Q: At the end of 2008, you said you were worried about the prospects for the Chinese economy in 2009. How do you see what has happened since then?
A: We need to take it within the context of what’s been happening globally. Obviously there’s been a massive public response to the crisis in 2009, and this has lowered interest rates to unprecedented levels and raised government debt to unprecedented levels. That has produced a huge amount of excess liquidity within the global economy because the real economy has not done very well. There’s been a huge amount of money printing and central bank injections into financial companies looking for a home.
China has sadly been a beneficiary of a huge amount of that foreign capital. This has added to the government’s inflationary policies and pushed loan growth and money supply growth to the kind of levels we’ve seen this year. If I was worried about the Chinese economy this time last year, I’m doubly worried about it now given what’s happened.
Q: We haven’t seen the currency devaluation against the US dollar that some were expecting…
A: No, they didn’t need to devalue their currency. If we knew what was happening in the export sector I think we would find that there has been massive reduction in activity, which has been papered over by the inflationary monetary response. I would never have foreseen that they would allow money supply growth and loan growth to get to these kind of levels. Our view was that they would use the currency to try and maintain economic activity. Instead, they’ve just used inflation.
So they’ve built out capacity. There’s been a further increase of 33-35% in fixed-asset investment, which is feeding the overcapacity that already existed in China. It creates economic activity, but the question is whether or not that economic activity is ever going to be profitable.
My own view is that what will happen next is the emergence of significant consumer price inflation. There’s still plenty of overcapacity, but not in consumer price areas. The amount of money that’s sloshing around in the system is likely to push consumer prices higher, along with asset prices and property prices. This will elicit a response from the government to try and tighten monetary policy, which will have an adverse impact on economic activity.
The one thing that China has been waiting for is a recovery in US consumption, and it’s not coming. The real danger for China now is that, in order to keep activity levels as high as they have been over the last year, it needs to increase the inflationary policy response, which will push money supply growth up more than 30%. In actual fact, I think money supply growth is going to be significantly slower, and there’s going to be very little in the way of external demand and much less in the way of private capital flows coming from the West.
So 2010, I think is shaping up to be a pretty tough year. China might find that although there’s not very much activity in the global economy, it’s actually got to start tightening rather than loosening policy because of an inflation problem.
Q: For the time being, Beijing is still talking about staying the course.
A: That’s what governments always say. Governments are very predictable beasts – they never actually tell you the truth about anything. They only tell you what you would expect to hear. Governments never forecast recessions, for example, which means that they’re amongst the worst forecasters on the planet.
They will stay the course as long as things don’t begin to fray around the edges, but I think we already know that they’re fraying around the edges. Hence the reason they’re having to reimpose some controls over property. You’re hearing people like the chairman of Vanke say that there are problems in the property market, that land prices are way too high given what the likely selling prices are going to be in the next five years.
Equity prices have not recovered their levels of two years ago, but some of these companies coming to market are pricing things at 25, 30, 40 times earnings. That’s just bubble-type equity listings. Emerging markets really should be listing companies at 10 times P/E, and no more than that. In China it’s two-and-a-half, three times that.
The biggest signal of all, of course, is the extent of loan growth and monetary figures. They say they’ll stay the course, but what they mean is that they will stay the course as long as there’s no consumer price inflation.
Q: Going back to the renminbi, you said that you had expected Beijing to use currency rather than monetary easing to maintain activity. Why wouldn’t they have taken the currency route?
A: They depreciated the currency as well – the only currency the renminbi has been stable against is the US dollar. The renminbi is one of the weakest currencies in the world because it’s been tied to the weakest currency in the world. If the US dollar had been very strong this year, I think we would have seen a devaluation of the renminbi. But they’ve been happy to go along with the weakest currency in the world, and at the same time produce a massive monetary response.
Q: Now we’re hearing that appreciation may be possible in the coming year…
A: I think it depends on what happens with global currencies. The renminbi has depreciated 15% from its peak this year against the euro. If the dollar continues to be weak next year, I wouldn’t be surprised if the renminbi began to appreciate against the dollar because the Europeans would be putting such huge protectionist measures in place against China.
If, on the other hand, the dollar recovers all its losses against the euro over the course of the next year – which I think is quite probable – the Chinese might re-peg the renminbi to a basket of currencies. Then it would start depreciating against the dollar, but not necessarily depreciating that much against these other currencies. Even if it rose against them, it wouldn’t return to the level seen at the start of 2009.
Q: Many have said that the stimulus, if nothing else, had the effect of improving consumer and investor confidence. Is that a fair assessment?
A: The danger is, I think, misunderstanding this whole crisis as a confidence issue. That was certainly the one that I heard most often when I was in Beijing earlier in the year – we’ve got to get confidence back, it’s all about restoring confidence.
To my mind, the classic monetary response China has adopted confirms that they don’t understand the problem. And the problem stems from a crisis of investment undertaken over a long period of time that was responding to the wrong price signals. So you have a balance sheet problem in the global economy, effectively a solvency problem at the level of assets, not a liquidity and a confidence problem.
That confidence and liquidity explanation of the problem is pretty common, and was very much the in-vogue explanation in the 1930s. After about four years people realized that there was a much bigger problem of overcapacity. The global economy had spent too much on bad investments, and those bad investments still existed.
Now, the bad investments still exist today. The overcapacity in China still exists today, except it’s now worse. That sort of bad investment and overcapacity will have to be destroyed over time before we get back to a much more private sector-led, sustainable growth.
The Chinese government hasn’t yet realized that this is a problem and, as a result, over the last year the problem has become worse. The government gives the impression that China has managed to get growth, but it took 30% of 2008’s GDP to get 6% nominal growth. That’s not a very good return on the amount of money put in. A lot of people have been fooled. The number of private sector investors that are starry-eyed because of growth numbers is simply mind-boggling. The fact that they can’t see farther than the end of their nose in terms of return is also mind-boggling, but there we go.
Q: There seems to be a lot of faith that gradual tightening later in the year will restore a kind of balance…
The tightening exposes those fundamental issues very quickly. It doesn’t resolve them. The only thing that resolves them is for large chunks of that capacity to be written off and closed down, but the government will be very reluctant to do this.
Q: One last question: Amid all the end-of-year roundups and forecasts for 2010, is there anything you’re hearing that you take particular objection to?
A: I just worry about the people who see no problem in a policy of inflation as dramatic as that undertaken by China. If what China has done this year had been effected in a country with a convertible currency, everybody would be talking about how far it was falling, rather than the prospect of it rising.
Only in China have we seen a massive acceleration in credit and money supply growth. Properly defined, that’s inflation. It surprises me that people talk about an appreciating currency in an inflating economy. It makes very little sense – but of course there’s no convertibility, which means that China can set the price and people can’t sell the currency. With convertibility, I think you’d be looking at a depreciating currency, given how much extra money has been made available within the economy this year.