ATLANTA— The seemingly unimpeded growth of China continues to draw new admirers the world over. The consensus view seems to be that China will continue in 7-9% annual growth for the next decade (and almost into perpetuity), given their vast population, natural resources and current under-development. Here is where I’m a contrarion – I simply don’t think so. I predict we will witness a major financial crisis in China within the next 5 years, which will stall Chinese growth and set them on a much more precarious and much less predictable economic and political path going forward.
I am convinced these viewpoints of almost uninterrupted growth in China are predicated on a basic assumption that “this time is different” in China. The reality is that no country has ever sustained the type of growth many are projecting for China year-after-year, decade after decade, without significant intervening business-cycle recessions and banking crises. I am convinced China won’t either.
I believe their primary problem is that their economy is still too strictly controlled by their central planners. The Chinese government can systematically over-stimulate, without any immediate accountability. As an example, consider 2009, in which China unilaterally directed their banks to expand lending, resulting in a credit expansion of over 9 trillion yuan (double the previous year). Many believe this in itself has already dangerously over-stimulated the economy.
Put simply, I think China is headed for a massive and painful market correction. This 8% growth simply cannot go on forever.
Here are just a few of the dark clouds I see on China’s horizon that I think will lead to a relatively severe correction in their growth in the next five years, as well as a much more uncertain recovery.
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The country has endured a massive surge in capital inflows during this past decade that will likely persist into the next decade, given the wide-spread belief that China will lead the world recovery over the coming years. Surges in capital inflows almost always stimulate credit booms in emerging markets and are a frequent precursor to banking crises.
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The country’s leaders believe they are politically hamstrung, because they need growth of around 8% in order to generate the jobs necessary to keep employment rates steady. Any dip below this amount and there is a risk of lay-offs and widespread political disaffection. Faced with this reality, central planners have every incentive to keep the peddle on the gas in terms of fiscal and monetary stimulus, even when asset prices are sending a signal there is too much credit flowing into the system.
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Asset prices are sending just this signal, with real estate prices in Shanghai and Beijing in particular reaching bubble-like levels in recent years. Historical evidence suggests an overwhelming link between significant housing price increases and subsequent banking crises.
Facing these and other factors, I think China faces a massive banking crisis in the near future.
Banking crises are inherently destabilizing. As we are learning in United States, a recovery from a banking crisis generally takes years and can severely depress GDP growth.
Knowing the trouble that banking crises cause, I believe the Chinese will move swiftly to bail out their financial industry. Unimpeded by democratic constraints on their economic powers, they will likely be able to do so in a hidden, deceptive manner that will hide the true breadth of the issues (quietly seizing banks, canceling debts, etc.). Unfortunately, I think such a policy will only perpetuate and exacerbate their problems, ultimately fueling more speculation, over-stimulation, bigger bubbles, and rapidly increasing inflation.
I think all of these factors, taken together, will be destabilizing for Chinese growth in the medium-term, until structural changes are made in their political system. China is an economic power- arguably an economic superpower. But unless, they further decentralize and liberalize their economy and political system, I don’t think they are going to be our direct rival and equal in our lifetimes. I believe they have a dark period of economic recession and stagnation in their near future that too many on-lookers are discounting by claiming “this time is different.”
NOTE: My predictions about the coming banking crisis in China are based on my reading of This Time is Different, by Carmen M. Reinhart and Kenneth S. Rogoff. The authors do not predict this for China, but they give plenty of “warning signs” about impending banking crises, and I am beginning to see that China is exhibiting many of those same warning signs.
TennesseePaul
Stephen VanNuys
Brooklyn Daniel
The Freedom Thinker
Unfortunately, I think such a policy will only perpetuate and exacerbate their problems, ultimately fueling more speculation, over-stimulation, bigger bubbles, and rapidly increasing inflation.
In essence, when you subsidize something you get more of it.
Seeing this here in the US I believe. Banks were “bailed” out from their poor and risky decisions. All this did was allow them to make more poor and risky decisions. i.e. you got more of something that you subsidized.
But, if the Chinese learn from America they will know that you can fight unemployment and banking crises with health care reform…. You know, the economy is sick so reform health care to make it better.
