Sep 11, 2015

Why will China go through a Great Depression

The month of August is a roller-coaster ride for global investors with global markets correcting more than 10%, as a result of the fear of the slowing Chinese Economy. The sudden devaluation of the Chinese Yuan sparked off fears of a potential currency war leading to one of the worst one day drop in recent times. Dubbed as Black Monday, global stock markets fell between 3-9% on 24 th August and continued to fall for the next few days. There was so much fear prior to the opening of the US Stock market that the US index Futures hit their Limit Down before the opening of the US stock market that morning. Limit Down is a safety mechanism by a stock exchange to limit the fall of an index to a certain percentage (10% in most cases) to prevent fear and panic among the investors.

The Black Monday may be the beginning of the end, for China.

History has shown that there is a certain economic cycle, which nations have to go through, before they can become an economic powerhouse. In the recent times in which the rise and fall of great nations were charted by a stock exchange, US and Japan comes to mind. China’s rise and potential crash seems to emulate the evolution of the rise of the two richest developed nations in modern history. In all three cases, prior to the rise of these mighty nations, they experienced a devastating war and conflict, which changed the cultural and economic landscape of these nations. For US, it is the American Civil War, for Japan, it is the WWII and for China, it is a combination of WWII and the Cultural Revolution. After much economic destruction, these great nations are able to build from a low economic base, a rapidly growing post war population and a building spree in basic infrastructure such as roads and railways.

The American industrial age created railway barons, steel tycoons, property and banking magnates. The stock and property market soared and it transformed America into one of the greatest industrial state within 50 years. World War I barely made a nick on the economy of the America and a whole generation of Americans grew up knowing only growth and prosperity. The Great Depression, caused by a currency war and a debt leaden American society, crippled the American society for the next decade.

The post-WWII Japanese society was seen as an Economic miracle during the 1970s. The Japanese economy progressed rapidly spurred by infrastructure building and a bloom in electronics and manufacturing and the bloom created tycoons, ranging from banking, property and household appliances. The property and stock market soared and the Japanese went on a property buying spree around the world. The value of the land which the imperial palace is located at Tokyo is worth more than the value of the entire real estate in California at the peak of it’s bubble. The post war Japanese generation grew up knowing only growth and prosperity for45 years and the good times never seem to end. The Great Depression of Japan reared its head due to a build-up of massive corporate debt and the following decade was known as the Lost Decade of Japan.

The modernization of China started in 1976, when Deng Xiao Ping took over an impoverished China after 3 decades of war and economic mismanagement due to the Cultural Revolution and the Great Leap Forward. Adopting an autocratic planned economic model, China has been able to develop quickly by taking over Japan as the factory of the world in the late 1990s and with her huge population and the rise of the middle class, China is able to power ahead and became the second biggest economy in the world. The Chinese was able to build up its wealth quickly, thanks to its concentrated effort to build up its infrastructure and banking sector and it was pretty much insulated from the 1997 Asian Currency Crisis, the 2000 Dot com recession and the 2008 Global Financial crisis, thanks to its closed economic system. The post Cultural Revolution generation saw their wealth grew quickly as the value of their land and property grew exponentially with no major hiccup in the past 40 years. Although its fledgling stock market has crashed twice, the property market has not seen similar correction.

During the depression years of US and Japan, the crash of the stock market only signaled the beginning of their depression years and it was the crash of the property market when the man on the streets really felt the pain of the recession.

In conclusion, the rise of all great nations from their initial chaos years often resulted in a rapid rise in wealth and power and almost without fail, they will have to undergo a great crisis in order for the country to move on to the next step of economic growth. Previously, opinion leaders believed that the Chinese might not follow the natural path of Growth and Depression due to the level of power and authority that the Chinese government wield over the country, which allows them to manage the country at a consistent Growth stage. However, as we have seen from the recent burst of the Chinese stock market, the Chinese government has surrendered in the face of the over whelming market forces, despite their ample resource and it still remains to be seen that there is any government in the world, that can go against the natural forces of Mr Market.

Whether the current stock market crash marks the beginning of a lost decade in China, only the future can tell. However, any investment strategy that we implement must take that scenario into consideration has to include such a possibility so that we will not be caught off guard, should China lapse into their own version of the Great Depression and Lost Decade.

Portfolio Strategy and Returns

The defensive nature of the portfolio has proven its worth during the month of August, with the cash portfolio gaining 0.1% for the month and the CPF portfolio losing 1%. The allocation into the USD money market funds resulted in almost a 1% difference in performance, which highlights the difference in returns, by simply riding on the right currency trends. We have moved 30% of the SGD denominated bond holdings into Europe and US equities during the third week of August, generally avoiding Emerging Market in the case of a deepening China crisis. Will a Great Depression be certain for China going by the laws of Great Nations? I do not know, but it will always be wise to heed the rhythm of history and assume such a scenario may occur. I will move more into equities once the coast is clear that there will not be another steep drop in equity prices some weeks down the road.
Related Posts Plugin for WordPress, Blogger...