The global economy can be seen as an dynamo with two poles, America and China. The future of the American economy is exhaustively debated, but remains mysterious. The range of expert opinion about our prospects for the next few years is wider than anything I have seen in 3 decades.
The consensus of expert opinion about the other pole, China, is much tighter — and almost uniformly optimistic. But perhaps wrong. I lack time to provide an analysis, so that post just points to a collection of datapoints and sparse analysis. It’s a warning, no more.
Summary of the China mystery: an excerpt from “Is China the hidden Achilles heel?”, by Albert Edwards of Societe Generale, 16 June 2009 —
It is amazing how easily group-think takes a vice-like hold in the financial markets. As the BRIC {Brazil, Russia, India, China} economies meet for their debut summit, few dare to speak out against the new, ‘New Paradigm’. We also saw this same investor mania 13 years ago with the Asian Bubble, which the consensus thought was a growth miracle. But to go that far against the consensus invites a deluge of hate mail – link. That is why I keep a copy of a World Bank book entitled Thailand’s Macroeconomic Miracle: Stable Adjustment and Sustained Growth — link. It was published in October 1996, less than a year before Thailand’s (and Asia’s) economic collapse.
China is perhaps, like America, a story of malinvestment spurred by easy credit. In China the worries concern excess investment in manufacturing for export and domestic real estate. The investment boom has produced growth at a rate seldom ever seen in the history of the world. If this investment was unwise, the bust might be equally spectacular. We don’t have the data to know at this time.
Some datapoints
- “Tears, Fears for China’s Property Gamblers“, Caijing Magazine, 20 February 2009
- “China property prices ‘likely to halve’“, Financial Times, 13 April 2009
- “Global Downturn’s impact hits China commercial property market“, Asia Pulse, 4 May 2009
- “China cuts lending amid asset bubble fears“, Financial Times, 11 May 2009
- “China’s Real Estate Riddle“, Patrick Chovanec (associate professor at Tsinghua University’s School of Economics and Management in Beijing), Far Eastern Economic Review, 8 June 2009
- “Fear the Dark Side of China’s Lending Surge“, Andy Xie (economist), Caijing Magazine, 19 June 2009
Afterword
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China has the potential to become the dominant economy in the next fifty years, but I suggest it will need a free society and legitimate government to do so. We can’t foresee that outcome. In the mean time America will retain outsized influence on the world stage by default, as the dollar will remain the world reserve currecny by default, there is no viable replacement these days..
Another point on this topic is that a huge chunk of those loans are going into Chinese State Enterprises, instead of going to pivate businesses. The Chinese State Enterprises are buying up foreign businesses and commdities like crazy while posting record profits. Private businesses in China are dying fast in comparison.
A reverse of free market reform in China I suppose?
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Fabius Maximus replies: Credit flows in China have always been largely under government control. The massive lending surge in the first 4 months of 2009 is just an extreme example. As you note, businesses are using this money for things like building commodity stockpiles — speculating with cheap loans.
However I don’t believe it is correct to say that private businesses are dying fast (except in the sense that this happens in every downturn). Also, corporate profits in China are down aprox 1/4 on a YoY basis through April. Few are posting record profits.
Probably we’ve mythologized China’s economic power. It’s part of our good/evil, friend/foe style of thinking about things. broadsunlituplands (great moniker!) indulges in a bit of that, in thinking Chinas has to become more like us (legitimate government, free society) to reach the heights. Maybe, a hybrid version of us!
FM: I just want to point out that the private business that are used to fuel China’s growth for the last decade is not fueling China’s growth now. The recent growth in Chinese economy is actually State owned businesses sucked on tax money and bank loans to go on a shopping spree world wide. Surely there is some structural differences between China and US on this point.
As for private business dying…well, it not really died, its just that export is controlled by private businesses, and the lump in export really hurt Chinese private business sectors instead of the State owned businesses. On top of that, Chinese governments had passed laws that made it harder for private businesses to compete with State owned businesses. If that is not a reverse of free market reform in China, I don’t know what it is.
