In early August, I shared four data points that signaled an imminent cool off for the world’s fastest growing economy, China.
And sure enough, this week the International Monetary Fund (IMF) trimmed its growth forecasts for the country.
According to its World Economic Outlook report, the IMF now expects China’s economy to grow by 9.5% this year – down from June’s estimate of 9.6%. And then slow to 9% in 2012.
I know. That’s still blockbuster growth juxtaposed against forecasts for 1.5% and 2.7% GDP growth in the United States for the next two years.
[ad#Google Adsense 336×280-IA]But investors have gotten spoiled expecting near double-digit GDP growth year-in and year-out in China. I’m convinced those days are long gone and that even more downward GDP revisions are in store for China.
Here are four more reasons why…
~ China Warning Sign #1: Yuan Appreciation
So far this year, China’s currency has appreciated almost 4% versus the U.S. dollar. And yet, the yuan “still appears substantially undervalued,” says the IMF.
In fact, on Monday, Karim told you that the yuan is destined to be the strongest currency on Earth.
That’s bad news. Especially since policymakers appear willing to “tolerate currency gains to fight inflation,” as Bloomberg reports.
You see, even after years of impressive growth and increasing middle-class wealth, China’s economy still relies heavily on exports. According to the latest World Bank data, almost 30% of China’s GDP is tied to exports.
So the faster the yuan appreciates, the faster China’s exports become less affordable to foreign buyers and the faster its overall economy cools off.
~ China Warning Sign #2: Runaway Real Estate
When it comes to real estate in China it’s like déjà vu all over again. Despite government efforts to curb runaway speculation – including increasing down payment requirements and mortgage rates – prices keep going up.
And we’re not just talking about in a few localized markets. In August, new-home prices rose in all 70 cities monitored by China’s statistics bureau.
Rest assured, August wasn’t some freak statistical anomaly, either. For the first six months of this year, new-home prices were up in 67 of out 70 cities.
Clearly the mentality that “real estate only goes up” runs rampant in China. As Americans, we know how this story ends. Badly!
In China’s case, though, the real estate collapse promises to be even more damaging. Warning sign #3 explains why.
~ China Warning Sign #3: Out of Control Municipal Borrowing
Local Chinese governments aren’t allowed to borrow directly. But they’ve found a loophole to fund massive construction projects. All they have to do is create special financing vehicles.
At the end of 2010, over 6,500 such vehicles existed with $1.7 trillion in outstanding liabilities.
However, these local governments don’t have the cash flow to service this debt. So they’re resorting to selling land to raise the necessary cash.
Here’s the catch – if real estate prices don’t keep climbing, they won’t be able to pay their debts anymore. And the knock-on effects of a wave of defaults promises to be catastrophic. You see, almost 80% of the $1.7 trillion in outstanding debt is via bank loans.
Again, Americans know what happens when the nation’s biggest banks get caught holding the bag on bad real estate loans. Financial armageddon!
~ China Warning Sign #4: Tightening Credit Markets
The Chinese government is working hard to prevent out-of-control borrowing by corporations. As I indicated last time, the government’s gone as far as raising bank reserve requirements 12 times since the beginning of the year.
But it’s not working!
Corporations are simply finding other ways to feed their need for capital. And now they’re turning to the commercial paper market in record fashion.
Bloomberg reports that commercial paper sales are poised for the “busiest first three quarters of the year on record.”
What’s even more troubling is the intended use for the proceeds of these bond sales – paying off existing debt.
In other words, Chinese companies are looking to roll over their debt. But “it’s hard to get a loan from the bank these days,” says George Weisi Tan of Fortune SGAM Fund Management. So they’re resorting to higher-interest rate commercial paper loans to pull off the refinancing this go-round.
It’s a vicious cycle – one that can only end badly. All it takes is a few major defaults and access to any type of credit disappears completely. And since credit is the grease that keeps economies moving and functioning properly, if it’s removed, all bets are off. China’s economic growth engine is going to seize up.
Look Out Below!
In the end, I know it’s heretical to badmouth the China growth story. But sue me for taking a controversial and contrarian stance.
Even China’s stock market is signaling trouble. It just hit a 14-month low. And stock markets are supposed to be forward-looking beasts. So clearly, there’s bad news on the horizon.
Bottom line: China could be on a crash course with a financial crisis just like the one we experienced. Even if the conditions don’t get that dire, all signs point to even more slowdowns for the world’s fastest-growing economy. Invest accordingly.
Ahead of the tape,
— Louis Basenese
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Source: Wall Street Daily