China gives up the ghost of its debt-fuelled investment boom
One of the factors behind today’s exceptionally low global interest rates has been the return of excess savings in Asia since the turn of the decade. Much of this excess savings is channelled through foreign-exchange reserves. So the fact that China’s official reserves fell to US$3.65 trillion (S$5.2 billion) in July from a peak of US$3.99 trillion a year earlier is striking, especially against the background of the botched attempt to prop up Chinese equities.
Note, too, that other emerging markets are using up official reserves to support their ailing currencies, Russia being a notable case in point. Could it be that one of the great drivers of the search for yield is going into reverse?
If China and others are serious about rebalancing their economies away from investment towards consumption, all those savings surpluses would undoubtedly shrink. Another group of excess savers, the petro-economies, are also seeing their reserves shrink as the fall in energy prices causes revenues to dwindle.
The fallout will not be confined to the United States Treasury market, which is the world’s main repository for official funds. In previous periods of weak oil prices, budgetary strain has caused energy-producing states to raid their sovereign wealth funds to plug fiscal holes. That means that equities and property could feel some backwash.
That said, the picture is very complicated. The recent overall decline in the official reserves of emerging market countries may partly reflect valuation effects. Because reserves are measured in dollars, holdings of euros, sterling and other non-dollar currencies will cause the reserve number to shrink. That impact will have been magnified where countries have rebalanced their reserve portfolios to maintain fixed currency weightings in response to the appreciation of the dollar.
In the case of China, rebalancing the economy could lead to more excess savings rather than less if the current high level of investment falls faster than the even higher level of savings. That would be tough for the rest of the world. It would imply a large current account surplus that would inflict a deflationary impulse outside China. And if Beijing moves to full capital account liberalisation, the composition of the outflows would change. Private capital would gravitate more to equities and property than to bonds.
In this very opaque territory where the waters have been greatly muddied by wildly volatile Chinese stock markets, one or two things seem clear. China is at the end of the wasteful debt-fuelled investment boom that created ghost towns and imposed more spare capacity on already loss-making industries. The economy is slowing more than official figures suggest. In such an uncertain environment, it seems entirely plausible that investment will indeed fall faster than savings.
Yet this might not be so terrible for the economies and stock markets of the developed world. One of the most important reasons for the anaemic recovery is weak consumption — a consequence of the debt hangover and fiscal austerity. The collapse in oil prices is now prompting consumers to spend. While China’s producer price deflation and probable future currency depreciation will make it dauntingly competitive against other producers, Charles Dumas, chairman of Lombard Street Research, argues that it will be fine if the world’s consumers can buy Chinese goods more cheaply, releasing income for other spending.
The world, he adds, can simultaneously meet the twin needs for less debt and more consumption only if household incomes increase so that spending can rise without borrowing — in sharp contrast to the 2003 to 2007 pattern that caused the financial crisis.
That increase in consumption, together with the rise in investment that would follow, would of course remove another big factor behind the low global interest rates: Debt-constrained demand. But even if markets find it hard to cope with the Federal Reserve’s first policy rate rise, a scenario where household incomes were rising without injections of more debt would make the creep back to interest-rate normality much easier to bear. THE FINANCIAL TIMES
ABOUT THE AUTHOR:
John Plender is a Financial Times columnist.
