Is the world embracing a brief recession?

HONG KONG — The world has been preoccupied with the slowdown in China, but the bigger issue is the global economy, says Jim Walker, founder of the independent
economic research house, Asianomics.
Walker believes the world is entering recession right now, but the consolation is that this recession will be brief, and is unlikely to cause a financial crisis.
The culprits, he says, are the European
Central Bank and the Bank of Japan. The European Union and Japan have pursued loose monetary policies to reflate their economies and, in doing so, have caused considerable grief to dollar-denominated economies around the world.
“To be precise, depreciation of their currencies as a result of their quantitative easing has squeezed some US$2 trillion out of the global economy,” says Walker. “Global recession is here. Volatilities in the global stock market, which started last summer, were signalling that the global economy is in trouble.”
Walker told ATI that Shinzo Abe started the downward spiral with his Abenomics policies to stimulate the economy, but Japan was not big enough to make a real difference.
“That came when Mario Draghi (President of the European Central Bank), turned to quantitative easing (QE) to boost the sagging European economy. The moment Draghi introduced QE, the global economy went into recession.
“Their exchange rate fell and what that does, in a global context, is to shrink dollar-denominated GDP. “Why does that matter? Because nearly every country, including those in Asia, has its trade denominated in US dollars. Even developed economies like Japan price goods and services in dollars.
“When the Euro dropped from 1.53 to 1.08 to the dollar, it removed US$2 trillion from global GDP. This contraction places a huge squeeze on everybody’s ability to sell to each other.”
Walker says the commodity and energy
exporting countries have been the first to feel the squeeze because they are in the early part of the global supply chain.
In his view, the under-performance now evident in the emerging markets and Asia will shift to Europe and the US.
“Commodity and resource producers see the recession first, but it is now moving through the global economy. We expect it to hit the US in the next two quarters.
“That is a big call for this year, but unlike 2008, I think this will be a short recession. It will be an activity recession, not a financial crisis.”
Consequently, Walker expects the US to lift interest rates one more time this year. Then he believes a move by the US Federal Reserve to turn to monetary easing in QE4 could be on the cards. That, says Walker, will be good for the global system.
By contrast, he is not nearly as bearish on China, saying that the economic adjustment there is close to the bottom.
“I would argue that China’s industrial sector is in outright recession – heavy industry, steel, you name it, the old economy is in recession. But China’s services sector and private consumption are booming.” The services sector’s contribution to China’s GDP has risen from 40 per cent a decade ago to 50 per cent today.
“They’ve got to the transition point — moving from manufacturing and investment to services and consumption — through luck rather than good planning,” he says.
Walker is frankly bemused and surprised that the world media is only now realising that China is slowing. “It is bizarre that it has taken them so long. Global commodity prices have been falling since 2012.
“I think the slowdown is just about finished. I don’t expect it to accelerate much from here, but I don’t really expect it to collapse either.
“I might be wrong. Maybe China has a greater crisis coming which I don’t know  about.”
The good news is that the current leadership in China, while it might be among the most repressive that China has seen in a couple of decades, is doing a lot of the right things on the economic front, says Walker.
“The anti-corruption drive is hugely beneficial to China. It is bad news for infrastructure development because local governments have stopped wasting money, and SOEs have stopped expanding.
“It is tremendously positive for the services sector and SMEs. Anti-corruption amounts to basically a huge tax cut. Instead of paying officials, SMEs are able to set up business having only to pay for the permits and licence.”
Technology is also driving growth in the services sector. Walker says mobile technology and Internet penetration is transforming  the way the economy grows, with the mobile phone becoming a virtual form of  infrastructure enabling flow of market information which was once delivered by roads, banks and railways.
Walker admits to being “pretty negative” about China for a long time. “We were negative from about 2007 right through the big boom
because the boom was driven by credit and a series of very bad policy decisions,” he says.
He adds that, unfortunately, other countries — Australia, Canada and Brazil included — along with commodity companies, misread the signals from China and invested heavily in expansion in anticipation of continued demand.
As for a pick-up in global demand for commodities and resources, Walker expects the sector to coast along at its current level for the next two to three years.
He says China is moving into closer integration with its neighbours through its One Road, One Belt and Maritime Silk Road initiatives.
These may well involve economic colonisation of China’s neighbours, he says, but the
reality is that capital will start to move into these countries and will generate economic
activities along the Silk Roads.
Walker says Asia is the only region that has excess capital and people. “When we talk about integration,” he says, “we are talking about capital from North Asia chasing the workforce and markets of South and Southeast Asia.”
He notes that Beijing’s economic strategy looks completely at odds with its political
actions, like sending a large oilrig into Vietnamese waters.
In his view, Xi, by increasing the budget of the Chinese military, the People’s Liberation Army, has given the PLA the opportunity to
occupy itself outside China. When it has its own preoccupation, the PLA could well leave the Xi Government to pursue its own agenda on the domestic front, he says.

n Hong Kong causalty of China slowdown, page 14.

