China is Japan and it’s goodbye iron ore

Japanication legend, Richard Koo, has turned his eye to China:

China is falling into a “balance-sheet recession” and needs to ramp up fiscal stimulus quickly to address the challenge, according to the economist who coined the phrase to explain Japan’s descent into stagnation in the 1990s.

“China is entering balance-sheet recession,” said Richard Koo, chief economist at the Nomura Research Institute, the research arm of Japan’s biggest brokerage. “People are no longer borrowing money,” due to concern about asset prices and the outlook for economic growth, and are instead “trying to reduce their debt” — a key element of the condition Koo defined decades ago.

Because of diminished appetite in the private sector to borrow and spend, the government needs to step in, he said. “The government should not waste time on monetary easing, or structural reform policies that economists love to talk about,” he said.

Koo’s concept has been widely discussed in Chinese economic and financial circles in the last year. He defines a balance-sheet recession as a situation in which households and businesses divert more of their income toward paying down debt, rather than consuming or investing. Koo argues that was a key reason for Japan’s descent into deflation, and for the slow US and European recoveries from the 2008 financial crisis.

But China’s awareness of the phenomenon should be an advantage, Koo said.

“There are already people talking about a balance-sheet recession in China — that was not the case in the US in 2008 or Japan in 1990,” he said. “The key difference is now the doctor knows what the disease is.”

The government needs to step in as a borrower-of-last resort to maintain spending that then provides households and business with income they can use to repair their balance sheets, until they are confident enough to resume borrowing.

“If the government puts in speedy, sufficient and sustained fiscal stimulus, then there’s no reason for Chinese GDP to collapse,” he said. The top priority is to ensure that builders complete unfinished projects, he added.

While China’s property slump offers a parallel to Japan’s case in the 1990s, the Japanese property-price decline was much more extreme, Koo highlighted. “I don’t think China will allow that kind of thing to happen.”

In addition, China’s population has peaked earlier in the development stage than Japan’s did. Along with a relatively greater dependence on construction, this indicates “the challenge China faces is probably much larger than Japan’s were,” Koo said.

China has space to expand government borrowing so long as private-sector savings remain high, he argued. However, “debt is already large, and you have to expand it to offset all the deleveraging that is going to take place — that could put some pressure on the Chinese financial market.”

Here’s Peter Zeihan with the latest population data to give you an idea of how large is the challenge:

And, finally, more on stimulus:

China will likely disappoint those hoping the government will roll out massive stimulus to shore up the weakening economic recovery, said Zhu Min, a former deputy managing director of the International Monetary Fund.

“There are a lot of expectations on the Chinese government to have more stimulus policies. I don’t think this is real,” Zhu said during a panel Thursday at the World Economic Forum’s Annual Meeting of the New Champions in Tianjin, China.

Zhu joins a growing chorus of experts who project the world’s second-largest economy will announce only moderate stimulus this year as the rebound loses steam. Consumer spending has slowed, while confidence among households and businesses is flagging.

I agree and expect China to fail to arouse property, keep building wasteful infrastructure (though not enough) and manage CNY much lower than it is today.

Nothing in this mix is good for commodity demand, especially iron ore. Today’s rally looks like typical seasonal restocking to me:

I’m resetting shorts into an H2 sell on stimulus news and seasonal dump.