Coffee House

China’s ‘Black Monday’ is just the start

24 August 2015

2:34 PM

24 August 2015

2:34 PM

One-party states are rarely any good at admitting to any form of blunder. It is certainly the case with China’s prickly political leaders, who love to flood domestic media with jolly tales of fashion shows and bamboo-chomping pandas – anything to divert people’s attention from a flagging economy and rising unemployment.

This makes today’s main headline on China Daily‘s website all the more arresting: ‘Stocks plunge most since 2007 as state support measures fail’ the state-run newspaper blared, after the Shanghai Composite share index lost 8.5 per cent in a single day. The wider world followed China’s lead: all major Asian stock indices fell on Monday, with oil tumbling to a six-year low. Even gold prices, usually a safe haven in bad times, inched down. By early afternoon, the FTSE 100 was trading 4.5 per cent lower, wiping more than £70bn off the value of UK blue-chip stocks in just five hours; shares in New York will surely follow the downward procession when they open later today. This is likely to further fuel fears that the Federal Reserve may be forced to delay its decision to raise interest rates until December.

China Daily‘s headline was telling, because it showed the country’s leading English-language newspaper admitting defeat on behalf of the Chinese state. Despite more than £100bn being spent since the middle of June to support slipping stock prices, policy measures have ‘failed to restore market faith’. Worse may be to come for mainland-listed stocks, the story hinted, with data pointing to a period of ‘deep contraction’.

Given that China’s leaders never admit to culpability unless they have a strategic reason to do so, it begs the question: what is going on here? It has always been hard to read the runes of such a secretive political system, but many believe that a genuine sense of panic is beginning to pervade the system. ‘There is real sense here that things are coming off the rails,’ says Andrew Polk, a senior economist at The Conference Board (TCB) in Beijing. ‘China’s leaders are trying to support share prices and a weaker currency, while propping up a stumbling economy. It doesn’t have enough money to support all those measures so one of them had to go, and it appears that domestic stocks were the loser.’ Rarely do such moments of crisis fail to include an allotted scapegoat, and in this case the role is likely to be filled by Xiao Gang, a mild-mannered official who oversees the country’s securities regulator, the CSRC.

China’s very own version of Black Monday could hardly have come at a worse time. Wherever you travel across the mainland, you see signs of malaise. The country’s economy is beginning to fray, undone by decades of poorly directed state spending and lending, and an unhealthy dependency on an export-oriented model that no longer works. The deadly explosions that tore through warehouses storing dangerous chemicals in the city of Tianjin earlier this month, killing at least 116 people, embodied the colossal challenges facing the country. Corruption is endemic. Laws abound, yet few are followed. Local governments drown in red ink, yet are encouraged to issue fresh municipal debt to paper over the cracks. Politicians at the highest level wax lyrical about the importance of a vibrant private sector, yet continue to lend their support to inefficient state enterprises.

A few weeks ago, I stood alongside the chairman of the board of a state-owned enterprise in eastern China. The factory floor, partially open to the elements, stretched out far in front of us, littered with towers and blades designed for some of the world’s largest wind turbines. It was an impressive sight, one to which regular visitors to mainland factories are accustomed: China as the workshop of the world.

But something was missing: workers. ‘They’ve been given the day off,’ the chairman said with a slight cough, as we stared out over the vast compound. On a Wednesday? It was hot but not searing, and workers get the day off only once the mercury tops 40°C. ‘It’s a local holiday,’ he said. But there are no such things in the People’s Republic, and national holidays only occur in May, October and around Chinese New Year.

I didn’t push it, but a later conversation with the firm’s senior engineer, a stocky chap in blue overalls clutching a pipe wrench, revealed the real problem. His cheery demeanour vanished when we started discussing the future. The factory, he admitted, hadn’t run at close to full capacity for a year. Experienced workers had been put on unpaid leave; migrant labourers from the countryside — lacking a local work permit, or hukou — had been told to hop it.

