of the BoJ, which weakened the Japanese Yen and created competitive devaluation pressures in Asia.
Not as bad as it sounds
It may not be as bad as it sounds. In a recent podcast, Leland Miller of China Beige Book, which monitors the Chinese economy from a bottom-up basis, argued that the market has over-reacted to the prospect of the Chinese slowdown. There are two elements of the China slowdown story, a cyclical and a structural element. Miller believes that Chinese cyclical growth is better than the market believes, though he allowed that the structural elements are creating long-term headwinds.
Consider, as an example, Fathom Consulting’s China Momentum Indicator, which tracks Chinese GDP in a noisy fashion. The bad news is that China is indeed slowing. The good news is growth momentum is exhibiting a series of higher lows.
Beijing’s announcement that it would stop reporting the youth unemployment rate, which is at about 20% and a record high, illustrates the long-term structural challenges facing the Chinese economy. This
NY Times article about China’s skyrocketing youth unemployment provides some context. Young educated graduates simply can’t find jobs, which has led to the “lying flat” movement, or the refusal to pursue a career, or consider leaving the country. In response, Xi Jinping advised the young to “eat bitterness” or to learn to endure hardships.
The youth unemployment problem seems curious in light of China’s aging demographics. Birth rates have been dropping and recently fell below the death rate. Why can’t the young find employment in an economy with aging population, which should give rise to strong employment demand?
The answer is a skills mismatch. There are plenty of low-paying jobs, but a lessened demand for the skilled workers that the Chinese education system is churning out. The NY Times article reported that “a 11.6 million college graduates are entering the work force this year, and one in five young people is unemployed”. The skills mismatch and youth unemployment problem illustrates China’s long-term challenge of transforming its economy from relying on low-cost labour as a source of competitive advantage to higher value-added production, which requires more skilled and educated workers.
In the long run, China faces a competitive imperative to migrate up the value chain. Chinese wage rates are already being undercut by its Asian neighbours such as Vietnam and it’s losing its edge in cheap labour costs. As well, the Party has tried to assert greater control over businesses, which as scared away foreign investment. As a consequence of these factors, Foreign Direct Investment has collapsed.
The market reaction
The market fallout from China slowdown fears has been limited. The primary tool for my analysis is the Relative Rotation Graph, or RRG chart, which is a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom left), which change to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.
With demographics turning down, China faces major headwinds. Chinese business model is flawed as well. Lack of innovation and increasingly harsh US policies are starting to have an effect. China started looking inwards a decade ago, when school curricula increased their Chinese language instruction and reduced their English language content (personal observations) at a High School level.
https://www.wsj.com/articles/china-past-peak-demographic-bomb-aging-youth-unemployment-grad-recession-taiwan-34fda75f?mod=hp_opin_pos_2#cxrecs_s
It is similar to the boom bust cycle. A commodity is scarce so they start mining or growing it like crazy and price collapses. Getting an engineering degree does not guarantee you a job unless the degrees are scarce in comparison to demand. So just because they churned out millions of diplomas does not translate into millions of jobs. What we have done is increase the service sector, which means more debt, spending, which creates jobs, however we can’t just spend forever. I don’t know when we started talking about people here with college degrees not being able to get jobs, but it’s been 10 to 20 years I would say.
When you combine this with the Chinese real estate investment method (unless I am misinformed) of people speculating and owning more than one house or apartment is worrisome. When the population is in decline and educated youth is unemployed, who will buy those apartments? That’s a macro meh. Glad it’s not my problem.
Skills mismatch has been going on for a long time and there is also a waste of resources to push people to college route. 20 years ago there were already college graduates working at rental car counters. I also knew one of my relatives who is a girl and graduated from a top college with a major in English Literature and was later retrained as testing tech and working for an electronics company. Today there is another element of expectation dislocation. Newer generation has been conditioned and pampered as “Everyone is Special,” which absolutely is demolished when collided with reality.
My understanding about China is that they graduated a lot of engineering students but majority of them is mediocre. That’s not what we want in today’s highly automated and highly specialized tech scenes. One really outstanding specialist can outwork tens of thousand’s average workers. It is very similar to trying to achieve a quantum leap. If you cannot leap over there is no point of continuing to waste time and resources. It is a “O and 1” world. Like Indians circling a wagon and don’t know how to attack. Do you know that Huawei’s chief tech guy in 5G is a Turk with a PhD from MIT? This guy had some problem when working in US. Huawei recruited this guy and he made Huawei competitive. Huawei has many engineers but they lack people who can go over the hump. I know a group of people just as competent as this Turk. Luckily they are in US, UK, and Canada.
China’s recent Counter-espionage Act has a curious connotation. The enforcement is arbitrary and it is a response to their Rocket Corps’ leaking military secrets. The consequence is that foreigners stopped going to China and Chinese are spying among themselves. Read all the official posters inside the country and you get a feeling China is on the way back to the Cultural Revolution. You are encouraged to expose anyone especially people close to you whom you usually can trust, on any ground, fictional or not, like your parents, teachers, friends, intimate partners …
With China ‘s internal problems piling up it looks like Xi has shortened the time table to invade Taiwan by five years or so. It is getting tense by the day. There just is no other way to avoid the inevitable.
I have a lot of colleagues, scientists who got positions at Chinese research centers and universities. For some of them it is a second job, the primary being at a US or European university. Others moved there after retiring. I have not noticed the trend slowing down or reversing.
Why invest in China? Short term or longer term? I don’t think a compelling case has been made for either.
Structural issues are not getting resolved anytime soon. That is the big cloud over China.
India today is where China was at the turn of the century.
India is a stable democracy, largest population of working age people, well educated, rapidly improving infrastructure and increasing FDI. Corruption and regulatory impediments exist.
Digitization is occurring at a rapid pace.
I am not counting China out but focusing on a very promising opportunity.
https://www.washingtonpost.com/opinions/2023/08/18/china-economy-deflation-debt-analysis/