Patrick Chovanec, chief strategist at Silvercrest Asset Management, a $19 billion firm based in New York, argues China’s rebalancing toward a consumer-led economy is happening regardless of what the authorities do. The relevant question for equity and bond investors is whether this happens in a constructive or destructive manner – with the summer’s market intervention suggesting the latter.
Chovanec, a Twitterati with over 23,000 followers, is a regular commentator on Chinese and economic affairs. His full interview appears in the October print edition of FinanceAsia.
You’ve talked about the need for countries reliant upon exports, mainly China and Germany, to rebalance to create new demand in the world economy. Where is China now? They authorities seem to have backtracked on freeing markets and robust SOE reform.
The Chinese economy has produced more than it consumes for decades. The good news is that they can now consume more than they produce: that $3.6 trillion worth of foreign exchange reserves represents purchasing power. Rebalancing will happen whether or not China gets the policy right. Consumption will become a larger part of the economy. This can happen in constructive ways, or in destructive ways, but it will happen. China’s economic slowdown can be helpful if it increases consumption – or China can promote ‘bad’ growth in which its investments are no longer sustainable or helpful to the global economy. Either way, however, the transition will put consumption in a greater role, internally and externally.
That’s important to China. What does it imply for the rest of the world?
It represents a sea change in the global economy. The old model, pre-2008, was that the US consumer was the consumer of last resort, and that China and emerging markets provided the output to meet that demand. We’re not going back to that model. We’re going to see consumption from China, while in the US, consumption will continue but it will be tied to what the US produces [as opposed to finance by debt]. That will create a different pattern of growth.
Who wins, who loses?
Providers of input to China may lose, such as iron ore producers from Australia or equipment exporters from Germany. Such sectors are getting hit hard by the end of Chinese over-investment. But China’s investment boom was also deflationary because it overbuilt capacity, as in the solar sector – there we saw Chinese players drive US competitors out of business, then they drove Europeans out of business, and finally they drove themselves out of business. Reining in Chinese overcapacity spells relief to a lot of other sectors. Yes, China has stopped importing so many commodities. But its food imports are up 24% year on year. Chinese consumer demand is resilient. America’s leading exports to China are soybeans and aircraft. Those exports are rising in value, driven by Chinese consumers, not by China’s investment boom.
How will the China stock-market intervention influence fund managers’ view on the best way to access China-related stocks?
A lot of investors have shorter memories than you’d think. But it has shaken a lot of peoples’ confidence in China’s domestic market as a market. The initial hope when the market began to plunge was for straightforward government intervention, which is what happened – but then the government restricted others’ ability to sell. In other words, Beijing shifted the burden of supporting the market away from the government as a buyer to investors who wanted to sell. I don’t think this is the bargain that most people wanted.
What about bond investors’ demand for renminbi exposure, and China’s drive to get the RMB added as a currency within the IMF’s Special Drawing Rights account?
I don’t know why China has made the SDR a priority. I just don’t see what SDR status means. They’re mistaking form for substance. The key to RMB becoming a reserve currency is the attractiveness to buy it, hold it and use it. The Rmb is already attractive to use, to purchase things. But it’s not attractive to hold and there’s not many things you can invest in with it.
Availability of the RMB depends on China’s balance of payments. People have to access net balances of RMB. That is hard to do when China is running a balance-of-payments surplus. The US runs a substantial balance-of-payments deficit which supplies the world with dollars. If China doesn’t do so, yes a company or a person could pay for things in renminbi, but the international role of the RMB is predicated, therefore, on others holding even bigger reserves of dollars. So I don’t see how that benefits China.
