Keep Your Eye On China

It used to said that "when the United States sneezes the rest of the world catches a cold."

That may still be true but it may now be true of China as well.

The growth of China's economy and the sheer size of its population means that anything that occurs in China today will invariably have reverberations around the world.

As we begin 2019 it may make sense to keep your eye on China to see where the world economy is heading. You can be sure that what happens in China's economy will also have major effects on the United States.

We saw evidence of this last week when Apple revised its revenue forecasts down for the first quarter principally due to lagging sales in China. Mind you that is the first time in 15 years that Apple lowered quarterly sales estimates. Apple's stock immediately fell 7.6% in the hours after the announcement was made.

The fact is that most U.S. and multi-national companies have come to rely on China for growth.

General Motors now sells one-third more vehicles in China than it does in the United States. Starbucks is in the midst of opening one new store in China every 15 hours. Adidas has seen its growth expanding at 26% per year in China while its home market of Europe is flat.

A lot of this has been driven by a 400 million (and growing) middle class in China. To put that in perspective, the total population of the United States is only 330 million. Most estimates suggest that the middle class is 50-60% of that total.

The problem is that a lot of the growth of the economy (and the middle class) in China the last decade has come about through a great deal of debt-financed spending. That spending provided wages for construction, manufacturing and service workers but interest and principal payments on that debt needs to be paid.

You get an idea of how large the debt load the Chinese have taken on by viewing this chart.

When I was in China recently I saw evidence of this debt fueled spending everywhere I looked.

There are scores of newly built apartment building complexes like this one I photographed in Tianjin, China.

The problem is that millions of the apartment units in these buildings around China are unoccupied.

This New York Times article on the problems in China's housing market cites a statistic that there are currently 65 million unoccupied apartment units in the country.

Let's put that number in context.

According to the National Multifamily Housing Council, there are a total of 20.8 million apartment units in the United States. Those are all the apartment units in the USA---occupied and unoccupied.

Therefore, China has 3 times as many UNOCCUPIED apartment units as the entire number of apartment units in the United States!!!

Do you think this might pose a problem to those holding the debt on those apartment units in China?

Add to this the recent news that births in China for 2018 are estimated to have fallen 2 million from the numbers in 2017. The government's family planning authority had expected births to rise by 3 million compared to last year due to fact that the previous one-child policy has been replaced by a 2-child policy. That works out to 5 million fewer births than predicted in China.

Let's put that in context. The United States had a grand total of 3.8 million births in 2017.

I would not be surprised to see the Chinese soon paying parents to have babies.

In addition to unoccupied apartments there is also a lot of excess production capacity that is not producing any economic return on the debt used to build those manufacturing plants.

Victor Shih, an economist who follows China closely, calculates that interest on all the debt in China now exceeds $3 trillion per year---22% of GDP.  In fact, interest payments on that debt are now higher than China's incremental increase in GDP.

Enda Curran in an article at Bloomberg.com titled "China's Debt Bomb" describes it this way.

It’s been called a mountain, a horror movie, a bomb and a treadmill to hell. To doomsayers, China's $34 trillion pile of public and private debt is an explosive threat to the global economy. Or maybe it's just a manageable byproduct of the boom that created the world’s second-biggest economy. Either way, the buildup has been breathtaking, with borrowing having quadrupled in seven years by one estimate. (China doesn't give a complete tally). President Xi Jinping has taken note, pushing authorities to announce a slew of measures that target risks lurking in the financial system. The challenge is how to wean the country off its debt drip without intensifying an economic slowdown. Since China is a key driver of global growth, it's a matter of concern for everybody.

On top of all of this, President Trump has turned up the heat on China's trade practices that have systematically worked against the United States for decades. Tariffs are now in place on over $250 billion in imports from China. More tariffs are set to be imposed in March if a trade agreement with China is not reached by then.

Trump has also worked to build a relationship with North Korea which surely has the Chinese concerned about losing control on the Korean Peninsula which borders China.

The United States also ordered that the CFO of Chinese tech giant Huawei be arrested and detained by Canada as part of a large criminal investigation in New York.

No one should ever doubt that Donald Trump does not know to use leverage when he has a goal to achieve an objective.

Trump knows that China is in a tough spot. There is a lot of debt to service. There are a lot of mouths to feed. Over 400 million Chinese have begun to taste the good life in that country. The last thing the Communist Party in that country wants is an economic implosion.

Can China avoid a financial crisis? Can it accede to Trump's demands without crashing their own economy? Can it continue to grow without taking on more debt?

All of these answers are keys to China's economic future.

However, due to the interconnected world we live in, what happens in China could very likely spillover to the rest of the world.

Keep your eye on China.

If it sneezes it might signal a cold wave for the rest of us.