The problem with economic consequences is that, they are not visible before long long time. As we have seen the effects now unraveling in different parts of the globe, like the debt and demographic crisis in Japan, or the sovereign debt crisis in Europe or the Budget & Trade Deficit in the U.S., they occurred and impacted the economies within long span of time. There are also some symptoms that have evolved in China, which are just tantamount with Economic Bubbles. Edwin Chancellor, a foremost authority on Economic Bubbles that occurred throughout history, has identified some classic symptoms of economic bubbles in case of China. Surely these have far-reaching consequences.
China has roared the most in the contemporary global economic arena. But its reputation as an unstoppable giant- as a country with an unending supply of cheap labor and limitless capacity for growth-masks some serious and worsening economic problems. China’s labor force is aging. Thanks to its brutally-enforced “one-child” policy, China’s population is actually set to decline in 2015, and its worker participation rate will peak this year- after which the numbers of people joining the work-force will fall off rapidly. If you would look at the real future of China, look at Japan, whose own aging population is the hidden cause of its continuing decline. Apart from that, its consumers save too much and spend too little. Its political and economic policy tools remain crude.
CLASSIC SYMPTOMS OF ECONOMIC BUBBLES IN CHINA
· The biggest is the staggering dependence of its economy on government-fueled investments boom: No major economy has had investment as a percent of GDP at 50% for a sustained period. No country can be productive enough to take that proportion of GDP and re-invest it into new capital stock without eventually facing massive over-capacity and a staggering non-performing loan problem. In a free-market economy, investments fall during periods of uncertainty. Yet in 2009,Chinese investments in fixed assets jumped by 30%, rising to a record 58% of GDP. Roughly a quarter of this investment was state-directed, with many projects serving solely to meet local GDP growth targets. One commentator says, China is following the “Asian growth model on steroids”- i.e., the pattern of the Asian Tiger economies, boosting growth through ever-increasing investment, which led to the Asian Crisis in 1997-98.
Most likely, as per the wizard forecaster economist Nouriel Roubini (who first correctly predicted the American Housing Crisis), after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP. China is rife with over-investment in physical capital, infrastructure and property.
Roubini further added that the economy is overheating here and now, but in the medium term, China’s overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible-most likely after 2013- China is poised for a sharp slowdown. Continuing down the investment-led growth path will worsen the visible glut of capacity in manufacturing, real estate and infrastructure.
Roubini says, “I was recently in Shanghai and I took their high-speed train to Hangzhou”, referring to the Maglev line that has cut travelling-time between the two cities to less than an hour from four hours previously.
“The brand new high-speed train is half-empty and the brand new station is three-quarters empty. Parallel to that train line, there is also a new highway that looked three-quarters empty. Next to the train-station, is also the new local airport of Shanghai and you can fly to Hangzhou” , he said. “There is no rationale for a country at that level of economic development to have not just duplication but triplication of those infrastructure projects.”
· Lack of domestic demand: Too few people in China had the discretionary spending capability to support its economy domestically. Analysis has shown that it took a per-capital gross domestic product of about $5,000 to have meaningful discretionary spending power in China. About 110 million Chinese had that much or more, but they constituted only 8 percent of the population and accounted for just 35 percent of GDP in 2009, while exports accounted for 27 percent. In contrast, in advanced economies, about 70% of economic output is attributed to domestic consumption! Even China’s middle and upper classes had only 6 percent of Americans’ purchasing power.
· Easy Money and Risky Lending: China today is keeping interest rates artificially low to promote investment and subsidize state-owned companies. For the past 40 years, the interest rate that major U.S. companies have borrowed at has been, on average, 1 percentage-point higher than the rate of GDP growth. In contrast, the Chinese prime borrowing rate has been on average 9 percentage-point below GDP growth over the past two decades!
What’s more, Beijing responded to the 2008 financial crisis and the resulting collapse in its exports by ordering its banks to lend. In 2009, new bank lending grew by nearly 10 trillion renminbi ($1.5 trillion), or around 29% of the country’s GDP.