Stephen; I’m going to have to disagree here. Not that I believe that China will continue into perpetuity with 8%+ growth. Nor do I disagree that China couldn’t have market corrections, it surely could and will. I think they will be minor in nature. I think on the long-term kondratiev curve China is pretty young given 1970s as being their fresh start (i.e. 1976 and the death of Mao). This gives them about 70 years to complete a full long-term cycle when one generation has fully forgotten about things like the Cultural Revolution.
As for some of your statistics how much is 9 trillion yuan per Chinese citizen? Perhaps it was to rapid an expansion but the Chinese People are Net Savers and NOT consumers. Contrast that to a country like the United States who holds nearly 1 trillion in consumer credit card debt alone! Or who took out 69.3 trillion in dollar debt last year alone!!!
China’s debt to GDP ratio is around 1-1.5 our debt to GDP is around 4. This is to say we’re getting 14 trillion in GDP for 62 trillion in debt.
Further, not only do the Chinese have very small debt levels in comparison to their economy and individual savings rates their economy is fundamentally structured more soundly then most economies in the world today. They have nearly 10% of their economy in agriculture those jobs (accounting for 40% of their labor force) won’t be touched by recession, compare that to our rate of 0.9%. Further they have 47.8% of their economy in industrial (i.e. actually making stuff). Compare that to the U.S. at 20%. The rest of course being made up of services. Even more of an issue is the fact that of their GDP 39% is exported with only 30% being imported and the lion’s share 40% being utilized as fixed investments in their society. Again, compare this to the U.S. at 14% we have one of the lowest in the world at 135 while China is near the top at #6!
Look at it as an investment which company do you choose? One with a more stable business (industry vs. service). One with a debt to revenue of 1:1 or 4:1. A company that is investing in itself by purchasing fixed assets over x3 more then the alternative. A country that has a savings rate of 39.7% of disposable household income compared to the U.S. savings rate at in negative territory? Personally on this alone (i.e. cash flow) I’d choose China as an investment. Their people are piling stock piles of yuan. Eventually, 10-20 years from now they will start spending and then China will get a true economic boom.
I’m opposite here long-term. Short term, sure their could be pull backs and corrections. Long-term China is going to explode for the next 20-40 years. I just don’t see data refuting it.
The best data against China is on their limiting child birth which will give them an older population taken care of by fewer children. Although with their savings rates they will be much more independent then the average American family faced with the same issues.
I don’t buy it 9 trillion in debt with their GDP is nothing!
One other thought. This isn’t to say that things couldn’t change. I’m not naive in that I think it will continue into perpetuity. But in terms of where to look to invest China is to me the obvious choice (long-term). Data could change in when one has the world to look at to choose investments it’s important to follow the data. If China began lending out 40 million yuan a year, if their savings rate drops, or any number of things changed my perspective could change. Again, though with their savings rates and low debt to GDP I just don’t see bank troubles. It’s when savings rates are low and debt is high that their is a banking crisis.
FT: Interesting stats. I have not studied China as closely as you in terms of making direct, statistical comparisons between their economy and ours, but I am generally aware of their high savings rates, etc. The articles I have read on China speak to more general trends, things that people might be overlooking. I actually cut the above post down a little bit from what I originally was going to put up there, but the long-term demographics is certainly a big component of analyzing their long-term financial health. Some people argue their economy is going to endure a steep drop in young people sometime in the next 20 years, at current rates. Through on top of that there is a 120:100 boy to girl ratio (by some estimates) and it sounds very difficult for the demographic trends to change that course. On the contrary, thanks to immigration and other factors, the US population growth (while not perfect), seems to be on a better trajectory. While the populations of much of the industrialized world will be shrinking and aging, ours will be growing, from what I understand.
You are correct in the near-term on the U.S.- I don’t dispute you there. We have horrible debt loads- both real national debt and more frighteningly off-balance sheet debt. That’s the fight we have to fight over the next decade and a half. I take comfort in the recent Tea Party revolution, b/c it tells me that more Americans are conscious of the need to change this course then people often give us credit for having. Hopefully, that can effect some lasting political change.
But going back to China, I think the biggest weakness (in my view) is the central government having too much power with limited immediate accountability. They seem hell-bent on growth at any cost. I don’t think they will have the suppleness or will-power to reign in excessive stimulus, which is what I am afraid they have been doing for the last year or two. Inflation in China was up around 8-9 percent in 2008, pre-crisis. My guess is it will be back up there even more in the coming years. I also don’t know how they will hold up when inevitable economic adversity comes. I tend to think it won’t be mild- I think it will be destabilizing.
in the long-term, you are right. There is no doubt China will be much more significant and powerful then they are today. I’m just not so sure they will overtake us within the next 40 years. (Though when you project out 40 years, at that point it is all just a bunch of blind guessing anyway).
