There was good news on the Chinese economy in August, and since this is the second largest economy in the world, this is good news for us all. But there is also a little piece of information on China that may scare the pants off you.
The latest Purchasing Managers Indexes, or PMIs, covering Chinese manufacturing in August did something they had not done since November 2014. The two indexes, one produced by Markit on behalf of Caixin, the other produced by the Chinese government, both stood at 50 or over. That is significant because any score over 50 is meant to be consistent with expansion, and under 50 consistent with contraction.
The Caixin index did in fact fall in August, from 50.6 in July to 50.00 – even so, that was the second highest reading for this particular index in two years.
The official PMI rose from 49.9 to 50.4, the highest level in almost two years.
Julian Evans-Pritchard, China Economist at Capital Economics, said: "Overall, today’s PMI readings paint a fairly reassuring picture about the current state of China’s economy and fit with our long-running view that earlier policy stimulus ought to be sufficient to shore up growth until the end of this year.”
So that seems encouraging. The fear relates to debt.
According to Standard and Poor’s, China’s corporate debt to its GDP rose to 171% in 2015, double the ratio in the US and Eurozone, and, to use words borrowed from the FT, ‘off the charts’ compared to other emerging markets.
The good news on China is that its debt mountain is largely internal – it owns money to itself – or rather its corporate debt is owned indirectly to its citizens. You may think it is ironic that a country with such a high saving ratio also has such enormous debts – but actually, debt ensures that savings do not leak out of the economy. There is no wealth creation in saving, only in investment – so savings are bad for an economy unless there is a corresponding rise in debt, ideally investment – but this can, in turn, create distortions.
And distortions in China are writ large.
Now we come to the scary bit.
According to Morgan Stanley: before 2008, in China, one dollar of credit created one dollar of GDP. Today, it requires six dollars of credit to boost GDP by $1. And for economists, that finding by Morgan Stanley is the equivalent of a horror film – in future, such findings need to be emblazed by an X certificate, to warn economists of a sensitive disposition to prepare themselves – to, as it were, brace themselves – hence the warning at the beginning of this article.