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Fabius Maximus replies: Some supporting data on this would be appreciated. While lending has fueled China’s 2009 recovery, I have not seen data on either recipiants of the loans nor private/SOE economic activity. Also, what are these new laws? That would be a significant change in policy!
senecal – maybe! but i was referring backhnadedly perhaps to why the US dollar remains the world reserve currency. it is not enough to have a powerful economy as china seems to be creating, people with money would need to feel safe using it, and would not likely feel so with a powerful yet unstable gubmint as china has now.
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Fabuis Maximus replies: Absolutely right. The reserve currency must act as both a global medium of exchange and as a storehouse of value. The RMB does neither at this time. The US Dollar is great at the first, increasily questionable as the latter — due to our feckless (or insane) economic policies since the late 1960’s.
The “China’s RMB as a reserve currency” meme is absurd over any short- to medium- time frame. The RMB is not even freely convertible, which makes it almost useless for trade — and not even a major currency. Perhaps at some point in the future, when China’s economy is must stronger and its financial institutions far more developed.
“China Stimulus Package: Part I, Bank Loans“, William Gamble, Seeking Alpha (blog of the Financial Times), 15 June 2009
“China’s economic recovery hits flat spot“, The Australian, 2 June 2009
I don’t think those are the most reliable resources, but most of what I read about where the Chinese loan is going points to State owned companies only.
{Two articles on the changes to the law about postal deliveries}: here and a better aticle on the law here. The is one of the interesting thing I noticed few month ago…some China watcher believed this is the government trying to stop private sectors from competing with SOEs.
Anyway, I’m not saying these are facts, but these are trends that people just keeps on missing about Chinese economy.
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Fabius Maximus replies: The Seeking Alpha article is IMO excellent; thanks for posting it! The Australian article says almost nothing. The laws protecting the postal monopoly are of microscopic significance, as postal deliveries are monopolies in many nations (and were so in the US for most of its history).
China’s growth did not come with institutional development, and it remains shockingly corrupt in every sense of the word. One thing that DID come with the growth is a litany of environmental disasters the likes of which the world has never seen, and will be forced to live with for centuries.
There are places in China so polluted that people under 30 are dying of cancer. China has fully embraced the cult of growth, even more so than the United States ever did, and will reap the consequences.
Their current ‘grand strategy’ is no different than that of the British Empire of old–control of the largest manufacturing base and the associated ability to ‘flood’ markets with their cheap products, control of capital markets, and control of primary resources; lets see how that model works out for them
Development is not built on cheap manufacturing, guanxi, intellectual property theft, and environmental degradation, though ‘growth’ most definitely can be.
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Fabius Maximus replies: You last sentence closely describes the early stages of America’s industrial development, and that of many nations. It’s a commonplace. Much of America had severe environmental damage until the clean-up began in the 1960’s.
When you travel around the world a lot and ask people what they think about China and it’s impact nearly everyone has an idea to how their economy will survive the increased competition. What is striking is that only people that didn’t were Americans – they either had no idea or hoped that China would fail in some way.
Part of this is that America culture is lagging in globalization. It is still remarkably insular and largely doesn’t understand the outside world. Partly this is that Americans just don’t do strategy and just muddle through with tactics.
But there is also a more fundamental reason. As someone who has worked in both the US and China as well as SE Asia and Europe, it is remarkable how similar businesses in the two countries are in competitive strategy. In a lot of ways China is the new America, it is rising to fill the same economic niche that America dominated for a century.
All the competitive advantages and disadvantages that you see in American companies are very similar to those in Chinese companies. In other countries they all have some angle that they can exploit to compete, but American companies are facing head on competition and they have nowhere to go. All the advantages that American companies once had are being matched several fold by China.
