Macro Perspective 34 | Understanding China's economic situation and differences from Japan's example

Peter Brooke discusses the economic situation in China and addresses the comparison between China's current state and Japan's past economic challenges in the 1990s. While some aspects of the "China is Japan" narrative hold true, there are significant differences and opportunities in China's situation. An International Monetary Fund (IMF) paper published this month, attempts to unpack the assets China holds to offset its huge debt burden of nearly 300% of GDP. They estimate that China has the most assets in the world, with an estimated US$12.5 trillion worth of assets. As a result, China has nearly 30% of government financial assets around the world.

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Chapters

• 0:11 Peter Brooke unpacks the popular narrative that China is a modern day equivalent of Japan in the 1990s, and how some of this is true
• 1:20 How the narrative is wrong when it comes to debt
• 2:13 Putting the numbers in context with government financial assets, and how understanding this makes the Chinese government policy more sensible
• 4:30 The difference between China and Japan with the price of financial assets

Transcript

Peter Brooke  00:01

Good day, I'm Peter Brooke, a Portfolio Manager at the Old Mutual Investment Group. This is Macro Perspective 34 of 2023, and I want to talk about China. 

Peter Brooke  00:11

A popular narrative currently doing the rounds is that with weak demographics, high debt levels, a big property crash, and deflation, China is a modern day equivalent of Japan in the 1990s and is about to enter a lost decade. Now, some of this is certainly true. China's terrible demographics as a result of the one child policy and is going to be very hard to turn this around. We definitely see this as a structural headwind to growth, much as we see it as a problem for most of the developed world. In terms of deflation, we'll have to wait and see. China is cutting rates while the rest of the world is hiking and has a weaker currency as a result. It is clear that they have read the history books and are avoiding the errors of a strong currency - remember the yen - and a hawkish central bank. Regarding the property bust, this will actually keep unfolding for years to come. The crash is a result of a deliberate policy with their three red lines, and while painful, at least future pain is not being built up. 

Peter Brooke  01:20

And this brings us to debt. And here, I think the narrative is plain wrong. Yes, China has built up a huge debt burden of nearly 300% of GDP. But this neglects the other side of the equation. What assets do they have offsetting these debts? Now, this is notoriously hard to calculate. But there has been an IMF paper actually published this month, so it's hot off the press, which makes an attempt. They estimate that China has the most assets in the world, with an estimated 12 and a half trillion US dollars’ worth of assets. Now, this is really because of the high level of state ownership of assets, which is unusual. And as a result, China has nearly 30% of government financial assets around the world. 

Peter Brooke  02:13

Just to try and put the numbers in context, there are more than 700,000 public institutions and 217,000 non-financial state-owned enterprises. The net result of these vast assets and vast debts is a net financial worth of plus 7% of GDP. Now, unfortunately, there's limited good data on this figure across countries. But from the limited data that is available, China is in the top 15% of countries in the world with a handful of positive net asset countries, often oil exporters, like Norway, Kazakhstan, and Russia. Italy, Japan, France, the United Kingdom, and the United States all have government net financial worth of negative 100% of GDP or more. And I think understanding this then makes Chinese government policy more sensible. They have not responded to the slowing economy and deflation with more financial stimulus and debt. Instead, they're focusing on structural reforms, for instance, pushing for more buybacks, how do they get a more efficient capital market? And their emphasis was how do we get these assets that we own to deliver a better return to pay for the high debt burden that is against it. So, you must remember that state ownership of - or, Chinese government ownership of state-owned enterprises, is roughly 80%. So, the better the ROE, the more net worth is created. So, we see this as a liquidity problem, which is not going to be easy to get through. But it's not a debt trap. And therefore, there's a better ability to avoid the Japanese example. Just at a household level, the very high savings rate of Chinese households means high deposits when they purchase a property, a very small mortgage market. and higher home equity. So, while undoubtedly painful for net worth, there is also less risk on households. 

Peter Brooke  04:30

Another difference between China and Japan is the price of financial assets. Chinese shares are cheap, trading on a forward price earnings ratio of 10.8 times, which is lower than the long-term average of 11.7 times. If we compare this to global equity markets, China is trading at a 35% discount versus the norm of 20%. So, while we agree there are some elements to this "China is Japan" narrative, there are also material differences and therein lies the opportunity. I hope you enjoyed this voice note. Until next week.