So there you have it.
After a rotten start to the year, the markets are pretty much back to square one.
In fact, based on Friday’s close, the Aussie market is up four points for the year…or 0.08%.
It’s not much. But considering where the market was just two weeks ago, we’ll take it.
The last two weeks should have taught you a valuable lesson – there’s nothing to gain from panicking, and everything to lose. Those who sold their stocks fearing a crash have missed out on making back their money as the market has rallied 5% in less than two weeks.
But barely a day goes past without another faux potential disaster hitting the headlines. More often than not it’s China…
According to the Financial Times:
‘The boom in lending augurs well for the Chinese economy in the coming months, allaying fears that higher market interest rates will starve companies of financing and weigh on growth.
‘But it also adds to concerns that China has become increasingly reliant on debt and that the government is struggling to wean banks and companies off that dependence.‘
We’ll make one tiny but hugely relevant point about that. Perhaps the FT would like to show us an economy that isn’t ‘reliant on debt‘.
We’re not sure such an economy exists. All developed and sophisticated economies rely on debt to some degree. If it weren’t for debt, arguably it would be much harder for any economy to grow.
That doesn’t mean we’re in favour of individuals or businesses leveraging up to the eyeballs. But by the same token it’s silly to think that all debt is bad.
Here’s why…
The one thing easily forgotten by those who rail against debt is that on the other side of the ledger to debt is savings.
(We won’t get into the argument about whether savings create debt or debt creates savings; that’s not important.)
A saver is someone who doesn’t have an immediate use for their money. So, they choose to save until they may need it in the future. One incentive for them to save for the future is that they’ll need a source of income after they’ve stopped working.
Another incentive is that someone will pay them (interest) if they forgo spending today, and save the money instead.
The person prepared to pay for the use of these savings (via a bank) is the borrower. The bank pools the savings and lends it out to a borrower. (Again, we’re not getting into the complexities of banking, we know how it works. We’re keeping this nice and simple to illustrate a point.)
The saver hopes that the bank lends responsibly so that they’ll earn interest and of course, get their principle back too.
That was one of the key problems with the subprime mortgage mess. The investment banks were so obsessed with issuing loans and selling them as investments to earn big fees that they stopped lending responsibly.
That was the problem. It wasn’t debt per se. It was the quality of the debt.
That’s the issue facing China today. There’s a lot of talk about the stability and fragility of China’s banking system.
But that’s not unique to China. The nature of a paper-based money system with no backing except the word of the government and central bank will always face problems.
However, that doesn’t mean an economy has to collapse today. For a start, let’s look at China’s debt to GDP ratio. Based on the last published figures from 2012, China’s gross public debt to GDP was 22.8%. That’s according to the International Monetary Fund (IMF).
To give you a comparison, Australia’s gross debt to GDP was 27.2%, and the US gross debt to GDP was 106.5%.
So, what should we make of that? Well, consider the following chart of US total public debt going back to 1965:
What do you notice?
That’s right, US debt to GDP was at 30% in 1980. This increased every year until 1995, when it peaked at 65%. This was also the same period as the US Savings and Loan Crisis, when 23% of US Savings and Loan institutions (the equivalent of building societies) went bust.
But what also happened at this time? You got it…the Dow Jones Industrial Average gained 359.9%. That’s even taking into account the 1987 stock market crash.
Now, we’ve warned in the past about the tendency of investors and investment pros to take a historical event, apply it to today and assume the same thing will happen.
There’s no guarantee that China’s economy will continue to grow just because US markets soared even as government debt soared, and even as a full-blown ‘banking’ crisis played out in the 1980s and 1990s.
Although it’s worth noting that as government debt took off again in 2009, during another full-blown banking crisis, the US market gained 128.7%. And from 1980 through to today the US market has gained 1,825%.
Before long we’ll have to throw away that hackneyed old saying about markets not liking uncertainty. It seems that sometimes markets love uncertainty.
In short, while those in the mainstream worry about China’s rising and potentially dangerous debt levels, we suggest you look at it a different way – as an opportunity. An opportunity to profit from a rapidly growing economy, which in the years ahead is set to become bigger than the US economy. (We’ll have more on what that means for the Aussie market later this week.)
As an investor, given China’s proximity to Australia and ongoing demand for resources, that puts you in the box seat to benefit.
Playing the China growth game isn’t without risks, but as far as we see it, the biggest risk is not taking part in it. Because if you stay on the sidelines you’re potentially missing out on the biggest growth opportunity the world economy has seen in the last 40 years.
Cheers,
Kris+
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