China Slowdown: What does it mean?

First, this is a long post, my point is that the anticipated slow down of China – due to its inflation worries – will negatively impact the Canadian economy.

A few months ago, Jim Chanos, president and founder of Kynikos Associates, a New York City investment company said that there was a property bubble in China, evidence was that there are 65 million homes in China that are not connected to the electrical grid – therefore no one lives there (See here and here).  There was a great deal of skepticism as to his views, but what is important was that Chanos said that he was not shorting China (despite his perception that a contraction was in the cards), rather, Chanos said that since shorting China was “impractical” he would short first and second derivatives assets.

What does this mean?  Well it means that if you believe that China will slow down, the demand for many raw materials will fall, as will their price, hence shorting the stock of firms that are active in these sectors, you achieve the same objective (as shorting China).  Yes dear reader, here comes Canada and Australia – the great commodity suppliers.  Obviously, Australia is directly impacted by a slow down in China, since it exports a great deal to the Middle Kingdom, but all materials are fungible, and therefore when steel, Copper, oil prices drop, both countries will be directly affected.  On the bight side these are not massive employers, but the impact on government revenues cannot be underestimated.

Consensus is now moving towards a Chinese slow down, because of growing inflation pressures the Chinese government fears unemployment but it fears inflation much more.  Looking back trough Chinese history it is inflation that has been the most destabilizing factor for the political class (the riots of 1987 – which culminated in the Tiananmen Square protest were first caused by high inflation).

Last week one of the most interesting economic analysts in China Michael Pettis made three assertions about growth over the next few years:

• Global demand growth over the next several years is likely to be anemic with or without China.
• If China's trade surplus contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.
• A slowdown in Chinese growth might not be the disaster for the world that many believe.

Uneven Consequences

Point number one is a given. I agree with point number two and three although I can see how many would disagree. The devil of course is in the details, and that's where I possibly differ from Pettis. It's hard to say for sure because he did not expound on country-to-country differences.

This is how I see it.

China is clearly overheating (see above commentary on housing), the slow down will halt the pressure on commodities and their prices.

For the U.S. falling oil and commodity prices would help reduce the US trade deficit, especially if grain prices remain firm. Falling energy, copper, and metal prices would help US homebuilders and small businesses hurt in a price squeeze of rising input prices and falling prices of goods and services. The net effect of this would be to strengthen the US dollar, yet help the US economy (BTW, American inflation will continue to be very low).  A slow down in China will impact corporation ad the stock market.  It may even but a dampener on Congress’ protectionist streak (one can hope, right).

Australia and Canada Will Suffer

Australia and Canada with their housing bubbles already poised to implode would suffer mightily if commodity prices tumble.  Resources account for nearly 1/3 of the country's GDP, a great deal of investments have been made in oil and gas while assuming energy prices in excess of $70 bbl.  What happens if oil prices drop by $30 to the mid 50s or 60s?  the impact would be hard.  In other primary resource sectors the same problem would arise.  

Given that the US and Europe are far more important globally, A slowdown in China might be a net benefit for the world "in general", yet a total disaster for countries overly dependent on continuous strong growth in China.

Australia and Canada would be especially hard hit, right at the worst possible time.