China’s slowing economy will hit the developed world, and no country harder than Canada, according to Yale economist Vikram Mansharamani.
Speaking at the CFA Society’s annual investment conference at The Ritz-Carlton, Grand Cayman on Oct. 15, Mr. Mansharamani predicted that the fallout from China’s slowing economy will also impact financial services and tourism in the Cayman Islands during the next three to five years.
As China’s economy recorded 6.9 percent growth in the third quarter, the lowest rate since the global financial crisis, the author of the 2011 book “Boombustology,” which predicted a worldwide ripple effect from a Chinese economic slowdown affecting virtually every asset class and commodity worldwide, said he believes the process is playing out today.
While China’s credit-fueled investment bubble has burst, the consumption boom that it was hoped would replace it has not yet arrived. “So I believe that China is entering this valley, where the consumption engine has not yet picked up steam and the investment engine has run out of steam,” he said.
Canada is one of the countries that Mr. Mansharamani finds “shockingly vulnerable.”
The country’s credit-fueled real estate market is not acting according to the typical laws of supply and demand, where higher prices stimulate supply which then brings prices down. Instead, higher prices have increased the demand, and Canada has not seen a marked housing correction since the early 1990s.
In cities such as Vancouver, demand has been driven by Chinese buyers entering the market, which turned it into “the second least affordable city in the world.”
The problem, according to Mr. Mansharamani, is that house prices are rising supported by extensive leverage. The 170 percent ratio of household debt to disposable income in Canada is approaching Greek levels, he said.
“The foreign buyers are coming in and drive up real estate prices. The locals have to take out debt to keep up with that process.”
The reason Canada still works, he said, is because interest rates are low and the debt is at an affordable level. Meanwhile, job creation has been high since 2009 and unemployment is on the decline.
“But if you disregard the job creation in Alberta, driven by the oil industry, what you find is that the unemployment rate was basically flat,” Mr. Mansharamani said.
“What you learn is that Canada has been an oil story. So oil supported the jobs, which supported the debt, which is needed to buy the houses at prices that are set by Chinese buyers. When you unwind this process, debt is the only factor that does not adjust.
“That’s the potential for a real bust.”
Similar dynamics are occurring in Australia, South Africa and Brazil whose commodity-based economies are overly reliant on China.
Cayman will be affected because deflationary dynamics are more entrenched than people believe, he said. “Interest rates will stay lower for longer. Lower interest rates and a lower return environment make the hedge fund return on investment structure less compelling.”
This means downward pressure during the next three to five years on legal services, fund management, accounting and other services Cayman offers to the hedge fund industry.
The general ripple effect from a Chinese slowdown will also affect tourism, Mr. Mansharamani predicted.
“In a world where a consumption boom has not yet happened and there is a slower economic trajectory in Canada and the rest of the developed nations, what does that do to tourism? That is the second dynamic that will affect Cayman as well.”
Despite the negative outlook for global growth in the short run and his concerns about “a deflationary dynamic that is grabbing hold of the world when there is already too much debt,” Mr. Mansharamani believes that in the long term, domestic demand in China will lead to a consumption boom that will have a very positive impact on the world.
Mr. Mansharamani will outline his theory of what happens to the global economy once this consumption boom takes hold when he returns to the Cayman Islands in January as a keynote speaker at the Fidelity Cayman Economic Outlook conference.