An Economist Visited China And Came Back With Three Big Insights

The fate of the Chinese economy continues to be of major concern to investors all around the world.

The country is a major driver of global demand for various goods, but there are growing fears that China is experiencing a "Minsky Moment" and that it will have a financial crisis or a severe slowdown, as the credit-driven growth model hits a wall. Right now, the world is watching Chinese leadership attempt to manage the tricky task of maintaining economic growth (which is crucial) while simultaneously reforming the economy away from overinvestment, debt, and bubbles.

Morgan Stanley economist Joachim Fels recently visited China - as he describes in his Sunday Star note - and after meeting with leaders and investors there he came back with three important observations.

Here's a shortened version:

First, everybody I met now agrees on the diagnosis: there is a serious debt problem and deleveraging is inevitable. This may seem obvious, but (believe me) it was different on earlier trips. The days of 'debt denial' are definitely over.

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Second, I strongly believe that if anyone can deflate a credit bubble gently, it is China. Why? (i) The debt is all internal as China's capital account is (relatively) closed. There are no foreign creditors that can withdraw from one minute to the next, and the domestic creditors cannot easily send their funds abroad. (ii) A large chunk of the debt is within the public sector - extended by state-controlled banks to state-owned enterprises or local public authorities. This makes it easier to "extend and pretend". (iii) The central government is in good fiscal shape and, if needed, has access to the central banks' printing press.

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Third, the Chinese authorities' response to the recent sharp slowing of growth is unlikely to be massive but rather selective and targeted.

So there IS a problem, China might be able to pull off a reform without a collapse, and stimulus will be targeted, not broad-based