China's next export: Inflation?

Investors should be wary of the risks of holding bonds at the moment, economist Andrew Hunt says.

Thursday, April 7th 2016, 6:00AM

by Susan Edmunds

Hunt is in New Zealand speaking at Nikko’s investment summit.

One of the key messages he is tackling is the outlook for China. He says what happens next for that country's economy will have huge ramifications for investors the world over.

Hunt said China had been flooded with newly-printed money to help support companies suffering through negative cash flow.

“China is 16% of GDP but a third of the world’s monetary supply. There is huge monetary wealth there that far outstrips actual wealth."

The Chinese government was faced with a choice. What it did would alter the course of international interest rates, he said.

“Either money leaks out, the currency falls and reduces the value of the money supply back in line with the economy, exports get cheaper and the country enters a period of deflation,” he said.

“Or China holds the currency stable through monetary controls, money is trapped in China and people diversify out of bank deposits, ultimately into goods, and the economy starts to inflate. If China starts to export inflation, it completely changes the global outlook.”

Hunt said China had only exported inflation four times over recent history, in 1993/1994 – the worst ever year for the bond market, 1999, 2007 and 2012.

“Given where the bond market is priced at the moment, expecting little to no inflation, if China hit an unexpected bout of inflation there would be a rout in bonds,” Hunt said.

“The investment implications are poles apart and it is keeping central banks on their toes. When China last got into this situation it didn’t matter so much but it still had an effect on the market.

“Now China is the second-largest economy in the world. If it devalues 25% there might be a few happy consumers but if you are competing with China, you are stuffed.”

He said investors should be conscious of the risk of owning bonds. “If China goes into inflation, the world will be amazed how quickly interest rates go up.”

People would dump low or negative interest bonds in that situation, he said.

“If China exports inflation the bond market could back up aggressively.”

He said he would not expect much more of a monetary response from global central banks if China entered deflation because there was little room left for them to move. He said negative interest rate policies had been proven not to work.

Tags: bonds Nikko AM