Over the last 10 years, we’ve seen the Chinese economy take a greater role in the global economy. As readers who follow the markets closely already know, any news of economic growth or contraction within the Chinese economy now has the potential to move markets around the world.
This makes long-term investing more difficult, as we have to move beyond simply looking at a company’s potential to including the underlying fundamentals of the Chinese economy.
One of the red flags that concerns me is the massive increase in debt within the Chinese economy. I believe that non-performing debt, especially within the local governments of China, could cause a serious issue, not only for the Chinese economy, but the global economy as well.
Another nation that took on a massive level of debt was Japan during the 1980s. As we all know, anyone who takes out a large amount of debt needs to pay it back, which usually involves reducing spending and hunkering down to pay the large bill, or as I like to call it, the “hangover effect.”
While hard statistics are difficult to come by, I believe that local government debt within the Chinese economy has risen by approximately 50% over the last five years. The impact when it comes to long-term investing even here in America could be dramatic if this were to suddenly cause the global economy to slow down.
It does appear that the leaders in China are trying to prevent the growth of debt from completely swallowing the nation. Much like investors interested in long-term investing were heavily bullish on Japan during their growth spurt in the 1980s, the impact of deleveraging has taken decades to work out and they’re still struggling with a lack of economic growth.
While there is potential for long-term investing within the Chinese economy due to the large number of people that are moving up into the middle class, the debt overhang is a serious concern.
How much of the debt was used to construct buildings that sit empty? This is not a productive use of capital, since it results in no return on investment. Empty buildings don’t increase growth rates within the Chinese economy over the long term, but appear only as a short-term blip.
One needs to be careful when creating a long-term investing portfolio to incorporate the fact that the Chinese economy will not grow at the rates we witnessed over the past decade. This transition to a more domestic-oriented Chinese economy can produce winners, but one needs to be extremely selective.
When it comes to long-term investing, there are far more things to consider than simply the quarter-to-quarter financial results. A global powerhouse such as the Chinese economy can and will have an impact on companies, even here in the U.S.
This article is brought to you courtesy of Sasha Cekerevac from Investment Contrarians.