The company’s woes are a microcosm of the daunting challenges that face China’s stuttering economy, the world’s second largest after the United States. This week China devalued its currency by 3.6 per cent in a dramatic bid to encourage exports — a clear sign that Beijing is panicking. Forget Greece. This could be the biggest financial story of the year. Even the threat of a significant slowdown in China’s economy could be enough to send the rest of the world tumbling back into recession. It’s certainly a source of concern for Britain’s still-fragile recovery. When the Bank of England Monetary Policy Committee met last week, they dwelt on the subject of China far longer than usual.


The picture isn’t pretty. From the polluted central metropolis of Zhengzhou, to Shenyang in the rustbelt northeast, the overwhelming sense is one of pessimism and urban decay. Idle cranes and vacant building sites dot the landscape. The ghost towns of legend — such as Ordos City in Inner Mongolia — are all too real, and remain a silent, cautionary reminder of the perils of engineered growth. In early 2009, at the height of the financial crisis, I travelled to the western suburbs of Shanghai, taking photographs of boarded-up factories. I returned last month to find many of the units still locked, their windows smashed, the paintwork peeling.

Signs of stockpiling and overproduction are everywhere, while central and local authorities strive to outdo one another not through innovation but by replication. Hangzhou is building an entire financial hub larger than Canary Wharf, despite being less than 100 miles from the big banks of Shanghai. Even the chairman of the wind-turbine maker admitted to branching out into renewable energy not because he’d spotted a gap in the market, but because ‘local party officials told us to’. That aspirational industrial logic — if you build it, the customers will come — once served China well. No longer.

Over the past year, every key indicator has begun pointing to bad times ahead. Electricity consumption, usually the most reliable single gauge of economic health in the mainland, expanded at the slowest rate in three decades in the year to June. Because of falling Chinese industrial demand, global commodity prices have slumped, threatening growth in producer countries from Australia to Zambia. Chinese house prices have stagnated, while the last time rail-freight volumes were higher than the year before was last September. Last week brought yet more bad news, with exports sliding 8.3 per cent in July from last year’s figures, imports falling for the ninth month in a row, and data pointing to further weakness in industrial output, capital investment and retail spending.

Predicting a serious slowdown in the mainland has long been a losing bet. Ask the Sino-American author Gordon Chang, whose book The Coming Collapse of China was released at the turn of the century, just as the mainland began its inexorable rise. Since then, China has dealt with every challenge thrown its way. Even the global financial crisis barely registered. Beijing merely flooded its domestic market with cheap money, creating an artificial infrastructure boom. While Britain’s economy shrank by 4.3 per cent in 2009, and America’s by 2.8 per cent, China grew by 9.2 per cent.

China’s National Bureau of Statistics has released data showing the economy expanding by 7 per cent in both the first and second quarters of the year. But the NBS is constantly accused of cooking the books — it’s notable that their figures tally precisely with state forecasts set out late last year.

A more realistic assessment comes from Andrew Polk, a senior economist at The Conference Board (TCB) in Beijing, who believes output grew at 4 per cent in each of the past two years, and will continue to expand at or below that rate for the foreseeable future. ‘For a fast-growing emerging market like China’s, which is in the mode of playing catch-up with the wider world, a growth rate of 3 per cent or 4 per cent is in or close to recession,’ he says. ‘It’s like zero growth in a mature economy like Britain’s or America’s.’

Anne Stevenson-Yang, co-founder of the independent Beijing consultancy J Capital Research, has spent the past few months in the industrial north-east of the country, wandering deserted factories and building sites. ‘That part of the country has been in rough shape for some time, with falling bank deposits, halted construction projects, high inventories and plummeting sales at auto dealers. I visited a large machinery factory running at 80 per cent of the capacity it was at two years ago, and that is not atypical.’

She found the same problems in the once-bustling cities of the far south, where discontent and joblessness is rising fast. ‘Everyone I meet is looking for a job, and considering moving to Shanghai,’ she laments. During a tour of a vacant cold storage facility in rural China with a party official, her group was confronted by an angry mob, who forced them to flee. The official later explained why: ‘There used to be an orange grove on that site, so we chopped down the trees to build the facility to create jobs. But no one wanted to invest in it, and now there are no jobs, and no oranges.’