“The size of this credit expansion is worrying in itself”, obereves Edwin Chancellor. “It beggars belief that lending could have expanded so rapidly without some decline in underwriting standards”. Indeed, much recent bank lending in China resembles the lowered underwriting standards that led to America’s subprime-mortgage meltdown of 2007-08. For instance, up to half of 2009’s bank loans went to local government funding vehicles that appear to have little or no current cash flows. Instead, local governments are now depending on asset prices for revenue-much as they did in places like California during America’s housing bubble.
· Real Estate Bubble: Chinese authorities are pursuing massive commercial and residential real estate construction despite lack of perceptible demand. Among the results: the newly constructed “ghost town” of Ordos in Inner Mongolia-with housing for a million, and virtually no residents. “Build it and they will come”- or maybe they won’t.
In addition, for Chinese households, artificially low rates of interest on their savings are also driving them into speculation in real estate-just as Americans did the years leading up to the 2008 crash. As a result, in China today, residential real estate is averaging between 20 and 40 times average household income-compared to roughly 10 to 12 times household income at the height of the U.S. housing bubble in the most overvalued neighborhoods. “This has to qualify as the most dramatically overvalued real-estate bubble in world history”, writes Steven Jon Kaplan of Truecontrarian.com.
· A Surge in Corruption: “All great speculative manias have been accompanied by rising levels of fraud”, observes Edwin Chancellor- and it’s only after the bubble bursts that the Madoffs and Enrons come to light.
Here, of course, is where the closed nature of Chinese society is especially worrisome: China recently earned a dismal 3.5 (out of 10, for “very clean”) in Transparency International’s 2010 Corruption Perception Index, giving it a rank of 78…just below Tobago.
More worrisome: the real estate boom and infrastructure spending that are driving Chinese growth are especially susceptible to corruption. As evidence, the New York Times reports, half of all those luxury sales are estimated to be bribes.
· A Fixed Currency: “Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts”, cautions Chancellor.
China’s currency, the renminbi, is pegged (fixed) to the U.S. dollar-leading to an undervalued exchange rate that boosts exports, keeps interest rates low, and encourages massive inflows of foreign capital.
And get this: The Bank of China is printing as much as $ 2 billion worth of renminbi per day in order to buy dollars and maintain the currency peg. The money supply skyrocketed 26% last year in China, creating an artificially booming economy that cannot last and will eventually cause a collapse.
CONSEQUENCE?
China avoided a hard landing during the global credit crunch but faces a downturn after 2013, as it will struggle to keep increasing fixed investments, Roubini said. He said, investment was already 50 percent of gross domestic product. Sixty years of data had shown that over-investment led to hard landings, citing the Soviet Uniion in the 1960s and 1970s, and East Asia before the 1997 financial crisis.
“A significant slow-down in China, or even negative growth, would likely reverberate throughout the world economy, including that of the United States”, warns Banning Garrett, Director of the Asia Program for the Atlantic Council of the United States. “The end of China’s role as an engine of growth would be a blow to global economic growth, affecting investors in China, purchasers of Chinese goods, and exporters to China”.
Bloomberg’s David Lynch agrees (1/26/11): “Any Chinese financial emergency would reverberate around the world. The total value of the country’s exports and imports last year was $ 3 trillion, with about 13% of the trade between China and the U.S. As of November (2010), China also held $ 896 billion in U.S. Treasuries.
If China’s growth falls to less thn 5% in 2011 (from the targeted 8%), global commodity prices could plunge by as much as 20%, warns Fitch Ratings (11/30/10). Shares of U.S. and other Western commodities, steel, energy, manufacturing, automotive and chemical firms- which have come to rely on China as their biggest customer-would tumble if the country’s construction and capital-expenditure booms abruptly ended.
“A bursting China bubble would be a massive deflationary shock to the world economy”, says Chen Zhao, Chief Global Strategist and Managing Editor for Global Investment Strategy, BCA Research Group. “With China in growth recession, global saving excesses could surge and world aggregate-demand would be vastly deficient. Bond Yields could move to new lows and stocks would drop, probably precipitously-in short, investors would face very bleak and frightening prospects.”
Like we have said at the beginning, it takes long for economic consequences to become visible. But, as symptoms often presage ominous outcome, this might be the case for the bubbles foaming in Chinese Economy over the years. And, if they burst, it will have far-reaching consequences.
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