Is China Heading to a 1930s-Style Crash?
 |  |
- One statistic summarizes the situation: in Q3, there was $460.6 billion of net capital outflow. No economy can survive outflows of that size. The Chinese economy has never made sense, but confidence held it together. Now, the confidence is gone.
- There are indications that China's economic growth rate is, in reality, close to zero. Take the most reliable indicator of Chinese economic activity, the consumption of electricity.
- China's Communist Party has been closing off the Chinese market to foreigners, recombining large state enterprises back into formal monopolies, increasing state ownership of enterprises, and shoveling more state subsidies to favored market participants.
- Just about everyone correctly agrees that a new round of structural economic reform could restart growth.
"On conservative growth projections, China's economy could well be bigger than the sum of all the G7 economies in real terms within the next decade," writes Peter Drysdale, the editor of the popular East Asia Forum website.
Not everyone is as optimistic as Drysdale, but the general view is that China will work through a transitory period and enter a new phase of growth powered by consumer spending.
Are China's economic problems merely temporary -- a year or two at most -- as the majority view suggests?
Perhaps, but there are also reasons to believe the country will have to endure prolonged hardship, either two or so decades of recession and stagnation or, more probably, a sharp 1930s-style crash followed by years of deep contraction.
Today, the Chinese economy is in far worse shape than most economists and other analysts think. China's economy could not have been growing at the 6.9% pace reported by Beijing's National Bureau of Statistics (NBS) for the third calendar quarter of this year or at the 7.0% rate claimed for each of the first two quarters.
It is more likely to have been the 4% that Willem Buiter, Citigroup's chief economist, recently suggested, and perhaps the 2.2% that people in Beijing were privately talking about a few months ago. And maybe it is even less than that.
There are, after all, indications that China's economic growth is, in reality, close to zero. Take the most reliable indicator of Chinese economic activity, the consumption of electricity. For the first nine months of the year, electricity consumption increased by only 0.8% according to China's National Energy Administration.
Defenders of NBS's gross domestic product (GDP) numbers argue the economy has shifted from energy-intensive manufacturing to services, so electricity is no longer indicative of economic trends. That, however, sounds like an excuse.
In any event, previous criticisms of the electricity numbers have been exaggerated, and Premier Li Keqiang, now China's economic czar, said in 2007 that official economic growth statistics were "man-made" -- unreliable -- and that he looked to electricity figures when he wanted to know what was really going on.
Yet even if electricity is no longer as indicative as it once was, there are other statistics confirming the sharp deterioration of the economy. For instance, imports -- a sign of both manufacturing and consumption trends -- fell 15.7% in the first ten months of this year in dollar terms. October, when they dropped a worse-than-expected 18.8%, was the 12th-straight month imports have fallen, and that equals the record from 2009.
Another disturbing sign is found in price data. In Q3, nominal GDP growth of 6.2% was less than the officially reported real growth of 6.9%, indicating deflation.
Deflation is never a good sign, and China looks as if it is now caught in the trap of falling prices. That means a 1930-style adjustment -- a crash, in common parlance -- is increasingly possible. And maybe even likely.
The problem for China's leaders is that nothing they have been doing in the past year to stimulate growth has been working. Six reductions in benchmark interest rates since last November and five reductions of the bank reserve-requirement ratio since February, for instance, have had no noticeable effect.
This monetary stimulus is unproductive because there is a lack of demand for money. Banks do not want to lend, and potential borrowers do not want to borrow. Central government technocrats can create money as if there is no tomorrow -- M2, the broad gauge of money supply, was up 13.5% in October -- but few see a need to invest available cash. So creating money this year has not resulted in growth.
At the same time, two other government tactics have come a cropper. First, the reckless promotion of stock price rises, beginning during the fall of last year, was intended to create a wealth effect. The campaign, however, led to the dramatic collapse in equity prices in June. Beijing, incredibly, had not learned its lesson, and in recent months engaged in another round of government cheerleading. Chinese officials, however, should realize that a rise in prices without an improvement in fundamentals can only lead to another horrible bust.
Second, the still-inexplicable devaluation of the renminbi beginning August 11 has not helped either. The move caused a global run on the currency, and Beijing still has not changed sentiment even if it has, through extraordinary means, temporarily stabilized the situation.
