Is China’s Economy About to Crash?

Sean Brodrick
by Sean Brodrick, Resource Strategist Market Trends Market Trends
China's stock; Securities and Exchange

My newsfeed is buzzing with panicky stories on China's economy. Professional worrywarts are terrified that the country's first corporate bond default (by a little-known Chinese solar company ) is just a taste of an economic earthquake to come - one that could shake the global financial system to its foundations.

China's corporate bonds had always been backstopped by the government, so when Shanghai Chaori Solar Energy & Science Technology missed a $12.7 million interest payment on a bond, people panicked.

Some of the more nervous types fear this is China's "Bear Sterns" moment.

And more bad news followed...

  • A few days after the Shanghai Chaori default, a second company, Baoding Tianwei Baobian Electric Co., saw its bonds suspended from trading and its shares fall by the daily limit.

 

  • Meanwhile, China's exports tumbled in February, falling 18%. This shocked economists who expected a 5% increase, following a 10.6% expansion in January.
  • For the first two months of the year, China's exports have had their worst showing in five years.
  • China also posted a rare trade deficit last month of $23 billion.
  • And its stock market dropped to an eight-month low.

All this bad news triggered collateral damage in the commodity markets. Copper, iron and soybean prices all plunged.

So, you can see why some people are scared. Now, let me tell you why they're wrong.

More Defaults Possible

What scared the market the most was the default of the solar company. It's true that China is the No. 1 risk to the global economy. And the "bird's nest" financial integration of many Chinese companies and assets can be a reason for worry.

Sure, a $14.7 million default is tiny in a $9.4 trillion economy. (And Baoding, the second company in financial straits, is government-owned, so it's not likely to default.)

But could there be more to come? It's possible. A Thomson Reuters analysis of 945 Chinese companies showed total debt soared by more than 260% to 4.74 trillion yuan ($777.3 billion) in the last five years.

Speaking at a meeting of the National People's Congress, China's Premier, Li Keqiang, warned that "we are reluctant to see defaults of financial products, but some cases are hard to avoid." At the same time, he said that the economy faces "severe challenges" in 2014.

So the 64,000-yuan question: Is Chaori the "Bear Sterns" of China? Could its default lead to a much bigger crisis?

I'd bet you dollars to Chinese dumplings that it won't.

Here's the thing about a managed economy: If government bureaucrats have to stand on street corners and hand out bags of cash to hit their economic target, that's what they'll do.

And they can hand out bags of cash if they want to. China's inflation rate is glacial.

The Chinese government said during its recent annual meeting that it was targeting a growth rate of roughly 7.5% in 2014 (down from 7.7% in 2013).

As for the plunging of copper and iron prices, it's not at all surprising. The metals are used as collateral for many companies that can't get conventional bank loans.

This is what's called the "shadow banking system."

When Chaori defaulted, it raised the specter of more defaults going forward. If that occurs, a lot of lenders may sell their copper and iron to raise cash.

And speculators sold in anticipation of such a move, thus making it a self-fulfilling prophecy. Prices plunged because of fear, not because there's an actual crisis underway.

A Changing Economy

And the scary export numbers? First, you can't read too much into China's trade data, which is always murky because of the timing of its New Year.

But it's worth noting that China is intentionally shifting from an export-driven economy to one driven by consumption. That isn't easy to do, and that's part of the reason why we see scary export numbers.

The government is already planning to cut production capacity of 27 million metric tons of steel, 42 million metric tons of cement and 35 million standard containers of plate glass this year.

These are fundamentals for lower commodity prices. But certainly not for an economic crash in China.

Good investing,

Sean Brodrick

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