Economy & Budget

China’s leaders avoid debt trap

China's leaders avoid debt trap

LAS VEGAS– China’s “autocratic” leaders have avoided the debt trap that has ensnared their counterparts in numerous western economies that have been hit with credit rating downgrades, said Keith Fitz-Gerald, a global investing expert and futurist who spoke at the recent FreedomFest conference.

China’s economy is slowing, but the 2012 rate of growth is still expected to reach 7.6 percent and rank among the strongest in the world, Fitz-Gerald said. However, China’s government still wields heavy influence about which projects are funded and that kind of centralized control allows inefficiencies and corruption, another China expert countered.

Any gloom-and-doom forecasts about China due to the tapering off of its annual growth from 8 percent or higher overlook the country’s role in fueling economic gains elsewhere in Asia, Fitz-Gerald said. China’s growth has helped companies in Japan and other countries in the region that do business in mainland China, Fitz-Gerald added.

Forecasters who take a dim view of China discount the potential of an economic recovery there, Fitz-Gerald said.

“The Chinese Dragon is coming to lunch,” Fitz-Gerald said. “We can either be at the table or on the menu.”

Companies in Asia that have shifted to doing business in China typically are outperforming their peers, Fitz-Gerald said.

Key reasons why China’s outlook remains positive, despite a recent economic slowdown there, include a growth rate that is fueling one of the world’s largest gross domestic products (GDP); a currency that is gaining strength outside of China; and direct foreign investments, Fitz-Gerald said.

China currently is importing 97 cents of every $1 it exports and the country will reach $1 of imports for every $1 of exports in 2015, Fitz-Gerald said.

However, a much different view of China is offered by David McAlvany, CEO of McAlvany Financial Group.

McAlvany acknowledged that economic reforms in China from 1978 forward have been “tremendous,” but he added that Chinese leaders have failed to implement needed political reforms to keep that growth story alive.

Keys to sustain economic growth in China are the need to maintain the rule of law, transparency in the financial markets, and safeguards against corruption, McAlvany said. To the latter point, estimates are that 17 percent of China’s GDP is related to corruption, he added.

The corruption problem is probably the most important, McAlvany said. An estimated 80 percent of the management of state-owned enterprises is appointed by the Chinese Communist Party, with the tacit understanding that those people will be involved in siphoning off money from the companies, he explained.

“This creates a situation of patronage, with the leaders of the critical economic industries supportive of current Chinese Communist Party leadership,” McAlvany “There has to be political reform to continue the nation’s economic growth. That, to me, is what is unlikely.”

State-owned businesses account for a significant portion of the country’s GDP and such patronage arrangements reduce the potential return to investors.

“In China, 50-60 percent of GDP is related to state-funded investment,” McAlvany said in a follow-up interview after the conclusion of FreedomFest. “That investment includes development and infrastructure projects, including many that are not necessary. The huge commodities boom is related to a build-out of roads, buildings and infrastructure that are of no use today but are being put in place in anticipation of a continued migration from agricultural areas to major cities. The problem is that all the people who are supposed to migrate need to have jobs. By contrast, other countries will have 6-8 percent of their GDP related to state-funded investment.”

China is shifting toward internal consumption, McAlvany said. On the positive side, wages are rising and allowing the currency to appreciate, which is a benefit to household consumption, he added.

But the economy currently has an unhealthy dependence on infrastructure spending, McAlvany said.

Another problem in China is a lack of confidence among its people about their financial security, particularly if they move, McAlvany said.

China’s relatively high savings rate of 49-51 percent is an indication of “social insecurity” and the need for a more robust safety net, McAlvany said. There is a safety net that exists but it is not transferable from agricultural areas to urban areas, he explained.

“It is a glitch in the system and Chinese government officials have to change it,” McAlvany said.

In contrast, the savings rate in the United States is 5-6 percent, which is an improvement from two or three years when it was zero, McAlvany said.

“The United States needs to save more and China needs to save less,” McAlvany said.

Paul Dykewicz is the editorial director of the Financial Publications Group at Eagle Publishing Inc., www.eaglepub.com, of Washington, D.C. Eagle publishes two free, e-letters, five weekly trading services and four monthly investment newsletters, Forecasts & Strategies, Successful Investing, High Monthly Income and The Alpha Investor Letter.

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