In a recent post, I discussed how the current slowdown in the Chinese economy posed a near term risk for global financial markets. However, I am now finding myself less concerned as the improvement in recent data along with increasing government support and accelerating growth in bank lending suggests that the economy could be stabilizing.
As seen in the following chart, the HSBC manufacturing PMI registered weak readings earlier this year which was predicted by the drop in new loan growth late last year.
In response, it appears that the Party has again panicked in the face of slowing growth and in recent months has stimulated the economy through tax breaks, investing in railways, rebuilding urban shantytowns, weakening the renminbi, cutting reserve ratio requirements for most banks, relaxing property curbs, and injecting liquidity into the banking system.
These measures have filtered through the economy causing the PMI to strengthen rather than weaken further as indicated by the lending data. In addition, the high rates of credit growth that occurred in the first half of the year are set to bolster the economy during the second half of the year.
Despite the government’s hope to rebalance the economy away from investment driven growth, in recent years whenever investment growth slows as it did during the early part of the year, it causes higher unemployment. Officials recognizing that a large number of people out of the labor force could be a source of social unrest, immediately stimulated the economy with easy monetary policies to increase credit growth and started new investment projects to reignite job growth.
In addition, FT Alphaville recently noted how little we are hearing of Chinese debt defaults despite being in the midst of a wave of distressed corporate loans and wealth management products that are set to come due. FT Alphaville highlights a Credit Suisse note that the likely explanation is that “a combination of bank rollovers, local government bailouts and asset management companies acquisitions has made the distress of trust funds easier to handle in the near term.”
If risks of major corporate defaults and a sharp slowdown in the Chinese economy are taken of the table in the near term, then there is unlikely to be a financial panic occurring this year.
The financial panics that occurred in recent years were due to governments not getting out in front of the problem. In the fall of 2008, it’s unlikely markets would have seized up if the government would have bailed out Lehman Brothers’ creditors as it did with Bear Stearns’ and the Fed cut rates to zero sooner. In 2011, yields on European periphery debt would not have blown out if the ECB had not hiked rates earlier in the year and had not waited until year end introduce the LTRO program.
Technically, Chinese stocks have been strong over the past few months and have recently broken out along with many other emerging markets. This along with depressed valuations and negative investor sentiment could lead to further gains for China’s stock market.
Given that Chinese officials are supporting the economy just when it began to slow, means that China’s Minksy moment has been postponed at the cost of inflating its credit bubble even more. And if there is no hard landing for China in 2014, then global markets should remain resilient and a 15-20% stock market correction is unlikely to occur.