Investors’ concerns over the economic situation in China may not be overblown, as the country is now the root cause that will lead to another 2008, George Soros (Trades, Portfolio) said while speaking with Bloomberg on Jan. 21 from Davos, where he was attending the World Economic Forum.
In fact, Soros said, the market is already headed toward repeating 2008. The main problem is deflation and over indebtness of the Chinese economy, coupled with the fact that China’s problems have a tendency to affect other parts of the world. In addition, China has long ignored the problem, making “a hard landing practically unavoidable,” Soros said.
China is struggling with slowing industrial production, which grew 6.8% in January and February of last year, its slowest rate since 2008. For 2015, the GDP growth rate was 6.9% — a 25-year low. As explained by Fortune, China opened a wave of bank loans during the financial crisis that caused the country’s debt-to-GDP ratio to swell to over 280%, which is the highest among emerging market economies.
Borrowers are now struggling to pay back their loans, the real estate bubble is growing and the country has an excess of infrastructure projects and factories. Soros, however, said the key problem is deflation. Since the last deflationary period was in the 1930s, today’s investors do not have the necessary experience.
“None of us have lived in a deflation environment,” Soros said. “We just don't know how to handle it, it's a different environment.”
China can only continue on their current path for another two or three years, Soros said. But with its trillions of dollars in reserves, China has the capacity to find a solution.
As of the third quarter, Soros has several call options in ETFs and stocks related to China. Soros bought a call option on 4,140,000 shares of Xinhua China 25 Index ETF (FXI, Financial), as well as a call option for 985,000 shares of Alibaba (BABA, Financial). A call option gives an investor the right to a stock at a specified price within a specified time frame, and generally indicates the investor expects the price of the asset to increase.
International investor David Herro (Trades, Portfolio), who heads the Oakmark International Fund, also weighed in on China, but took a less drastic opinion on the effects of China for the rest of the world.
While he pointed out that China has significant macroeconomic and political issues to solve, “"it doesn't mean the whole world is going to get sucked down the drain because of some uncertainty in China," Herro said.
In his fourth quarter fund commentary, Herro wrote that Prada (HKSE:01913, Financial) was a large detractor during the quarter due to sales decline in China, a reality that many companies who do business in the country are facing.
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