China recession will be ours to share

A worker monitoring an aluminium production line at a factory in Zouping in China's eastern Shandong province. Picture: AFP

Behind the current global share market game based on the US-China trade war are a series of hidden and dangerous forces. On the surface we have sharemarkets that are entirely predictable. If there is a leak from China that all is not well with the trade talks or President Trump tweets a similar sentiment, then shares fall. If the tweeting or leaks convey good news then shares rise. The official GDP numbers from China show that that while there is a decline, it is smooth and manageable.

But that veneer is masking the real story.

Mining executives from around Australia packed the Melbourne Town Hall this week for the address by Alumina CEO Mike Ferraro. Alumina and aluminium consumption are wonderful economic indicators and the Australia-based Alumina (the old WMC company) is a global alumina giant.

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Ferraro said demand from China was weak, so I then turned to the old fashioned China indicators that we used before China found a way to issue GDP numbers faster than any other developed nation.

Alumina CEO Mike Ferraro speaking at the Melbourne Mining Club. Picture: David Geraghty.

You discover that China’s electricity output, highway transportation, exports to the US, overall imports and even tax revenue are in sharp decline. In the Trump camp they will be looking at these figures and concluding that China in real terms is not far off being in recession. They then translate that into concluding that they can win the trade talks.

Viewed from Australia there does not seem to be a China problem, but the China demand swing to Australian iron ore and metallurgical coal has masked this real down trend. Indeed, our exports to China are holding up our GDP numbers. Australia will fall into recession if something seriously goes wrong in China.

It’s becoming clear that while the trade war with the US is a problem, China faces much deeper issues. And those deeper issues are affecting China at the same time as the trade war.

I vividly recall that during the Global Financial Crisis the central authorities in China gave their bankers weekly lending quotas. We joked at the time that if the bankers did not meet their lending quotas then they would be sent to Mongolia. The bankers did meet their quotas by lending to mates in state owned enterprises that had no hope of repaying. The consequent China debt mess is similar to the debt mess that held back Japan for decades after 1990.

Chinese President Xi Jinping may be forced to undertake more borrowing.

When dictators face these sorts of problems their solutions are usually the same: fight wars, don’t worry about human rights, and/or borrow more money. China has already taken the human rights path, but the other two choices are now on the radar. It is highly likely that China will overcome its problem by extra borrowing, even though it means the much-needed reform of the country’s financial system will be sidelined. And to be fair, China borrows from its people.

In the recent past China has always found a way around these sorts of problems, but each time the can is kicked down the road it gets bigger. Assuming President Xi selects the more borrowing path, a crisis will be averted if a deal is done with President Trump. But as Australians we need to understand that the current sharemarket game is masking these serious underlying problems in the economy our major trading partner.

By not recognising the problem we make mistakes. Meanwhile in President Trump team they feel time is on their side.