Paul Singer, founder and President of Elliot Management Corporation is known for being a skeptic of traditional market pundits. In his fourth quarter letter, he made several different predictions about the market. He acknowledged the highly unpredictable environment that we have highlighted before in our articles about Trump and the markets. The letter also contains a specific warning about the worsening situation in China.
“The seeds have been sown across the globe for a variety of large problems,” Singer says, “with China high on the list for either miscalculation related to some geopolitical foray or a major speed bump in economic and financial engines of growth…”
Chinese Consumption at Record Highs
Since the Nixon administration started a relationship with the Chinese in the 1970's the country has been booming. An economic alliance with the Chinese was a key strategy for the U.S. as it diminished Soviet influence in Asia. Over the last 20 years economic growth in China has accelerated to a very fast pace. The standard of living increased significantly but this rapid pace of expansion is starting to slow.
From Paul Singer,
“There are rumblings coming from China which could mean nothing, or could portend changes in the economic and financial market outlook that potentially swamp, in magnitude and impact, all of the other factors discussed in this report. In so many spheres, the metrics in China are not just bigger than anywhere else, but orders of magnitude bigger: the consumption of commodities; their investment boom; the construction of towns, cities, power plants, railways, houses and office buildings; the amount of lending from banks and other institutions; the bad loans; and not to mention the $3.5 trillion of wealth management products (basically “give us your money and we will figure out what to do with it”), which are as gamey as any bubble-era get-rich schemes that America has ever produced.”
As Singer points out, the statistics around the Chinese consumption bubble are staggering. China is the largest consumer of most commodities, excluding oil and gas. The Country consumes over 70% of the world’s met coal and 40 to 50% of the world’s thermal coal, aluminum, nickel, zinc copper, iron ore and lead. These commodities are used primarily in the construction of real estate and infrastructure. Construction spending has been the primary driver of Chinese GDP growth.
Rural to Urban Migration Slowing
“China was in such a cycle for a long time, helped by the movement of people to cities from rural areas, a modicum of economic freedom, and the incredibly low base at the start of the boom. But recently the boom has shown signs of fraying, and despite the fact that China is not a free society and that one can only accumulate significant wealth with the permission of the authorities, questions are arising about the ability of the authorities to control and direct to a safe landing this next phase, whether you want to think of the next phase as a speed bump or Armageddon.”
The movement of people from the rural farms to cities is a major driver of economic growth in China. A 2009 study estimated that the urban population in China grew by 440 million to 622 million people from 1979 to 2009. Further estimates show the urban population growing to an estimated one billion people by 2025. The flow of migrants from rural farms to cities helps improve the productivity. Migrant workers receive training, learn new skills and make higher wages. This system helps improve economic development in the rural regions as well as wages are typically sent home.
While these are massive numbers, these trends have been slowing. According to an article from Reuters the number of migrant workers in 2015 only rose 0.4%. This was the slowest increase since the financial crisis in 2009. 2016 data has not been released yet but given the amounts of migrant protests during the year it seems like 2016 was another weak year as well. The slowing migration rate shows that migrant workers no longer view cities with the same level of optimism.
Trade War?
Paul Singer goes on to comment about the election of President Trump and its impact on China.
“The country has historically been treated in many respects as an “emerging nation,” and as such has received special terms and leeway … However, the developed world, and in particular the New U.S. Government, may not be willing to accept perceived asymmetrical terms of trade any longer.”
A trade war with China would be a very unsettling event for the financial markets. A tax on Chinese goods would hurt retailers as prices increase on items like electronics and clothing. Some sectors in the U.S. would clearly benefit from the protectionist actions such as industrial manufacturing. China will feel the biggest impact of the trade war. The slowdown in trade will stress the economy and massive migrant workforce.
Paul Singer Concludes
Investors have predicted the Chinese bubble for many years. While the media uses this as evidence that the bubble doesn’t exist Paul Singer warns otherwise.
“Predictions of a crash of the Chinese financial system have been frequent, and so far all have been wrong. Similarly, predictions of a country-wide crack in real estate prices have also been inaccurate. Our point is that the numbers are so large that if real problems surface in China, it is not an exaggeration to say that “all bets are off,” if only in the near-term directions of stock, bond, currency and commodity markets throughout the world. Given the foregoing, China should be near the top of the “must-monitor” list for every businessperson, investor and trader.”
Article originally posted on Boom Bust Market.