On the face of it, the Chinese economy — the bedrock of Australia’s continuing economic success — appears to be lifting out of its torpor. But looks can be deceiving, and many economists believe China’s better economic data might be a classic dead cat bounce. Some economists are forecasting next year’s growth will fall below 7% — if this is indeed the case, Australian mining stock and the Australian dollar are in trouble.
First, the good news. Second-quarter GDP figures showed growth has picked up from 7.2% in the first quarter to 7.5%. There was more good news last week; the “flash” Purchasing Managers Index released by HSBC — the first of the PMIs realised each month that measure manufacturing activity — showed a lift in orders to mark 50.7, up from 50.2, which was the best mark all year. (Anything over 50 means growth, and most PMIs have been in sub-50 territory this year.)
Markets welcomed all this positive data, sending the Australian securities exchange index and the Australian dollar higher. To boot, Australia’s export and trade data with China lifted last year, according to figures released by the Department of Foreign Affairs and Trade on Friday. China remains Australia’s biggest two-way trade partner, with $150 billion, more than double that with Japan’s $70 billion.
But while markets cheered, most economists did not. To lift growth, Chinese leadership has resorted to the only strategy it knows: economic stimulus by way of broadening credit availability through state-owned banks and pumping money into infrastructure projects — which gives manufacturing the boost that is now becoming apparent.
The problem with this constant string of stimulus programs is that they have diminishing returns, as each one must service interest on the debt produced by the previous one. Stephen Green at Standard Chartered Bank has estimated that China now carries a debt load of 250% of GDP and insists that “more rigorous” reforms are now needed.
Australia escaped too much contagion from the GFC because of the Chinese government’s 2008 stimulus program that caused sales of Australian resources to China to soar into the stratosphere. Yet China’s latest economic data disguises the fact that the aim of the Xi Jinping administration — to rebalance the economy away from asset investment towards domestic consumption — has, at least so far, failed to take hold. Retail sales for April were soft and trending downwards. Domestic consumption is fading rather than growing, forcing the government into yet more spending on infrastructure projects underpinned, this time, by a boost in railway investment.
Having promised, hand on heart, it would not use stimulus to boost GDP growth again, Xi and his chief economic lieutenant Premier Li Keqiang have done precisely that. At a meeting with economists last month, Li Keqiang clarified his target for the nation’s economy for 2014:
“As long as development brings jobs and incomes increase, it is of high quality and efficiency, it saves energy and protects the environment, and the reports are truthful, a growth rate a little bit higher or lower than 7.5 would be acceptable.”
That’s up from last year’s 7.4 %, and so far there’s little sign of the government moving towards more sustainable, stimulus-free, lower growth targets.
As far as Australia’s concerned, the one sector that is not growing is the one most important to Australia’s massive mining sector: housing in China, which accounts for about 60% of the national steel consumption. The Chinese property bubble, which has been the key driver of Chinese economic growth since 2008, has finally popped. The over-production of apartments across the country — well documented in multiple reports of “ghost cities” — is hurting the market. As prices fall, consumers no longer see housing as a good investment.
At the same time that China is staring a very real housing crisis in the face, Australia’s biggest iron ore producers, Rio Tinto and BHP Billiton, have announced better-than-expected production and future production targets. Smaller producers such as Atlas are also continuing to raise their production as they race to build scale that helps reduce their per-tonne costs and save them from becoming the victims of lower iron ore prices.
“A major lift in supply from Australia has overwhelmed China’s demand growth and weighed on the iron ore price in 2014. But the supply-side of the trade is rebalancing. Production cuts have emerged in China and are likely elsewhere, while Australia’s supply growth looks largely done for 2014,” a report from investment bank UBS said this week. And Gina Rinehart’s Roy Hill project is yet to come online with its 55 million tonnes per year.
The price of iron ore dipped as low as US$89 in June before recovering; now it’s heading back down again, closing at US$93 on Thursday night. UBS believes it will bounce back to an average of US$100 next year; others, such as rival bank Goldman Sachs, disagree — they are more bearish with a figure of US$80 for 2014.
If the latter is right — and they could be with more supply due to come online from Brazil in the next two years — and the housing crunch in China gets worse, it’s economic bad news for Australia. As growth demand for our minerals softens considerably and supply continues to rise, it will hit jobs, domestic spending and receipts. The government will be hoping the picture in China and surging iron ore supplies don’t get any worse.