Volatility and Trouble in China

My favorite presentation during the second day of presentations at the CFA Institute Annual Conference centered on the future for China.

Over the last 12 months (through 5/10/16), the iShares MSCI China ETF is down 32.6%.  This downfall caused volatility to spread throughout the world, primarily in other emerging market countries.  The fear is that a slowdown in China will cause the same in other countries

As pointed out by one of our speakers – Michael Pettis (Professor of International Finance at the Guanghua School of Management at Peking University) – China’s debt burden has reached very troubling levels.  In fact, Mr. Pettis’s research indicates that every country with historically similar debt levels had to restructure their debt.  This can take several forms, ranging from outright default (unlikely in China’s case) to implicit restructuring.  This can be done through financial repression towards households or companies.  The secondary issue, however, is that China desperately needs its citizens to increase consumption in order to keep growth from cratering.  This leaves businesses drawing the short straw in the financial repression scenario.

The key for China, according to Mr. Pettis, is for China’s growth to decline no greater than 1.5% per year; anything more than that may have disastrous consequences.  Pettis feels China will be able to manage this process of slow decline, primarily through the sale of state-owned enterprises.  Is it possible for the privatization of assets to stave off a meltdown in China?  Our team will be on the lookout as the answer will have consequences felt around the globe.

– Lance Gunkel, CFA, CFP®