Soft or Hard Landing In China? Richard Koo Vs. Andy Xie22 June, 2011, 22:16. Posted by Zarathustra
Tags: Andy Xie, Economy, Jonathan Anderson, Michael Pettis, Richard Koo
Richard Koo believes that there will be blood in China’s real estate sector, as he explains that the Chinese government is very committed to solve the inflation and property prices problem. He believes that China can muddle through without a hard landing because the government will implement massive fiscal stimulus to cushion the shock. He went even further to explain that because the Chinese government is a one-party dictatorship (sort of), there is no one to stop the government from spending too much. That’s why Japan failed to reflate its economy, and that’s probably why the United States will fail too.
Yesterday, in his latest research note, he once again warned Washington on spending cuts. In his own words, he wrote:
In China the authorities are trying to rein in an inflationary bubble in textbook fashion—by reversing overly aggressive monetary easing implemented in response to the Lehman-inspired financial crisis of 2008. Western governments, meanwhile, are pursuing fiscal consolidation. This is the chief reason for their slowdowns and is an extremely dangerous option given that their economies are in balance sheet recessions, defined as a situation in which businesses and households have chosen to minimize debt in spite of zero interest rates.
In particular, the slowdown in the US economy coincides with the gradual phasing out of the Obama administration’s $787bn fiscal stimulus package of February 2009. At present this program has a negligible probability of being renewed. This means those people who have benefitted from this spending must become more cautious, and that could lead to further weakness in the economy.
China will not have that problem of not spending enough, and that’s why the bust of the real estate bubble in China will not lead to a hard landing in Richard Koo’s View.
However, there is something bizarre about Richard Koo’s argument on China. China’s economy has been very much driven by fixed asset investments. Both Michael Pettis and myself has been very sceptical on the investment-driven model, and it will ultimately unsustainable. As Michael Pettis puts it:
An unsustainable rise in debt is, for me, one of the key indicators that the investment-driven model has passed its useful life and is generating negative growth while posting positive growth numbers.
There is a need for rebalancing the Chinese economy, and it has been delayed precisely because the financial crisis triggered a massive fiscal stimulus. If China faces another crisis (say a real estate market crash), we can expect another round of massive fiscal stimulus just as Richard Koo prescribes, and that will only delay the shift in the growth model for even longer. As I have written before in 10 Reasons To Short China:
Although the Chinese government is aware of the need to rebalance the economy in order to make it less investment-driven and more sustainable, the government invested heavily when crisis came to stimulate the economy, thus the necessary adjustment has been once again delayed.
The reason for further delay is simple: investment is the most easily controllable part for the economy. After all, you can’t force people to buy more when the economy is poor, but you can build something.
If soft landing will lead to more delay in necessary adjustment, what is the alternative?
On the other side of the spectrum, we have Andy Xie, who has been a China bear for a few years now. He absolutely has no love for such soft landing. In his latest column article in Caijing, he wrote that “Soft landing could be a trap”. In his view, the situation in Japan can be characterised as a soft landing which last for 20 years, and even the Lehmanesque bust in the United States wasn’t hard enough a landing to clear up the mess. To Andy Xie, the alternative for China is clear: hard landing. Not only is a hard landing necessary for China to solve its inflation and property bubble problems, it is also desirable for China in the long-run: it will be a catalyst for necessary change for the economy.
Jonathan Anderson of UBS seems to echo this view in some way (via Stephanie Flanders):
"In emerging markets… most crises in the past two decades have proven to be liberating events, with both a rapid recovery and a considerable trend increase in growth.
"How can this be? In our view, precisely because of the cathartic dual impact of bankrupting capacity and writing off debts."
When crises struck in Asia and parts of Latin America in the 80s and 90s, emerging markets didn’t get given a lot of room for Keynesian stimulus or "kicking the can down the road".
Instead they went straight to "Austrian-style" deep cleansing: currencies collapsed, foreign money evaporated, and credit shortages forced large parts of the corporate sector out of business.
Although the Chinese government will be trying hard to avoid hard landing, I have stressed that there is no reason to believe that the Chinese government is omnipotent in managing its economy. If the view of Andy Xie and Jonathan Anderson is right, hard landing is actually desirable.
So whose recommendation will lead to better outcome? Richard Koo or Andy Xie?