CHOVANEC: It's China's economic slowdown Australia should be worried about, not the stock market crash

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Australia has hitched its economic wagon to the Chinese growth engine over the past decade. That’s been great for growth during that period and was one of the key reasons why the Australian economy was able to weather the GFC so well, and without a discernible economic downturn.

But those chickens are coming home to roost, according to noted China watcher Patrick Chovanec, chief strategist at Silvercrest Asset Management, and Adjunct Professor at Columbia University’s School of International and Public Affairs.

In an interview with the ABC’s “PM” host Peter Lloyd, Chovanec said the the crash in Chinese stocks prices happened because:

The rally in the first place was completely unjustified by economic fundamentals in China.

“…there were problems in a whole host of sectors and corporate earnings, especially if you take out investment returns from investing in the stock market, were shrinking. Normally that would be a recipe for a stock market that at least didn’t go anywhere, it might even go down. And instead it took off like a rocket and it was fuelled by a lot of margin lending.

Key for Australia though are Chovanec’s thoughts on what the Chinese stock rally, bubble and burst tell us about the deeper issues within the Chinese economy.

“China’s stock market bubble and the crash is really more of a symptom than the cause of China’s economic troubles. It does complicate matters a little bit but China’s economy has already, for much more deep-seated reasons, been running into some serious headwinds and growth has slowed significantly.

“We saw it reflected in the price of iron ore, the price of oil, the price of copper – all these things that China was importing to drive investment has seriously tapered off, but the stock market was ignoring that and blissfully ignoring it until reality caught up.”

That’s not good news for Australia because Chovanec said the investment boom was unsustainable but “some people in Australia I guess don’t want to hear it”. He highlighted that the collapse in the iron ore price being purely a result of oversupply is too simplified an explanation.

Rather, Chovanec says, the oversupply has been a result of mining companies “building out capacity, mining capacity in anticipation that Chinese demand was infinite and it would grow at an ever rising rate”. So all Chinese demand needs to do is plateau and you get oversupply.

As a result, iron ore has crashed, Australia’s budget bottom line has deteriorated materially, and national incomes have fallen. That begs the question, Chovanec says, of “whether Australia can kind of shift gears and benefit from the shift that China is going to make in the coming years towards a more consumer driven economy”.

That’s where the recent signing of the Chinese Australia Free trade Agreement (ChAFTA) is so important. With its focus on the total Chinese Australia economic relationship and with the Australian service sector getting greater access to do business in China, Australia might be able to make this very important Chinese trade transition.

The good news is that Chovanec says China has the capacity to make that shift “and to sustain consumption, even in the face of a difficult economic adjustment”.

But he also highlighted that the Chinese economy has slowed and will continue to slow. The stock market bubble is a huge distraction, he said.

It’s not the crash that needs to be feared, it’s really the adjustment that China’s undertaking which it needs to undertake.

“It needs to go through this adjustment. It can’t stave it off but that’s the thing that people should be focused on.

Australia, take note.

You can find the full transcript of the interview here.

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