This Philly Business Guru Predicted the Chinese Financial Crisis Plaguing the U.S. Stock Market
At Monday’s opening bell, the Dow Jones industrial average dropped an astounding 1,000 points in minutes, then stock prices rose and fell in a volatile roller coaster throughout the day.
It all stemmed from fears about the Chinese economy and the country’s ability to remain a strong catalyst of economic growth. It was even dubbed “Black Monday” by some.
You know who wasn’t surprised? Richard Vague, one of the managing partners of Gabriel Investments and chairman of The Governor’s Woods Foundation. He predicted the Chinese economic crisis in a book titled The Next Economic Crisis and a recent Democracy Journal article in March. Now he’s joined BizPhilly to help us make sense of what happened yesterday and what the future may hold.
BizPhilly: What happened to the stock market on Monday?
Vague: It started with China’s Shanghai Index down over 8 percent (and down 38 percent since its June 12 high), which brought the Dow down 4 percent (and 9 percent in the last five days).
Why is China’s stock market down, and how did it bring down the Dow?
First let’s look at China, which has some of the biggest issues in economic history, and who we will be hearing about on this subject for some time to come. With a GDP of $10 trillion, China is now the world’s second-largest economy, well behind the U.S. at $17 trillion, but dwarfing third place Japan at $5 trillion. So unlike 10 or 20 years ago, when China ranked much lower among world economies, if something big happens in China, we are going to feel it.
China reached its current No. 2 ranking through very fast growth. For much of the past 20 years, China has been growing at over 10 percent per year. It is now purportedly growing at 7 percent, which is nevertheless still well above the anemic 1 percent growth rates of Japan and the Eurozone, and the modest 2 to 3 percent growth rate of the U.S. (It’s a small, small, world: If you put them all together, the U.S., Europe, China and Japan are 67 percent of world GDP.)
How did China grow so quickly? (Please don’t say irresponsible lending…)
Yep, runaway private lending. In fact, since our crash in 2008, China’s private debt has grown $15.5 trillion, the most in world history. And in so doing, they’ve built and produced far more real estate and goods than anyone could possibly need in any near-term time frame—as one example, more than one in five homes in China’s cities is empty, with 49 million sold but vacant units, and 3.5 million homes that remain unsold—and China has made $2 trillion to $3 trillion on problem loans in the process.
So China has so much overcapacity that its businesses can’t avoid the need to slow down and let demand catch up. That will take years and bring China’s growth rate down far, far below 7 percent. Maybe even to a near zero level. It’s very similar to what happened in Japan in the 1990s. Remember in the 1980s when Japan was growing at a double-digit pace and was going to take over the world? Japan’s growth rate has been near zero in the 20 years since. China could very easily be on a similar trajectory.
You predicted this. Are you ready to say I told you so?
I’ve been predicting this for well over a year, first in a book I published in 2014 called The Next Economic Crisis, then in the Democracy Journal article. My prediction came when we first noticed the unprecedented and astonishing buildup in private debt in China, but I take no credit for the analysis and I take no pleasure in recent events. This development will bring a tremendous amount of suffering for years to come in a world that had not completely healed from the crisis of 2008.
What happens if China’s growth decelerates?
Remember, Europe and Japan are growing at a near zero rate, and the U.S. is showing tepid growth, that means we are now in a low-growth world, and that recognition is a big part of what has caused the stock market swoon. And that deceleration in demand has also brought non-agricultural commodity prices down — the price of iron, steel, aluminum and even oil. And many of China’s companies have borrowed using these commodities as collateral, compounding the bad debt problem.
Because China’s growth has been so high, a number of countries and companies throughout Asia Pacific, Africa and South America have seen a boom based on exports to China. So with the slowdown, those countries and companies are facing crisis too, especially where they have used debt to fuel their exports to China. The U.S. and Europe are less exposed, but China is so big that they too are feeling the slowdown.
How should China address its problems?
The unsettled nature of the markets will continue as China and the world work through these issues, which will likely take months or years. The reality is that there is no quick fix. But since high private debt levels and overcapacity brought these problems, then addressing high private debt and overcapacity has to be central to the solution. China should prudently slow both lending and growth, allowing demand to begin to catch up with overcapacity, and it also needs to require its lenders to broadly restructure debt with overburdened corporate borrowers — leaving them better positioned to lead a more measured growth after the slowdown. But because the crucial and central role private debt plays has not been widely recognized, this approach to crisis management is absent from almost everyone’s thinking.
Is there anything the United States can do to stem the tide and lessen China’s affect on the U.S. stock market?
As the old proverb goes, “the horse is already out of the barn” as regards the impact from China. If you are a pharmaceutical company or car manufacturer, and 10 percent of your sales come from China, that will be impacted, and shifting your sales efforts to other parts of the globe won’t change your short term results anytime soon. That said, the amount of exports from the U.S. to China is relatively low as a percent of our total economy, especially compared to other countries, so I expect the impact to our GDP growth to be well less than 1 percent. The stock market is a different story. Stocks often don’t reflect underlying fundamentals, so I won’t be surprised with any outcome in the stock market. That said, at these levels, stocks should represent an opportunity more than a risk.
What if the economic situation in China gets worse?
I think the situation in China will get worse. China’s government has always intervened in a massive way in its economy, and I expect it will continue to do so, so its GDP growth (as opposed to its stock market performance) will decline more slowly that it might in a Western economy. But it will continue to decline, probably to a very low single-digit growth level, and there will be continued downward pressure on commodity prices. So this is a situation that will be an issue for some time to come.