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On The Winners And Losers Of The Great Chinese Rebalance

On The Winners And Losers Of The Great Chinese Rebalance by Bryce Coward, CFA, Gavekal Capital

Change can be hard, but change can also be good. At this very moment we are living through one of the largest and potentially destabilizing periods of economic change in the last century. It is the mirror image and reversal of the last great economic paradigm shift. It is China’s shift from an investment driven growth model to a consumption driven growth model. For some it is painful. For others who are correctly positioned it is extremely lucrative. It is affecting all of us whether we know it or not. But most of all, it is inevitable.

This week has seen what we believe to be an acceleration of this change. China continued to make baby steps towards liberalizing its financial system by altering – slightly – the defacto peg to the US dollar. China is notorious for “feeling the stones as [they] cross the river”, and this latest currency regime shift is just one stone of many that will eventually lead to a much more open and consumption driven economy, but it will take years.

To be clear, when we say that China is shifting from an investment led economic growth model to a consumption led model, we are referring to a literal flip flop in the share of investment and consumption as a percent of GDP. As the first chart below shows, from 2000-2013, investment as a percent of China’s GDP grew from 35% to 48%. Meanwhile, consumption as a percent of GDP fell from 47% to a low of 36%. There is no correct ratio of investment as a percent of GDP, but many emerging market countries run at about 35%. This is because sustaining an abnormally high investment share of GDP – say around 48% as China has done – for a long period of time requires a massive buildup of debt which has practical limits. China is undergoing this uncomfortable shift in its economy and it will likely take a decade to get there. In the meantime, there are plenty of consequences, both good and bad, for stakeholders.

Great Chinese Rebalance

From an arithmetic perspective, transitioning from 48% investment to 35%...