This gathering storm helps explain Beijing’s reaction to the bursting of the latest stock-market bubble, which had been driven by speculative retail buying. When shares in Shanghai and Shenzhen topped out in mid-June, having more than doubled in just seven months, China’s leaders had two choices: to let prices settle at a more natural level, or to intervene.

Having tacitly encouraged the boom by lifting restrictions on buying shares with borrowed money, Beijing saw little choice but to intervene, particularly when day-traders, deeply in debt to loan sharks, began flinging themselves from office windows. Party leaders clamped down on ‘short selling’, forced tame banks and brokers to buy and hold shares, and blamed the whole sorry mess on meddlesome foreigners, who had played no part in it at all. In fact, the real losers in June and July were holders of securities listed in the West. A generalised anxiety provoked by tumbling Chinese shares (contradicting the view of some London pundits that it was all a local difficulty, of no great relevance to western investors) knocked the stuffing out of the FTSE 100 index, and dragged British blue-chip stocks to their lowest levels since January.

The reason for the party leaders’ heavy-handed action, which makes a mockery of China’s much-trumpeted desire to reform the financial system and wrest market share away from inefficient state firms, is simple. ‘China’s leaders are panicking,’ says Polk. ‘They don’t want any volatility in the financial sector, as they truly don’t know how shaky its foundations are.’

There’s a strong and abiding fear of economic slowdown here. The last time growth seriously stuttered was a quarter of a century ago, when China’s political leaders made a series of panic-induced and near-fatal missteps. Hasty reforms designed to boost wealth and improve the lot of farmers led to a credit glut and a brief but unruly housing boom, and inflation exceeded 30 per cent in late 1988. With living conditions deteriorating the following year, tens of millions of migrant workers flooded into the cities, while students spilled on to the streets. The party panicked and sent in the tanks. China’s global image is still recovering.

But China’s economic troubles today are nothing for the rest of the world to feel smug about. We should be desperately worried about a sharp contraction in an economy that really matters. Many spent the summer fretting about contagion stemming from a failed Greek state. Greece accounts for less than 0.3 per cent of the world’s economic output. China’s share is 13.4 per cent and rising. A blowout in one or more of its tyres would hurt everyone, from indebted multinationals who have bet heavily on continued Chinese growth to overleveraged nation states whose finances would be devastated by another slump.

In recent weeks, everyone from fund managers to multinationals has begun to speak about what might happen if China’s economy falters. Audi, Jaguar Land Rover and BMW have all slashed local production forecasts or issued local profit warnings. Ford is expecting car sales in China to fall for the first time since 1990. Given how integral China is to global trade, this matters. Last year, Beijing was the largest sovereign importer of crude oil, copper and soy beans. It is a voracious buyer of French cheese, Scottish salmon and New Zealand lamb, and the world’s biggest consumer of cars and smartphones. There is virtually no industry that it does not influence, nor any multinational that does not include Chinese land, labour or capital somewhere in its supply chain.

We simply don’t know what a slump in 21st-century China would look like. Will it be short and sweet, allowing the economy to cleanse itself of a huge backlog of toxic bank loans before emerging invigorated? Or will it mark the beginning of the end of the Chinese dream: the moment when, from Washington to London to Tokyo, we see that the new emperor really has no clothes? To Fraser Howie, co-author of Privatising China, the greater concern is whether the current leadership is capable of keeping calm and carrying on. ‘Look at the way the government handled a simple stock crisis,’ he says. ‘How are they going to manage a genuine debt or bank crisis? Everyone’s confidence in the competence of the government has been shaken, and they are now seen as highly reactive and highly incompetent. It should be worrying for everyone.’

The last time China’s economy actually shrank was way back in 1976, a year also marked by the death of a dictator and the denouement of one of the most horrific revolutions in human memory. Back then, a recession in the People’s Republic would have been of only peripheral concern to the outside world. Now, it could drag the whole world economy down with it. Little wonder that alarm bells are ringing in Beijing and beyond.

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