Be careful what you believe about China

11 October 2017

Western prophesies of economic doom both oversimplify and underestimate China, advises David Mahon.

When it comes to the world's second-largest economy, most analysts get distracted by short-term cause and effect, says veteran China hand David Mahon. He says predictions of a banking crash triggered by extreme overleveraging are just the latest examples of analysts' failure to understand the evolutionary power of Chinese pragmatism and gradualism, and the resilience of its people.

In its October 2017 report on the economies of East Asia and the Pacific, the World Bank signalled concern about Chinese debt levels, and in particular vulnerabilities associated with the rapid growth of 'shadow banking', which in 2016 reached more than 31% of GDP – up from 7% in 2005. Weeks earlier, the World Economic Forum issued its own warning about the growth of business credit in China, which it said mirrored what happened in the United States before the Global Financial Crisis (GFC).

However, Mahon, who has called Beijing home since 1984, urges people to take a deep historical view of the momentum behind events, saying that for more than a century China has been a country struggling to stand up.

"The real march started about 1912, not in 1949, nor with Deng Xiaoping's later economic reforms," he says, alluding to Mao's Long March of 1949 and the founding of the Republic in 1912.

"So, the momentum is coming from a long way back."

The GFC collapsed Chinese exports, and the Communist Party mandated vast government and so-called private investment to boost demand, says Mahon. And banks certainly overextended themselves alarmingly by lending to provinces and municipalities, leaving excess capacity and unused infrastructure. However, 2017 brought credit restraint, he says.

"In general terms, lending and credit are no longer the major issue in the  day-to-day Chinese economy. It is a much more discerning process because the centre has recognised that too much debt was being accrued."

Likewise, banking policies begun in mid-2017 are curbing rampant coastal city property inflation, defying predictions by the Wall St Journal, the Economist, and the Financial Times, he says. And, crucially, growth has dropped to a more realistic 6.7%.

"I was more worried 12 years ago, when it was growing at ridiculous rates. I'm waiting for 5.5%."

Consumption, which now accounts for 60% of annual DGP growth, co-drives the economy, says Mahon. Demand is robust, and he notes the spread of an increasingly prosperous 'commonwealth' beyond the urban middle class.

In assessing 2017's political centrepiece, the five-yearly National People's Congress (from 18 October), we must abandon Cod War 'Kremlinology', he says. Unlike the political machinations in the former USSR, China's General Secretary Xi Jinping heads no all-powerful faction, though his position is secure. The Party is highly competent, represents broad interests, and fiercely scrutinises the performance of its rising stars, he says. And, despite being selective, Xi's anti-corruption drive remains popular.

Mahon is nevertheless cautious.

"There are massive problems and some of them are not being addressed. China risks becoming a very unbalanced society in terms of the difference between rich and poor. As the country levels out, how many people will be in what we call the middle class?"

Moreover, the Party's economic model may continue to prioritise what he calls "a dumb faith in GDP growth".

Geopolitically, Mahon considers the South China Sea reclamations to be a minor part of the picture. He portrays revisionist China as asserting sovereignty – and, characteristically, ignoring international rules based on an inherited world order – but not empire building. More than the United States, he says, China understands interdependence.

He sees the country's softer power as epitomised by its Belt and Road Initiative – a mega-infrastructure project designed to create a China-centred trade network, connecting Asia, Africa, and Europe.

"So, through economic influence, China is already binding countries – not too tightly, but in a very interesting way – to itself."

Where is New Zealand in all this?

Even more Asia-dependent that we realise, says Mahon. And, in China's eyes, New Zealand remains non-aligned – a status as valuable as our green credentials. We need to cultivate that position, he says. Above all, when it comes to China's economy, we should be careful who we listen to.

David Mahon spoke at an event organised by the Business School's China Studies Centre in September, 2017.


David Mahon

David Mahon is the Founder and Executive Chair of Mahon China Investment Management.

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