The Chinese bubble economy
The well-regarded and surprisingly independent Beijing-based media outlet Caijing is no more. The site is up, but the content is frozen in time, nothing having been written since early November. Happily, Caijing editor Hu Shuli has now re-appeared with Caing. And Caing has started things off where Caijing left off, drawing attention to the bubble economy China has become.
Andy Xie writes today:
The biggest risk to China’s economy is the desire to maintain past economic growth rates by maximizing investments in property — an unproductive asset. It supports short-term growth by sacrificing long-term growth as capital’s average productivity declines over time.
Local government performance in China is measured according to GDP and fiscal revenue. Property development can achieve high numbers for both quickly. This is why property’s share in China’s capital allocation is rapidly rising as prices appreciate and volumes increase. This is a politically driven bubble — and it’s already massive. Unless the trend is reversed by reforming incentives for local governments, China’s property bubble could mushroom in two years from what’s now a dangerous level. The burst could happen in 2012, endangering social and political stability.
The statistics support Xie’s view that China is overheating. This morning we heard that both China’s exports and imports were surging on the back of strong economic growth. Exports were up a gargantuan 17.7% from a year earlier, making China the world’s largest exporter, pulling ahead of Germany. Meanwhile imports were up three times as much, an eye-popping 55.9% year-on-year. Clearly, domestic demand is strong. Will this take pressure off of China to revalue it’s currency? I doubt it. China still had a monthly $18.4 billion trade surplus despite the surge in imports.
What’s more, China’s peg to the dollar means it is forced to ‘import’ the easy American monetary policy, leading to a surge in the Chinese money supply. And while the money multiplier in the U.S. is falling because of weak credit demand, China has the opposite problem. And the Chinese are sticking to an expansionary fiscal stance nonetheless.
Despite the indications of gathering economic momentum, Finance Minister Xie Xuren said China would stick to its pro-growth fiscal stance, warning that withdrawing stimulus spending too early could damage the economy.
New loans amounted to about 600 billion yuan ($88 billion) in the first week of January, nearly twice as much as the monthly average in the second half of 2009, banking sources said, confirming a media report earlier.
Corporate treasurers see tighter monetary policy down the road and as a result are front-loading their funding needs. That may only make officials move quicker to normalize policy, Isaac Meng, an economist with BNP Paribas in Beijing, said.
"In terms of credit controls, our expectations for a hike in reserve requirements should be brought forward from the end of the first quarter," said Meng, who had penciled in loan growth of 800 billion yuan for all of January.
"Inflation is heading to 3-4 percent in the next few months. It is no longer just expectations, it is becoming a reality," he said. China’s consumer price index rose 0.6 percent in the year to November, which marked the first increase since January.
How are local governments dealing with inflationary pressures in this top-down environment? Andy Xie says they are looking to property development.
China needs to depend more on improved efficiency for growth. But instead, the recent trend seems to be going the other way. Rising costs and weak demand are making manufacturing less profitable. Hence, capital investment is weak, as reflected in weak equipment import data.
Most local governments seem to embrace property development as a growth savior. But shifting surplus capital into property is likely to lower future growth by decreasing average capital efficiency. This deters consumption development by increasing property expenditure expectations, and threatens financial stability by increasing loan levels, using overvalued land as collateral.
This is a bubble, and as with all bubbles, it will end badly. Xie says the bubble is now supported in the main only by cheap money where strong export-demand growth had sustained it in the past. The recent trade statistics seem to confirm this view. Xie believes the Chinese cannot look to appreciate their currency to keep the gravy train going, as Japan did post-Plaza Accord during its own Bubble Economy. This is unlikely to work in China’s case because China relies on cost more than technology as an advantage in exports, Xie says. The Japanese were at the cutting edge and could absorb the costs of a revaluation, while the Chinese cannot.
Xie says that China’s growth model is unsustainable because it produces what I would call a Latin American style distribution of income where the middle class is quite small. These comments echo thoughts from Xie’s former Morgan Stanley colleague Stephen Roach, who sees an economic safety net as critical to increasing domestic demand and forming the middle class of which Xie speaks.
Bottom line: China’s economy is a bubble economy right now. And bubbles do not deflate; they pop.
Sources
Trapped Inside A Property Bubble – Andy Xie
China lending reportedly jumps, feeding hot economy – Reuters
See also Contrarian Investor Predicts Economic Crash in China from the New York Times
What is the definition of a bubble?
While I look at asset price appreciation that is 2 standard deviations above trend as a bubble, there is no acceptable definition of what a bubble is. This is one reason that Ben Bernanke and even Paul Krugman believe less attention should be paid to trying to burst a bubble.
Instead, one has to look at the fundamentals underlying the asset prices and crack down on reckless lending which can lead to the bubble.
In practice this means limiting money supply growth and regulating the provisioning of credit.
For the sake of argument let us accept Andy Xie’s logic and evidence. The problem is that Andy has used similar logic and evidence to make the same argument for about a decade and has been wrong time after time. While he may get it right eventually, that won’t make him any more credible as an analyst. The bottom line is that he has shown himself to be very inaccurate and somewhat incompetent.
Replace “China” with “Ireland”; “peg to dollar” with “euro membership”, go back a couple of years, and you’re there. Export growth falls way below that of imports, but large trade surplus relative to GDP means that the aggregates still look good, and huge property bubble takes over as GDP driver in low interest rate environment, pushing up tax revenues and keeping government finances strong so everything seems fine. Big country or small, dynamics are the same. Just wait.
Very good summary.
Being right should eventually redeem Xie’s credibility. Although I think it was Keynes who said it is better for an economist’s career to be respectably wrong with the crowd.
Who is going to bail out China? Do you think they are doing this on purpose- perhaps to get a bit of revenge?
I’d be interested in knowing how much of the increase in imports is attributable to the growth in exports, ie what are they importing to use in the production process as raw materials etc. Once you remove that component then you’d get a more accurate picture of domestic demand.