Before an earthquake, you sometimes get small tremors - little warnings. The same is true in finance.
For example, before the global financial crisis kicked off in earnest, there was a year or so where it was clear there were problems in the US mortgage sector, but it seemed like they were under control. The current rumblings from China remind me of that time.
Also by Jason Murphy:
China has some big property developers who have gone broke. The original one is Evergrande. Now, another one called Country Garden is warning it might default. For now, that hasn’t caused a major tidal wave of financial stress. Everyone is hoping it will stay contained to those companies and not become systemic. And fair enough. China’s government has done an amazing job over the past 20 years on avoiding financial chaos.
Whenever there have been bad loans, they’ve managed them. A debt crisis has never blown up. But in the past 20 years, China has been growing unbelievably fast. GDP has been expanding at 8-10 per cent a year. That kind of income growth means past mistakes look small. Past losses can be paid back with future gains.
Risk grows when growth slows
But China’s growth has slowed. The days of a 10 per cent growth target are long gone, but this year they look like missing even their new, lower 5 per cent growth target.
That means there’s less cover for past screw-ups. The chances of China being unable to solve its own problems are higher than ever. All those ghost cities they built are haunting them, and they lack the power to scare the ghosts away.
When China began its insane building boom, the Chinese people lived mostly in the countryside. A nation with big cities to be sure. But with hundreds of millions of farmers too. Farming half an acre didn't make much sense in a global economy. And, as China joined the global economy over the past two decades, the children of China’s farmers leaked away to cities. They worked in the factories that clothed the world (and made its toys, and its electronics).
That process has its limits. China is now highly urbanised, and having fewer kids than ever. In 2005, there was demand for 30 million new apartments every year. Now, not so much.
Property development is a business where you borrow money upfront, build things, sell them, and pay back the lenders later. The situation for companies like Evergrande is they borrowed a lot, built a lot, and haven’t earned back enough money to do the paying-back part. If the people they owe are also big financial firms who could be insolvent, you get a financial crisis. That risk has the world on the edge of its seat.
Australia relies - a lot - on China
Australia has most of its eggs in the China basket. Not all, but a lot. We are not diversified enough to avoid absorbing China trouble. Being undiversified has been a great gamble over the past 20 years. China’s growth has been our growth. We live in a country where labourers drive brand new cars and going on an overseas holiday is normal for people of all ages and classes. Hi to all the 19-year-olds heading to Bali on their footy trips. We are rich and China is why.
As the next chart shows, China is 40 per cent of our exports now. They account for $20 billion a month in exports, and we are running a monster trade surplus with the rest of the world, thanks mostly to the high price of Australian commodities. Take away those exports and our GDP collapses.
Take away the high commodity prices and Australia’s tax take will tumble. Mining profits fill the coffers of the federal treasury (don’t confuse these with oil and gas company profits, which are regularly zero, thanks to a mix of enormous development expenses for gas hubs and nefarious transfer-pricing strategies. Mining companies like BHP generally do pay a lot of tax.)
A China financial meltdown and recession could easily spark a recession in Australia. It would also slam the government’s ability to roll out a fiscal response to that recession. Funding another JobKeeper package or JobSeeker increase when taxes are shrinking would be a challenge. Not to mention the fact our government debt is now far higher than it was when the pandemic hit.
If China’s financial system melts down and China goes into recession, it will mean job losses here. We’re not immune. Unemployment will rise, fear will spread, firms will reduce hiring and cut people’s hours. The recent gains we’ve made on unemployment and underemployment will be lost.
The good news is the Reserve Bank has some wriggle room now. It could cut official rates substantially from their current level of 4.1 per cent. If China falls, the central bank will certainly need to do so, urgently.