For the past few years, the conversation that the world’s rich and powerful have been having about China at the World Economic Forum in Davos, Switzerland, has sounded like this:
BULLS: China is going to be a world power, surpassing the US, and one with the power to cleanly vault over the challenges posed by a modernizing economy – with a management capability and store of cash reserves to weather a storm.
BEARS: China will suffer terrible shocks to its economy in order to manage a transition from a system based on investment to one based on consumption.
It seems, though, that in 2016 that conversation has shifted to something more specific. World leaders speaking candidly about China’s progress no longer speak in generalities. Now they point to specific, crucial issues that need to be handled as soon as possible.
Some don’t see them being handled at all. And there are some who think it’s too late.
This isn’t to say that there aren’t China bulls in Davos. It’s just that across the board, money managers and political leaders can point to China as a point of consternation and confusion. They can point to when that all started too.
“Since August, we’ve seen some very large inconsistency out of the Chinese leadership,” said Larry Fink, the CEO of BlackRock, in an interview with Bloomberg Television.
- Screenshot via Bloomberg TV
“China is a really important economy, it’s very important for the emerging world and that uncertainty from China, that lack of a cohesive message really has become very unsettled. And for me, that probably was the most unsettled component of why we had this huge capitulation.”
In August, China – which had already experienced two stock market crashes in short order – devalued its currency.
Around the world outsiders were confused. The government had said that it was committed to keeping a stable currency and stable markets. After that devaluation, though, the yuan held stead until December. Then it started to slide, compounding the fears of those worried about other indicators flashing red.
“I think the Chinese situation with the currency is very important. Very important. If there is significant currency weakness for the yuan that will mean more imported deflation and it will make things more difficult,” said Ray Dalio, founder of massive investment fund Bridgewater Associates.
China’s continued intervention in its stock market – and financial sector in general – is giving the world’s elite pause as well.
“There have been signs that China wants to have an open, free economy, an open, free marketplace, but in certain situations the Chinese have intervened into their market, making it less than a free and open market,” said Goldman Sachs’ COO Gary Cohn during the conference.
How is it being handled?
Where Cohn sees mixed messages some see no messages at all. The yuan’s continued slide into 2016 has roiled markets, and left leaders with unanswered questions.
“There is a communication issue,” said Christine Lagarde, managing director at the International Monetary Fund, who was also on Cohn’s panel. “Better and more communication would certainly serve that transition better.” Because of that lack of transparency, it’s hard to tell exactly why and what the Chinese are doing.
To recap, China faces a falling currency that it is spending billions to keep stable, and massive companies in sectors that used to drive growth getting swallowed by debt and buried by overcapacity. The Chinese government has said it has plans to combat these problems, but the plans are yet to be made public.
Measures to keep money flowing through the economy aren’t having the same effect as they used to. Credit growth, for example, is yielding less than half of what it did back in 2011 – $0.27 for every dollar pumped in.
So leaders have a right to wonder, is the government having success in restructuring state-owned enterprises? Is it planning on allowing the yuan to fall more, risking competitive devaluations and more global stock market turmoil?
“I think that if they stick to the reform program that they’ve announced, they can have a soft landing and level off at a rate of growth that is sustainable,” Treasury Secretary Jack Lew said in an interview with CNBC.
“If they don’t they have bigger problems than we’ve seen in the indicators. I think they’ve announced the policies that they know they need. Now the question is, can they implement them? … They have not been entirely clear in their movements how they’re behaving and it creates confusion.”
Can it even be handled?
- World Economic Forum, Flickr
George Soros, the billionaire investing living legend, is not confused.
“It’s serious,” he said in Davos. “And the Chinese left it too long to address the changeover in the growth model that they have to adopt from – investment and export-led to domestic-led. So a hard landing is practically unavoidable,” he said during separate Bloomberg event in Davos.
Soros is in the camp of people who think it’s too late for China to avoid a period of intense pain. The state-owned enterprises are too heavily indebted. The world is slowing down and the demand for Chinese goods isn’t what it used to be.
And of course there’s the falling yuan. Over and over again, conference attendees point to it as a source of major consternation.
“There is a huge financial problem and economic problem that it’s not easy for them to solve. They’ve been talking about liberalizing their capital account for a long time. At the same time, they do not want a massive depreciation of their currency, they want a nice gradual one. That may be impossible with massive capital outflows that have been in recent months,” said economist and historian Niall Ferguson.
“I think one of the big questions here, to which nobody really knows the answer is, is it going to give? Is there going to be a big slide in the renminbi in the coming months? That would be a huge blow to other emerging markets and to the world economy as a whole.”
It would also be a money suck for China. Yes, the country has implemented capital controls, but as long as market forces compel yuan holders to sell, they’ll find ways to get around them and the currency will be expensive to defend.
That complicates this entire picture – one that looks murkier to the world’s elite than it ever has before.