A final thought I have is that I bet tariff wars with China grow stronger and not weaker in the coming years. I read some articles about how China provides ample capital even to failing businesses, in order to support them so that no jobs are lost. The government more or less guarantees the debt, I guess. Supposedly, there are 117 or more car manufacturers- as you can imagine, not all of them a well run or produce quality product. But yet the government helps keep them alive. But what this results in is cheap access to capital by their manufacturers – which in turn allows them to produce artificially cheap goods, which then flood the world markets.
Over time, against every instinct of mine, I might could be convinced to back off my “free-trade” inclinations in this respect, b/c China is using its unusually high savings rates to avoid playing by the natural rules of the market.
Suppose more and more countries put up tariffs on Chinese goods for these reasons? That’s a political guess as to whether that would happen. But it certainly would not be good for China.
Anyway – the rise of China is a fascinating topic. I’ve started to pay a lot closer attention. Right now, I’m in the crowd of doubters- believing that somethng’s got to give in the near future.
I don’t take comfort in the Tea Party Revolution. I agree with what they are saying but it’s got be more basic than that it starts with the homes. Negative savings rates… Until the American people man up and start taking care of themselves the Tea Party is a group of people demanding responsibility to a nation of irresponsible people. It’s cultural to and big time. Even in my own home. I have to fight with my wife to tithe the church 10% and then put 15% into investments and savings. And I’m as stubborn as an ox. Less then 5% of American’s tithe and the savings rate is down to -2.5%. How can we culturally demand principles and fiscal responsibility from our government???
As for their one child policy that is the biggest wild card to me as to its affects on China in the future. Also, is the cultural issues as more and more children are born forgetting the age of Mao and the more open society they will be more spoiled and spend more freely on things they want. This is a long cycle though as you say 40 years.
As for tariffs you make an interesting point. I’m not sure protectionism is a healthy solution. Making ourselves more competitive by upgrading our taxes (see my numerous comments on the Fair Tax) is a much better solution. Tariffs seem like a unfair and manipulative way to control things making industry the beneficiary of price controls while hurting the consumer.
However, damage probably could be done to China with tariffs to the benefit of American consumers. Of course then who is going to buy are debt… China of course isn’t playing completely fair but neither have we for that matter. They’ve been importing our inflation for years now. One day they will wise up. When the house of cards falls it’s going to take generations for America to pick up the pieces.
FT: You make good points about the cultural problems of America, in terms of savings rates, etc. But I blame the savings rates on the Federal Reserve, for holding interest rates too low, too long (too often!). The Federal Reserve has spent the last three decades or more fighting every recession with increasingly more inflationist policies. Loosening the currency to counter-act a downturn seems to have merit, from everything I have read. But I think those policies should be much more limited- and used much more sparingly.
Our problems are also the latent problems of democracy- it’s easier to win office when you promise something for nothing. And politicians do that all the time.
As I am learning more and more, I am realizing how frequently they suppress interest rates in a manner that is intended to sustain growth, but actually only expands credit and indebtedness. I would be curious to hear if a study has been down to say whether we would be in nearly as bad a spot as we are in if the Fed Reserve didn’t exist and we merely pegged our currency to some range of commodity prices or prices of a basket of commodities.
I think China will start creating social safety nets in terms of a national pension plan and a national health and welfare plan (something like Social Security and MediCare). My understanding is they don’t have either, really. Once they do, savings rates will go down significantly. I’m not saying such plans are ideal- they aren’t (in our case, they are unsustainable). But they seem to be inevitable in developed economies…
As to tariffs, I generally agree with your statement that they ultimately punish consumers. But I think China is going to be able to play this currency manipulation game and credit manipulation game for a while longer. I would be open to the possibility of targeted tariffs on Chinese goods over time, if nothing changes. Again, I’m breaking with my free market inclinations here, but it may become a matter of national security interest, if we otherwise keep building yawning trade deficits and increasing debt to the Chinese.
[...] a post from about a year ago, I outlined why I am a contrarian with respect to China and its future growth potential. While I [...]