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China - time to cut the apron strings

18 July 2019 Bryn Hatty, Chief Investment Officer at Stonehage Fleming Investment Management

“Intervention has always been their watchword. Every time the Chinese government has seen an economic dip on the horizon, it has responded with a combination of monetary accommodation – lowering interest rates - and fiscal stimulus to give things a boost.

This approach has stood it in good stead in the short to medium term. Certainly, driven by these credit injections, there have been periods where the Chinese economy has done extremely well. Subsequently the government has tended to step away a little, concerned that it has done too much, mindful of the build-up of credit and debt. The problem with this approach is that the Chinese economy has become accustomed to a pattern of stimulus and, in effect, ‘trained’ to expect it.

The Chinese model is vulnerable to several things including inflation, increases in unemployment and the accompanying lower living standards and social unrest. With its many outlying provinces, China is a large country whose stability is dependent on people not coming out forcefully against the government in the form of strikes or social unrest for instance.

The motivations of the government therefore are clear. It has always been minded to intervene to rescue the country from potentially damaging outcomes. Continual government intervention, though, will not help the long-term sustainability of the economy. At some point, domestic non-government agencies and participants will need to be free to let their animal instincts take over.

The Chinese government knows this. This time, as the market slows, they haven’t come back nearly as forcefully with monetary policy because they are concerned about a build-up of debt. Officials have implemented fiscal measures - cutting taxes, increasing government expenditure, facilitating private sector partnerships – rather than the extreme measures they took in 2015-2016 to dig themselves out of an admittedly deeper hole.

Now, as the economy enters a developed market cycle, a model less reliant on government involvement is required. After all, it is the second biggest in the world. Having peaked at 14% in 2007 the economy is now closer to 6% growth – a figure many governments would be glad to report. The Chinese economy is slowing fundamentally, but the time is now to take the punchbowl away from the market and let it find its own feet to reach the next level.”

 

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