Fund heavyweight Crispin Odey has claimed China could be forced to devalue its currency to boost uncompetitive exports.
He says the policy was used to good effect from 1994 to 2008, and may be seized on as the solution to faltering growth and rising wage demands.
“It looks like China cannot find an easy equilibrium without becoming more competitive with the rest of the world, and that demands a 30 per cent devaluation,” said Mr Odey.
Commenting on the rationale of his Odey Opus portfolio, he added, “China is caught by its own success. A fixed undervalued exchange rate from 1994 allowed it to build the infrastructure of a developed economy, using the cash produced by the export sector.
“This worked well until 2008, but China then chose to increase the infrastructure spend to offset weak exports.
“Six years of compensating for uncompetitive export industries by increasing building activities has led to a vicious circle of pushing up wages, which undermines exports and drives the government to spend more.”
While China bulls claim growth can continue with a tweak in bank reserve requirements and lower interest rates, Mr Odey said the presence of shadow banking showed returns do not exist inside China at present.
“We live in a world where quantitative easing in the US has already driven savings to find returns in the periphery, where hidden dangers lurk behind attractively high yields,” he added.
“No assets are cheap, but the rest of the world does not have to grapple with this dialectic of capital spending undermining the competitive position of the Chinese economy.
“At some point, the Chinese will dream about what they did in 1994 and at that moment, [no-one wants] to be a country that sells raw materials to China and borrows cheap money from the US.
“Whereas 2008 was a crisis over solvency, with borrowing at 8 per cent to invest assets yielding 3 per cent, this crisis will be a crisis of liquidity.”
Meanwhile, Europe remains stymied and expensively priced, with little to recommend investment, according to Mr Odey.
The manager said stockmarkets had recently been kept near new highs by heavy buying of defensive shares and emerging markets.
“This quest for value would be understandable if it also reflected a breakdown in currencies, a crisis of growth in the developing world and another deflationary shock through the system,” he added.
“However, in such a scenario, these so-called safe companies, the likes of Unilever, Nestle and Kellogg’s, would be hit hard by their emerging market exposure.”
Mr Odey said he doubted the European Central Bank president Mario Draghi could successfully tackle deflation in Europe by introducing some radical “QE bomb”.
“From here, European banks are staring at sharply lower net interest margins unless private sector demand reverses its relentless decline, and there is nothing to indicate this will happen,” he added.
“The political environment across the vast majority of Europe is far from encouraging of entrepreneurial activity.”
The China conundrum?
It is often said economic growth is not equal to stockmarket gains, and China is perhaps the best example of this.
The country is expected to register GDP growth of 7.3 per cent this year, according to BofA Merrill Lynch Global Research.
However, in spite of the bullish mood across many markets, BoAML says China’s stockmarket “cannot catch a bid”. The Shanghai Composite index registered an 8.5 per cent loss in 2013 and has continued to slide so far this year.
Many investors were optimistic following November’s third plenum – a meeting of the Communist Party’s top brass – which marked an acceleration in the pace of market reform. But, more than six months in, reaction is muted.
“The long list of reforms that came out after the third plenum aroused enthusiasm among people who have been craving for reforms for many years, but to no avail,” BoAML said.
“Implementation will be key to how markets perform.”
Net fund flows also paint a picture of investor bearishness towards the world’s second largest economy, with data from BoAML showing more than $4.6bn (£2.7bn) has come out of Chinese equities year-to-date – far greater than the $451m outflow from Brazilian equities and $303m outflow from Russian equities.
The question investors need to ask themselves is whether at these levels the market presents a buying opportunity, albeit one which may need patience.