China is doing to America what America did to Europe in the 19 century, only it is happening much faster.
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“Position of strength“, China Economic Review, May 2009
What the Chinese State owned businesses are doing those days with those risky Chinese bank loans…
CNOOC buying up oil fields through out central Asia and South America; Aluminum Corp of China trying to buy Australian mining giant Rio Tinto but failed; China Investment Corp looking at Europe for more investments; Chinese DongFeng Auto Maker trying to buy Opel…etc, etc.
So those risky bank loans are not really throw away money like what the US did with Citigroup, they are geopolitical weapon for the Chinese to control more resources/markets through out the world.
As for why the private sector is left out cold, most of them are expandable businesses that manufacture toxic goods. The leaders can’t wait for them to go away. Case point, Chinese government refuse to bail out 100 small automakers in China while trying to protect and expand the big brand names like GM, Ford, HongQi and DongFeng.
“No Beijing Bailout for Chinese Automakers“, BusinessWeek, 21 November 2008
So what the Chinese is really doing right now with those risky bank loans is consolidating their positions, protecting the profitable businesses, securing resources, and cutting out the fat in their economy. The foundation for Chinese economy rebound is sound due the amount of money they dump into it, the real problem is how long can the Chinese wait for the economic rebound before they go bankrupt?
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Fabius Maximus replies: This is one perspective. Another view is that the Chinese are putting their economy into overdrive through sustained malinvestment. As we did with housing and commercial real estate. Perhaps they are building factories without markets, buildings and malls without customers. As suggested by the articles given in this post. It is difficult to tell which perspective is true until we see the results.
sunlit: there’s some doubt that the dollar will remain the global reserve currency for long. You’d have to be very certain that inflation isn’t in store for us, to park your money in US Treasuries. On your other point, the superiority of our political system to theirs, many people think ours has just demonstrated a major weakness, maybe even fatal.
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Fabius Maximus replies: The worries about inflation are IMO totally unfounded, a classic example of fighting the last war. In the midst of debt deflation, with high levels of unemployment and 70 year low levels of capacity utilization, worrying about inflation is nuts.
When the economy recovers, if we still have high levels of cash sloshing around, then we should worry about inflation. This is like the worries about inflation in the mid-1930’s.
“the mysterious other pole of the world economy”
A headline you’d never see in a Chinese blog. The hope as strategy relies on China remaining a mystery to Americans. And it is in China’s interests that things are hazy as it quietly usurps the American role in the world.
Thats why when the Chinese speculate that IMF special drawing rights (SDR) should become the reserve currency they quickly back peddle and you know somebody will get rapped on the knuckles for letting the cat out of the bag.
Going around the world arranging currency swaps so nations no longer have to use US$ to trade with is much more the Chinese style. Low profile, hard to track, and Americans don’t really understand the significance while the dollar gets gently eased out of it’s role and US indicators slip quietly down.
The Chinese understand the American psyche very well.
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Fabius Maximus replies: This is grossly exaggerated. Neither of these are signs that China seeks to “unsurp the American role in the world.” If significant, they are signs of China’s weakness — in terms of underdeveloped finanical institutions.
* China’s advocacy of SDR’s is an attempt to get out of a bag they’ve put themselves into. Their merchantilist policies (aka Bretton Woods II, massive exports driven by an undervalued currency) required them to amass an insane two trillion (and growing) in foreign exchange reserves — much of which (half or more) in US dollars. Now they fear the inevitable exchange losses from a USD devaluation. Shifting this to SDR’s would move the losses. Nobody has any sympathy for their plight, hence the cold reception.
* Setting currency swaps is a interim step on China’s long march to currency convertibility, an obligation under the WTO treaty. They’re moving slowly, as this will open their financial system to hot flows of money AND make their currency manipulation far more difficult.
May I suggest the Special Drawing Rights, Currency swaps et al, and the Iranian Oil bourse do not undermine the dollar —IF— the ultimate purchases and trades are still reckoned in dollars.