‘Negative
sentiment
exaggerated,
excessive’
Leading Chinese investment banker Fred Hu dismisses current negative sentiment towards China as “exaggerated and excessive”.
Despite commentaries on the weakening of China’s renminbi, Hu, founder of the leading Asian-based private equity firm, Primavera, says the currency has risen by 30 per cent on a trade-weighted basis over the past three years.
A respected economist who has served at the International Monetary Fund and advised the Chinese Government on financial reform, SOE restructuring and macro-economic policies. Hu says softening of the Chinese currency in the short term is to be expected because of monetary easing.
The currency has weakened by 10-15 per cent in the past 12 months, but it is unlikely to fall further, he says. “In all likelihood, the RMB will be more flexible in its movements, but it will largely be stable and strong.”
Of the Chinese stock market, he says there was mass hysteria among investors, and the Government made the “grave mistake” of intervening to prop up the market. Intervention, he says, has caused more harm than good.
Hu believes further decline is likely on
China’s stock markets, but he says it is important to bear in mind that Chinese stocks have been sold off too much. In terms of price earning ratios, he says Chinese equities are now five times lower than Brazilian stocks, and less than half of those in India or Indonesia.
“On any reasonable assessment, it is hard to justify such deep discount of Chinese equities,” he says. The ultimate fear stems from the health of the Chinese economy, which has slowed for two years in a row.
Hu says real growth in China in 2015 will be lower than the official forecast of 6.9 per cent. But given the size of the Chinese economy, he adds: “Let’s say that growth in China is 6.0 per cent on a US$11 trillion economy. We are still talking about new growth that is equal to the size of two Malaysias or three-quarters of Indonesia — and that is in a single year.”
China’s slowdown is necessitated by the shift from infrastructure investment and exports to rising middle class consumption and innovation, he says.
Hu is a former Chairman of Goldman Sachs in Greater China. He says China is gradually cleaning out ‘zombie’ firms in sunset industries, and its local governments are starting to deleverage.
He rules out a collapse of the Chinese
economy, but warns that the road ahead will be bumpy — and that growth will be uneven.
Three sectors will hold up the Chinese
economy, he says.
The first is consumption, which has held up well and even more importantly continues to grow. Since 2011, it has grown steadily from around 40 per cent of Chinese GDP to 50 per cent today — and it is still rising.
Second, he says, education, sporting events, entertainment, leisure and travel are booming. These sectors are growing in high single digits of 6-8 per cent — the fastest growth rates anywhere in the world.
Lastly, he speaks of the “buzz” generated by research and development and innovation in China. China is outspending all countries in the world, with the exception of the US, on R&D, and has led the world in patent filing.
Today, more than 200 Chinese IT companies have billion-dollar market capitalisation, second only to the US, where 230 firms have achieved this level of market size. Other than Internet and IT companies, Hu says Chinese firms are pressing ahead in the areas of stem cells, renewable energy, clean tech, drones and so on.
China’s advantage is its human capital, which, when combined with the domestic market, Chinese entrepreneurial spirit and Government support, will unlock huge potential for China in the future.
Far from the gloom and doom being reported in international media, Hu says China is beginning to reap the benefits of restructuring. The Government is currently deregulating rules around approval of offshore acquisitions.
2015 was the first year in which China has exceeded the US$250 billion level in cross-border acquisitions, and this is rising to more than US$300 billion.
The early waves of Chinese offshore investment were in sectors such as energy, but that is now broadening to acquisitions that will help strengthen China’s industrial companies.
Increasing pressure to lift competitiveness is forcing more Chinese enterprises to look for M&A opportunities overseas. Hu says lack of brands and intellectual property hampers
Chinese manufacturers, and this provides the motivation to acquire Western companies for their brands and IT.
Hu refers to the takeover of the Swedish carmaker, Volvo, by China’s car manufacturer, Geely. This is proving to be a big success. Volvo-branded vehicles had their best year yet in 2015 in terms of the number of cars sold.
Currently, Chinese whitegoods giant, Haeir, is in the throes of a takeover offer of US$5.4
billion for the whitegoods arm of the US behemoth, GE. It is planning to take over GE Appliances, which will greatly boost its existing business and give it a distinctiv house-hold brand name.
(Other speakers at the Asian Financial Forum
in Hong Kong also predicted a rapid increase in the number of Chinese companies making strategic acquisitions
offshore. One speaker said he is aware of a multi-billion dollar deal that is even bigger than the Haier bid for GE Appliances. He said this involves negotiations to take over another Western firm, but he declined to provide
details.)
Hu expects Chinese authorities to create more Shanghai-style Free Trade Zones to facilitate trade and investment, offering investors fewer impediments to entering China.
The anti-corruption campaign, he says, has increased transparency and adds to the overall improvement of the Government functions.  
Gradually, the Government is handing over key financial and monetary functions to the market and he points out that interest rate movements are now market driven. This has been made possible by financial reforms.
He also believes that, with China’s inclusion into the International Monetary Fund’s basket of special drawing rights (SDRs), the pace of convertibility of the RMB will accelerate.