The Chinese Cliff Hanger

We don’t make forecasts about future events, but it’s a virtual certainty that the long-running story about the Chinese economic slowdown will remain in the headlines well into 2016. You can pretty much take that one to the bank.

There are three reasons China’s economic woes will keep our attention next year, one completely valid, one bogus and one intellectual.

The valid reason is that China is one of the three largest economies in the world, and what happens there affects the entire global economy. Whether you use GDP or Purchasing Power Parity, there is a continent’s worth of capital flowing through China, and a hiccup in its commerce, manufacturing or consumption will be felt everywhere. China gets big attention because it’s big.

The bogus reason for all the headlines is that there is a sizable segment of the global economic press that’s actually happy to see China having trouble. This may be for ideological reasons (China is communist or China violates civil rights or China is the world’s biggest polluter) or just because China is a growing superpower that’s carving out a zone of influence for itself. (Those in the last group should review the Monroe Doctrine if they think the Chinese are doing anything unique.)

The intellectual reason is simple. China is an ongoing experiment in a mixed economy, one that combines market and command elements. China’s adoption of market or capitalist elements has transformed the country into an army of entrepreneurs, all competing for a larger slice of the pie. This is the part of the economic picture that has produced the wave of new Chinese millionaires and billionaires and the thriving businesses that we are invested in.

But the Chinese government also retains a huge role in directing the economy, for instance, changing regulations in a tactical way to encourage or discourage investment in housing and other popular investments. And many large companies are still state-owned enterprises (SOEs), protected from market forces and allowed to remain inefficient and unprofitable because privatizing them would be expensive and put many workers out of jobs. Solving the problem of SOEs is said to be high on the agenda for 2016, along with continuing efforts to root out corruption and revive economic growth.

Strengthening economic growth is a high-stakes poker game for China’s leaders. Too little growth will raise unemployment and may instill discontent in the populace at large. It’s being reported that China will run its biggest deficit in over 50 years in 2016 as the government increases spending to stimulate the economy, which is still facing deflationary pressures despite a program of interest rate cuts, fund injections and lowered loan requirements.

Because we follow market trends rather than forecast them, we will face 2016 as we always do; watching what’s happening carefully and adjusting our portfolio in response to what’s happening.

But if we had to put money on a prediction (which we might do for a maximum 25 cents, U.S.) we would bet that the government will be successful at keeping growth at or near required levels. The government has the necessary control and the necessary capital to keep money flowing. And there are large sections of the economy that are prospering quite well under the new capitalist rules, showing that Chinese consumers, at least, are ready and able to spend money.

All in all, it will be a fascinating story to follow in 2016.

This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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Paul Goodwin can be found on Google Plus.

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