Just about everyone correctly agrees that a new round of structural economic reform could restart growth, but such change has become exceedingly unlikely because:
Xi has also strangled his country's financial markets in order to keep share prices high and currency values elevated. For example, this summer his government restricted stock-index futures because it considered these derivatives a source of downward pressure on stock prices, but the restrictions killed activity. China's stock-index futures market, the world's largest in mid-June when the slide began, was devastated, with transactions down 99% by September.
Even when Beijing has summoned the gumption to announce reforms, there has been more show than substance. For instance, late last month the People's Bank of China, the central bank, announced it was eliminating the caps on deposit rates, but officials are now informally dictating to commercial banks the deposit rates they may offer.
Let us not be surprised by the end of liberalization in China. Xi Jinping's signature initiative, encapsulated by the phrase "Chinese dream," contemplates a strong state, and a strong state does not sit easy with the notion of market-oriented reform. Unfortunately for Xi, also the Communist Party's general secretary, there are no solutions that are possible within the political framework he will not change.
Therefore, Xi's government has fallen back on fiscal stimulus to create growth. Fiscal spending was up 36.1% in October, according to the Finance Ministry. This follows increases of 26.9% in September and 25.9% in August. In the first ten months of this year, fiscal spending was up 18.1% while revenue rose only 7.7%.
No analyst is cheering the new spendathon. Just about everyone knows China does not need another "ghost city." And everyone is concerned about the debt that has been created to fuel growth. McKinsey Global Institute puts the country's debt-to-GDP ratio at a worrisome 282% at the end of June 2014, but the number is surely higher than that now, perhaps in the vicinity of 350% once all hidden obligations are counted and GDP is accurately assessed.
And even with this extraordinary spending, growth has been anemic -- if there has been any growth at all. Beijing's problem at the moment is that there is deep pessimism about the prospects for the economy. One statistic summarizes the situation: in Q3, there was $460.6 billion of net capital outflow, as documented by Bloomberg. No economy -- not even one the size of China's -- can survive outflows of that size.
The Chinese economy has never made sense, but confidence held it together. Now, the confidence is gone, and Beijing does not know how to get it back. Therefore, money is gushing out of the country.
"Deep winter will continue," said Liu Dongliang, a China Merchants Bank economist, to Hong Kong's South China Morning Post. Chinese leaders, not willing to open up their political system so they can reform the economy, should expect the weather to remain cold a very long time.
Not everyone is as optimistic as Drysdale, but the general view is that China will work through a transitory period and enter a new phase of growth powered by consumer spending.
Are China's economic problems merely temporary -- a year or two at most -- as the majority view suggests?
Perhaps, but there are also reasons to believe the country will have to endure prolonged hardship, either two or so decades of recession and stagnation or, more probably, a sharp 1930s-style crash followed by years of deep contraction.
Today, the Chinese economy is in far worse shape than most economists and other analysts think. China's economy could not have been growing at the 6.9% pace reported by Beijing's National Bureau of Statistics (NBS) for the third calendar quarter of this year or at the 7.0% rate claimed for each of the first two quarters.
It is more likely to have been the 4% that Willem Buiter, Citigroup's chief economist, recently suggested, and perhaps the 2.2% that people in Beijing were privately talking about a few months ago. And maybe it is even less than that.
There are, after all, indications that China's economic growth is, in reality, close to zero. Take the most reliable indicator of Chinese economic activity, the consumption of electricity. For the first nine months of the year, electricity consumption increased by only 0.8% according to China's National Energy Administration.
Defenders of NBS's gross domestic product (GDP) numbers argue the economy has shifted from energy-intensive manufacturing to services, so electricity is no longer indicative of economic trends. That, however, sounds like an excuse.
In any event, previous criticisms of the electricity numbers have been exaggerated, and Premier Li Keqiang, now China's economic czar, said in 2007 that official economic growth statistics were "man-made" -- unreliable -- and that he looked to electricity figures when he wanted to know what was really going on.
Yet even if electricity is no longer as indicative as it once was, there are other statistics confirming the sharp deterioration of the economy. For instance, imports -- a sign of both manufacturing and consumption trends -- fell 15.7% in the first ten months of this year in dollar terms. October, when they dropped a worse-than-expected 18.8%, was the 12th-straight month imports have fallen, and that equals the record from 2009.
