There are two primary views on China. One is bullish, one is bearish. They both have merit.
The bull case is that China is in the rise. Its economic growth is sustainable, and soon it will surpass the United States in GDP (although with over one billion people, it will take far longer to rise to parity in terms of GDP per capita).
The bear case is that China is the mother of all asset bubbles, thanks to an economy managed by the heavy hand of the communist government at every level from the nation to the most remote village.
So which case is true?
I’m going to say both. In the short-term, the next few years at least, the bull case is alive and well. China is thriving, and any multi-year look through the rear view mirror shows a country growing at a rapid rate.
But the bear case will turn out right as time goes on.
We know this because China’s move is mimicking that of post-World War II Japan.
It’s doing that in several ways. First, China’s spending has been fueled by debt. Putting up GDP growth is easy when your economic base is starting from nothing, as China essentially did around 1980. By 2002, joining the World Trade Organization, the growth was still rapid but slower in recent years. Now, there’s talk of major trouble already with a growth slowed to the 5-7 percent range, still beating the pants off the
That growth will stop in time. The tree grows toward the sun, not to the sun. And when that growth stalls enough, the growth built on debt will collapse.
Much like how Japan’s rapid growth in the 1970’s and 1980’s led to bubble valuations in the Nikkei index. During the 1980’s, a great decade for stocks in general, Japanese stocks averaged over 28 percent per year, nearly double the average 16 percent return that the average Western nation was getting at the time. At one point topping U.S. stocks in total capitalization, the Nikkei index fell to less than one-fifth that of U.S. stocks in just a few short years.
Investors in other Japanese assets thought they had found a free money machine as well. The country’s real estate market became so valuable that the land around the Emperor’s Palace in Tokyo was considered more valuable than all the real estate in the state of California. (Of course, back in the 1980’s California real estate was far more reasonably priced, but still!)
The next biggest issue with China is one that plagued Japan as well: Demographics. While Japan has an aging population that made it the oldest and grayest of the industrialized world, China’s problem is different.
Because of its “one child” policy, the country has a huge gender mismatch in its working age population right now. The ratio of males to females is way out of whack. This has created a sort of “bulge” generation with a larger percentage of males than there would be. This partly explains China’s military spending priorities. A large (male only) army, navy, and other military programs provide jobs, and a way for the government to spend on this demographic.
But this will change. The ratio will balance, without government incentives otherwise, and it’s likely that the country’s population growth will slow and, yes, age.
The era of Chinese aggression will likely fade in the next few decades, although until then, it’ll be a risky time. The country’s moves to create artificial islands and expand its territorial waters as a result haven’t been challenged as strongly as they could have been by China’s neighbors and biggest trading partners. While the world tolerates economic aggression, this borders on military aggression and should not stand.
This goes to a fundamental macro investment maxim: You can’t outrun demographics. The United States, despite strong immigration (legal and otherwise) is also joining Western nations in becoming older on average.
Things go up and things go down. You can’t escape a recession. Yet somehow, for nearly 40 years, China has done just that. But governments can do a lot when they control their (Chinese-invented) paper money supply and its 21st century digital equivalent.
When Japan’s growth stumbled in the mid-1980’s, they used their cheap currency to go on an international buying spree, largely in the United States. It didn’t work out. It’s always easy to overpay when you feel rich—and when financing is readily available.
There’s no telling when the growth will finally stop in China. But when the music stops, it’s going to create a challenge. Right now, the market is ignoring that challenge, and at its own peril. It’s a bigger issue than any trade agreement, where the market is focused on China right now.
At the end of the day, however, China is putting itself into a debt-and-demographically-created problem that will make one final, big growth before bursting.
How bad the damage will be—and how good the buying opportunities are—remain to be seen. But don’t count out a “hard landing” scenario for China to create the next big buying opportunity for a decade to come.
So what should investors do? There’s likely still one or two more big surges left, despite the recent market weakness. So embracing China now doesn’t look like a terrible idea, particularly ahead of the announcement of any trade deal.
Just look for a parabolic move in asset prices there to ease out into cash or whatever market is the relative value then. And remember, a Chinese economic recession could be the next big reason for a global recession anywhere near on par with the 2008 market meltdown. Don’t be afraid to take profits quickly!
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.