China’s Fortunes Fading Into Crisis

July 24, 2013

As China’s economic growth falters, investors are faced with tough choices ahead.


China, the world’s second-largest economy, is in crisis, according to analysts and economists who point to a longstanding faltering in growth that has finally reached critical mass for U.S. investors, many of whom are likely to recalibrate investment goals going forward.

For years, investors have looked to China’s historic expansion as the leading edge of an emerging market boom that offset the flagging growth potential in the developed world. That’s been especially true since 2008, when the U.S. credit crisis triggered a massive downturn in major developed economies that has left often-unprecedented levels of debt in its wake.

China has loomed large as a way to lift emerging markets out of a funk that has been linked to civil unrest in once-high-flying developing countries such as Brazil and Turkey. But it appears China’s problems are too big, and many countries—commodity producers, in particular—will feel the pinch of a China slowdown.

“Many have asked when China would find itself in an economic crisis, to which we [Stratfor] have answered that China has been there for a while—something not widely recognized outside China, and particularly not in the United States,” Stratfor’s George Friedman said in a commentary issued this week.

The latest estimates of Chinese GDP growth, for instance, now have some concerned that expansion there could fall below 7.4 percent, or even below 7.0 percent—if Chinese statistics are to be trusted—this year, following June data that showed a slower manufacturing pace, a drop in exports and a CPI level in China that hit a one-year high.

Friedman is among those who don’t trust China’s statistics, saying that they serve a political or public relations function for internal as well as international audiences. He reckons growth there is probably more like 5 percent.

A Growing Chorus Of Concern

Friedman’s comments come about a week after Princeton Economist Paul Krugman expressed concern in his New York Times column that China’s slowdown is now not only unmistakable, it’s deeply rooted in fundamental issues.

“The country's whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits,” Krugman said last week in his column, which Friedman cited in his comments. “You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be."

Chinese policies over the years have allowed inefficient businesses to keep growing through bank lending in an effort to avoid unemployment spikes—something the government there feared.

These inefficiencies have led to higher production costs and ultimately to inflation in a vicious cycle that now threatens China’s economy.

“The increase in inefficiency is compounded by the growth of the money supply prompted by aggressive lending to keep the economy going,” Friedman said. “As this persisted over many years, the inefficiencies built into the Chinese economy have become staggering.”

Looming Questions

What happens next is anyone’s guess.

From an ETF standpoint, many investors already seem to be trimming their exposure to China’s growing threat.

There are more than 20 ETFs that tap into Chinese equities, and many of them have been very popular with investors. Funds like the iShares China Large-Cap ETF (NYSEArca: FXI), which in nine years since inception has accumulated more than $5.2 billion in assets, and the SPDR S&P China ETF (NYSEArca: GXC), with $868 million in assets, speak to the demand for exposure to Chinese stocks.

But these funds haven’t been performing well in 2013, feeling the weight of crumbling confidence in China’s growth story amid asset outflows.

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