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Fabius Maximus replies: They do not undermine the USD no matter in what currency the trades are conducted. That is at most only of psychological value. More important is the holding of dollars by individuals and governments (usually through their central banks). Should the US dollar no longer be considered a safe storehouse of value, its status as a reserve currency is over.
The Iranan Oil Burse is too small to matter, in any case.
Intriguing article about China’s economic numbers here. Bottom line? They seem to be fairly reliable, so a Chinese economic collapse covered up by phony stats seems unlikely.
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Fabius Maximus replies: The Economist article states both sides of the debate, then (with their typical unsupported arrogance) they say one side is correct. This is easy as they ignore most of the reasoning supporting the other side. IMO Prof Rawski’s analysis of both the late 1990’s and current electrical production numbers is compelling. Several Wall Street firms have written rebuttals to support their almost always bullish views, just as most wrote that the tech boom was well-founded.
To cite one example of many, they don’t revise the numbers. It takes the US, with its far more sophisticated system for collection and analysis of data, a year or so to produce final numbers for most key economic stats (e.g., employment and GDP). The final number often substantially differ from the initial release. China announces GDP almost immediately after each quarter, without revisions.
“but I suggest it will need a free society and legitimate government to do so”
China has a legitimate government. It is recognized by the UN and the US and the EU and Canada and Japan and etc. etc. The communist party has been the governing party in China and the recognized government for decades. So saying they need a legitimate government, what exactly are you saying. They need a democracy, they need a constitutinal monarchy, they need a military Juanta, they need a dictator?
The Chinese government is doing a lot better job raising the quality of life and world status of China in the last 10-15 years than argueably any other government in the world. In India, the world’s largest democracy, over 25% of their political office candidates were in fact convicted criminals and this includes cabinet ministers and mayors. Brazil and Russia the other two BRICs have their share of dodginess, Russia expessially. China is a very safe country for residents and tourists, though it does not have total Freedom of Speach, Freedom of Press, and Freedom of Movement, even Freedom of Public Assembly may be limited.
But it definitely has a legitimate government, one which has done a lot to improve the quality of life and economic prosperity of the country. China has a high level of personal savings and although property speculation and even outright financial shananigans are not unknows, GM, Bernie, Enron, etc. etc. were all US companies and individuals. There is a lot of optimism and imagination in China and the US is more dependent on the China than vice versa, though China’s obsessive purchasing of US Paper has hamstrung them, if they gradually transition to holding other reserve currencies they would be better served and more independent of the US economy.
China has survived as entity for 1000s of years, longer than almost any other entity in the world, they will continue to adapt and as long as their economy is growing at near double digits their won’t be any general elections.
Muskie – I say free and legitimate meaning that coercive power is not needed domestically. I know all about their history. As long as the power of the government is maintained by force one can reckon on its unexpected termination. Therefore those outside of China will be somewhat reticent to be in any way beholden to brittle power such as that. Like the Shah, or the USSR, Siad Barre regime in Somalia, if it takes a security service to keep power it is inherent unstable. We went thru the nonsense of our 2000 election. Ridiculous, dishonest, unforeseen, yet there were no tanks in the streets. The College of Electors (not the SCOTUS) made their selection and the overwhelming majority of Americans accepted it, even those who decried it. They don’t have that in China, as of today. There is nothing to replace the dollar as of now, and we haven’t been able to break it though 40 years of ill advised fiscal policy. This is the difference between being an empirical observer and an ideological observer.
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Fabius Maximus replies: What is your basis for the following statement.
“long as the power of the government is maintained by force”
I know quite a few A-team China experts, and none believe this is the case.
Well our governments official record of poor prognostication, poor strategy and poor execution leave me feeling a sad sigh. These are the guys who didn’t foresee the invasion of Kuwait, (I did btw) or the collapse of the USSR?