China, the world's second-largest economy, is in crisis,
according to analysts and economists who point to a longstanding
faltering in growth that has finally reached critical mass for U.S.
investors, many of whom are likely to recalibrate investment goals
For years, investors have looked to China's historic expansion
as the leading edge of an emerging market boom that offset the
flagging growth potential in the developed world. That's been
especially true since 2008, when the U.S. credit crisis triggered a
massive downturn in major developed economies that has left
often-unprecedented levels of debt in its wake.
China has loomed large as a way to lift emerging markets out of
a funk that has been linked to civil unrest in once-high-flying
developing countries such as Brazil and Turkey. But it appears
China's problems are too big, and many countries-commodity
producers, in particular-will feel the pinch of a China
"Many have asked when China would find itself in an economic
crisis, to which we [Stratfor] have answered that China has been
there for a while-something not widely recognized outside China,
and particularly not in the United States," Stratfor's George
Friedman said in a commentary issued this week.
The latest estimates of Chinese GDP growth, for instance, now
have some concerned that expansion there could fall below 7.4
percent, or even below 7.0 percent-if Chinese statistics are to be
trusted-this year, following June data that showed a slower
manufacturing pace, a drop in exports and a CPI level in China that
hit a one-year high.
Friedman is among those who don't trust China's statistics,
saying that they serve a political or public relations function for
internal as well as international audiences. He reckons growth
there is probably more like 5 percent.
A Growing Chorus Of Concern
Friedman's comments come about a week after Princeton Economist
Paul Krugman expressed concern in his New York Times column that
China's slowdown is now not only unmistakable, it's deeply rooted
in fundamental issues.
"The country's whole way of doing business, the economic system
that has driven three decades of incredible growth, has reached its
limits," Krugman said last week in his column, which Friedman cited
in his comments. "You could say that the Chinese model is about to
hit its Great Wall, and the only question now is just how bad the
crash will be.'
Chinese policies over the years have allowed inefficient
businesses to keep growing through bank lending in an effort to
avoid unemployment spikes-something the government there
These inefficiencies have led to higher production costs and
ultimately to inflation in a vicious cycle that now threatens
"The increase in inefficiency is compounded by the growth of the
money supply prompted by aggressive lending to keep the economy
going," Friedman said. "As this persisted over many years, the
inefficiencies built into the Chinese economy have become
What happens next is anyone's guess.
From an ETF standpoint, many investors already seem to be
trimming their exposure to China's growing threat.
There are more than 20
that tap into Chinese equities, and many of them have been very
popular with investors. Funds like the iShares China Large-Cap ETF
(NYSEArca:FXI), which in nine years since inception has accumulated
more than $5.2 billion in assets, and the SPDR S&P China ETF
(NYSEArca:GXC), with $868 million in assets, speak to the demand
for exposure to Chinese stocks.
But these funds haven't been performing well in 2013, feeling
the weight of crumbling confidence in China's growth story amid
FXI is now down nearly 12 percent year-to-date-the mega-cap fund
is heavily focused on financials-while the more broadly diversified
GXC has bled 6.4 percent of its value so far this year after
rallying roughly 15 percent in 2012. This downfall has come
accompanied by net asset outflows of more than $2.28 billion from
FXI and $119 million from GXC since Jan. 1.
Perhaps even more striking is the performance of a fund like the
Guggenheim Small Cap ETF (NYSEArca:HAO) or the Global X China
Consumer ETF (NYSEArca:CHIQ).
Also facing net asset outflows year-to-date, the $184 million
HAO exclusively taps small-cap stocks, which are often said to be
more closely connected to domestic themes such as consumer demand
and local growth. CHIQ is a consumer-focused fund, meaning its
holdings are the same companies that have their fingers on the
pulse of China's consumer cyclical and non-cyclical sectors.
HAO rallied nearly 25 percent in 2012, and has slid 3.5 percent
so far in 2013, while CHIQ has now bled 4.7 percent since the
beginning of the year, after gaining nearly 18 percent in 2012.
"The macroeconomic outlook for China continues to deteriorate,"
Guggenheim's Scott Minerd said in a recent research note, saying
that the chances of a financial crisis there over the next six
months are rising.
Tough Choices Ahead
"Chinese officials have shown they are willing to tolerate a
lower growth rate than originally anticipated as they attempt to
reduce the moral hazard in the financial system. This, combined
with instability in Japan as Abenomics continues, puts all of Asia
in a precarious situation," Minerd said, referring to Japan's
massive monetary stimulus program.
"If the bad news becomes worse and volatility rises further,
there will inevitably be greater knock-on effects for the global
economy and markets," Minerd said. "China's economic growth will
likely continue to slow in the near term, given the chaos in the
banking system and the potential squeeze of credit to the real
Stratfor's Friedman argues China is unlikely to collapse
economically, much as Japan and South Korea averted economic
Instead, he sees the government there focusing on containing
social and political backlash while allowing the economy to
deteriorate slowly, stretching out the decline.
"The Chinese economic performance will degrade, but crisis will
be avoided and political interests protected," Friedman said.
"Since much of China never benefited from the boom, there is a
massive force that has felt marginalized and victimized by coastal
elites. That is not a bad foundation for the Communist Party to
"China could very well face an extended period of intense
inwardness and low economic performance," he added.
A faltering China could also translate into higher demand for
the safety of U.S. Treasury bonds, he said, which would pressure
U.S. interest rates further.
Moreover, other emerging markets are also likely to be hit if
overall demand from China slows down. China is one of the biggest
producers and biggest consumers of various commodities.
"The past 30 years is a tough act to follow," Friedman noted.
"China in fact has had an extraordinary period of growth. The last
30 years have been remarkable, marred only by the fact that the
Chinese started at such a low point due to the policies of the
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