China’s failed gamble for growth25 May, 2012, 13:25. Posted by Zarathustra
Looking at the latest data, media reports and what the government is doing, it might not be too far fetched to say that China is probably already in a so-called hard landing, if that is defined as sub-7% growth. In fact, depending how you look at the GDP growth figure, the annualised growth rate for the first quarter of 2012 was a mere 7.4% with the reported seasonally adjusted quarter-on-quarter growth rate at 1.8%. A 0.1 percentage point drop in this quarter-on-quarter growth rate is enough to put China’s growth rate just at 7.0% (that is after rounding off to the closest one decimal place).
Of course, not all people believe such diagnosis. Indeed, there are still remarkably little people who appreciate the fact that the Chinese economy is running into a big trouble. Perhaps the recency effect of human memory is that the last stimulus was both implemented quickly and effectively, that brought the economy back from the brink.
However, it was that last massive stimulus which is sowed the seed for the problems facing China today.
In fact, one can view that as a gamble. A gamble that is going to be proven as failed.
|By Jamie Adams from Hull, United Kingdom (Poker chips) [CC-BY-SA-2.0], via Wikimedia Commons|
The idea of this gamble is simple. With the financial crisis in 2008 hitting the developed world, it naturally affected external demand. The Chinese knew these. At the end of 2007, trade surplus accounted for more than 7.5% of GDP. Currently, the same number is at its low single digit, probably 2% or so. No longer is China’s growth driven by trade. It is now driven largely by domestic demand.
And this is where the gamble lies. The massive stimulus was meant to stimulate domestic demand for a few years, in hope that perhaps the rest of the world will recover, and hence external demand would have recovered. Or else, in hope that domestic demand will become strong enough and sustainable so that the economy no longer depends on the health of the rest of the world.
By domestic demand, there are two things. Private consumption, and investment. China has been known for low rate of consumption, or in other words, high saving rates. Everyone seems to have the same opinion that this ratio should be higher, while the size of investment should be lower relative to its GDP. However, private consumption is not something that one can stimulate easily. After all, there is only so much that one can eat in any given period, and one of the fundamental problems for low consumption is simply that income of an average worker is simply not that high. It is true that the government did try to stimulate consumption by essentially subsidising purchases of white goods and other stuff, but there is only so much you can do. After all, you don’t buy a new fridge every year.
So it all comes down to investment, both public and private. Infrastructure, real estate, and many other pointless stuff. It did not help rebalancing the economy, but it guarantees growth. Once the stimulus package is there, banks went unleashed and lent money like there is no tomorrow. They lent to local government financing vehicles to build ever more pointless thing, and real estate developers to build ever more apartments that, although for the time being were selling, had no one to live in.
And the massive bank lending spurred a rate of money supply growth that we have never seen before. When the general consensus loathes about the Federal Reserve’s effort to “print money” by quantitative easing, they always forget that the People’s Bank of China is the mother of all quantitative easing. The rate of PBOC “money printing” even before the massive RMB4 trillion stimulus was extremely high, not to mention the subsequent period when bank lending went crazy. The result is that the broad M2 money supply of China is almost 2 times of GDP. That ratio was a mere 65% or so for the US at the end of 2011.
Source: People’s Bank of China
Thus not surprisingly, there was high inflation in China. With deposit rates hugely negative for a long while, those who are not rich enough (think average worker) just wouldn’t spend, while those who are rich enough (read: corrupt) went around and buy real estates. If possible, they leveraged it up and buy a lot of real estates. That was brilliant for a while as long as the real estate market is going up. Real estate developers leveraged themselves up to buy land and build, selling to all these rich folks who buy up properties, earning a big fat margin. These rich folks were happy because their real estate purchases appeared to be very wise. They left their houses empty, but that doesn’t matter so long as the prices are going up.
At first, it seems that this helps consumption after all: luxury products sales were booming, cars sales were booming, everything seemed to be booming. But that only looks good as long as the real estate market is still going well. Housing has a large wealth effect compared to stocks. As rich folks became richer, they spend like there is no tomorrow. Overall, however, the hope for a more sustainable pattern of consumption is not realised. Worse still, the growth in consumption has rolled over amid slowing economy.
Source: National Bureau of Statistics
So the wish that domestic demand will grow sustainably is not realised despite throwing in huge amount of money, and the rest of the world has not recovered according to plan. Worse still, by throwing in that much money to stimulate investment, China has committed a huge error in that it has built even more production capacity on top of the over-capacity that was probably present before the massive stimulus. Now domestic demand growth is not strong and sustainable enough to consume all these production capacities, and the rest of the world is not going to rescue the country.
Thus, unfortunately, China is in an very precarious situation, and much more precarious than most recognises.