Another disturbing sign is found in price data. In Q3, nominal GDP growth of 6.2% was less than the officially reported real growth of 6.9%, indicating deflation.
Deflation is never a good sign, and China looks as if it is now caught in the trap of falling prices. That means a 1930-style adjustment -- a crash, in common parlance -- is increasingly possible. And maybe even likely.
The problem for China's leaders is that nothing they have been doing in the past year to stimulate growth has been working. Six reductions in benchmark interest rates since last November and five reductions of the bank reserve-requirement ratio since February, for instance, have had no noticeable effect.
This monetary stimulus is unproductive because there is a lack of demand for money. Banks do not want to lend, and potential borrowers do not want to borrow. Central government technocrats can create money as if there is no tomorrow -- M2, the broad gauge of money supply, was up 13.5% in October -- but few see a need to invest available cash. So creating money this year has not resulted in growth.
At the same time, two other government tactics have come a cropper. First, the reckless promotion of stock price rises, beginning during the fall of last year, was intended to create a wealth effect. The campaign, however, led to the dramatic collapse in equity prices in June. Beijing, incredibly, had not learned its lesson, and in recent months engaged in another round of government cheerleading. Chinese officials, however, should realize that a rise in prices without an improvement in fundamentals can only lead to another horrible bust.
Second, the still-inexplicable devaluation of the renminbi beginning August 11 has not helped either. The move caused a global run on the currency, and Beijing still has not changed sentiment even if it has, through extraordinary means, temporarily stabilized the situation.
Just about everyone correctly agrees that a new round of structural economic reform could restart growth, but such change has become exceedingly unlikely because:
- powerful vested interests are blocking it;
- there is now a perception in Beijing that reform will reduce growth at first and China cannot afford any dip;
- President Xi Jinping's idea of change is regressive.
Xi has also strangled his country's financial markets in order to keep share prices high and currency values elevated. For example, this summer his government restricted stock-index futures because it considered these derivatives a source of downward pressure on stock prices, but the restrictions killed activity. China's stock-index futures market, the world's largest in mid-June when the slide began, was devastated, with transactions down 99% by September.
Even when Beijing has summoned the gumption to announce reforms, there has been more show than substance. For instance, late last month the People's Bank of China, the central bank, announced it was eliminating the caps on deposit rates, but officials are now informally dictating to commercial banks the deposit rates they may offer.
Let us not be surprised by the end of liberalization in China. Xi Jinping's signature initiative, encapsulated by the phrase "Chinese dream," contemplates a strong state, and a strong state does not sit easy with the notion of market-oriented reform. Unfortunately for Xi, also the Communist Party's general secretary, there are no solutions that are possible within the political framework he will not change.
Therefore, Xi's government has fallen back on fiscal stimulus to create growth. Fiscal spending was up 36.1% in October, according to the Finance Ministry. This follows increases of 26.9% in September and 25.9% in August. In the first ten months of this year, fiscal spending was up 18.1% while revenue rose only 7.7%.
No analyst is cheering the new spendathon. Just about everyone knows China does not need another "ghost city." And everyone is concerned about the debt that has been created to fuel growth. McKinsey Global Institute puts the country's debt-to-GDP ratio at a worrisome 282% at the end of June 2014, but the number is surely higher than that now, perhaps in the vicinity of 350% once all hidden obligations are counted and GDP is accurately assessed.
And even with this extraordinary spending, growth has been anemic -- if there has been any growth at all. Beijing's problem at the moment is that there is deep pessimism about the prospects for the economy. One statistic summarizes the situation: in Q3, there was $460.6 billion of net capital outflow, as documented by Bloomberg. No economy -- not even one the size of China's -- can survive outflows of that size.
The Chinese economy has never made sense, but confidence held it together. Now, the confidence is gone, and Beijing does not know how to get it back. Therefore, money is gushing out of the country.
"Deep winter will continue," said Liu Dongliang, a China Merchants Bank economist, to Hong Kong's South China Morning Post. Chinese leaders, not willing to open up their political system so they can reform the economy, should expect the weather to remain cold a very long time.
Gordon G. Chang is the author of The Coming Collapse of China, a contributor to Forbes.com, and a Distinguished Senior Fellow at Gatestone Institute.
- Follow Gordon G. Chang on Twitter
No comments:
Post a Comment
Note: Only a member of this blog may post a comment.