Equity markets in the U.S. ended on a sour note Friday as crude oil prices moved into bear market territory (defined as a 20% decline) giving investors another reason to worry about a potential downturn in the U.S. and global economy. While data for the U.S. continues to point to solid growth, it is reports out of China that are increasingly giving investors pause given that policymakers there could be running out of stimulus levers to pull to stem slowing growth.
Is Beijing running out of levers to pull?
Recently we wrote about China’s weaker third quarter gross domestic product (GDP) report and some perceptions about its economic slowdown being related to trade. While the slower growth is noteworthy, as we pointed out in our previous post we think last year’s policies aimed at curbing credit growth and other excesses likely have contributed to this years deceleration (and not the trade dispute).
Beijing has nevertheless ramped up stimulus efforts, like once again opening up credit spigots and cutting corporate and income tax rates to get ahead of trade-war related concerns. While positive, we think there’s an increasing potential that credit related stimulus efforts are likely to be less effective as they had been over the past decade because households are tapping out of their ability to service debt.
Households today are more debt burdened
To this point, the chart at the top this post shows that household debt as a percent of the total size of China’s economy (GDP) has trebled over the past decade. This comes in contrast with falling U.S. household debt as the economy has expanded and households have delevered since the Global Financial Crisis. Higher debt levels for Chinese households on the other hand is important because individuals can only service so much debt at a given level of income.
Indeed, Chinese household income has increased over the past decade, but not at the same rate as the total amount of debt outstanding. Here in the second chart we see that yearly earnings increased from about $5,000 per year in 2008 to about $11,500 in 2017. On a per capita basis, household income increased from $550 in 2008 to $5,000 in 2018. In other words, debt increased from around 9% of annual income to over 40% in 10 short years. This number is still low by western standards, but nevertheless constrains the ability of Chinese consumers to put more credit to work as the government has intended.
The whole purpose of stimulus is to provide a temporary boost to household spending and business investment activity as a means to stave off a sharp deceleration in economic activity. The earlier noted higher debt service load has nevertheless borrowed from future spending by constraining consumers’ propensity to spend at current income levels. To be sure, the latest report on Chinese retail sales shows that growth in household spending has continued to moderate this year.
Constrained policies and the markets
A continuation of slowing household consumption despite the increased availability of credit and other stimulus efforts could draw a negative rebuke from investors. We believe this to be a potential case because market participants have for a long time been waiting for China’s economic shoe to finally drop after years of debt-fueled, government and corporate-led growth.
While we do not expect growth in China’s economy to suddenly come to a halt, we are watching for signs that stimulus efforts are losing their efficacy in terms of promoting household consumption and economic activity as households grow increasingly borrowing-fatigued. Markets, being the forward discounting mechanisms that they are, likely will be watching these developments as well and respond accordingly. For now, we believe that Beijing has the tools necessary to support growth (which is market positive). Data releases over the coming weeks and months will nevertheless tell how successful these efforts have been.