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Storm warning: China is headed for an epic hard landing
17th Jan, 2011 - Dee Woo
Beijing: For the better part of the past year, my concern about the Chinese economy was constantly aggravated by the depressing stories of entrepreneurs who committed suicide, fled the country or emigrated to the West in droves. Much of the media has blamed the credit crunch and monetary tightening for these unsavoury episodes. The public outcry over the deteriorating conditions for Chinese entrepreneurship climaxed with the seemingly positive step that the People's Bank of China(PBOC) took to alleviate the liquidity crisis: it cut the reserve requirement ratio in early December 2011.
Right now, the outlook for the Chinese economy is confusing: should it continue the painful structural adjustment to burst the economic bubble built up after so many years of high growth? Alternatively, should it adopt expansionary policy to reinvigorate the flagging economy? Either way China is approaching dangerously close to an epic hard landing.
The real problem
It's easy to blame tight monetary policy for China's problems — but nothing can be more wrong. The main overseas markets for Chinese goods — Europe and the US — are both battling a possible recession. To make matters worse, cost-push inflation in China, especially wage inflation, is eating away the comparative advantage of China's manufacturing industry. All this has nothing to do with tight monetary policy – and everything to do with the structural change of the Chinese economy.
Contrary to what many assume, China now is not even close to suffering a liquidity crisis because of tight monetary policy. Reuters
In any case, for Chinese private small and medium businesses (SMBs), the driving force behind China's manufacturing industry, securing access to credit is a chronic problem they faced long before the monetary tightening began. More than 70 percent of the Chinese banking market is controlled by the "big four" — Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China.
These state-owned commercial banks skew monetary resources towards state-owned enterprises or other privileged corporations. This allocation deficiency provides the breeding ground for China's huge and complicated shadow banking network, where most credit-starved private SMBs seek costly funding. The shadow banking system is awash with cash that fled negative real interest rates in the commercial banks. It is hardly regulated and monitored.
Contrary to what many assume, China now is not even close to suffering a liquidity crisis because of tight monetary policy. There is more than enough liquidity to go around. China's M2 has surpassed that of the US or Japan. In fact, if anything, the PBOC failed to rein in the liquidity binge that Beijing indulged itself in for so long. Given such a gloomy context, China's continued credit expansion against all odds is breath-taking.
We can't blame tight monetary policy for the sorry state of China's economy. Likewise, we can't pin our hopes on loose monetary policy to turn around the fortunes of China's economy either.
The undoing of the Beijing Consensus
Monetary policy alone won't fix the structural deficiencies of the Chinese economy, which is hugely leveraged on the consumption economy of the US and Europe. The economic turmoil in the US and Europe puts a massive strain on the demand for Chinese export. The substantial and increasing wealth gap in China has shackled domestic demand so much that it cannot pick up the slack from the US and European markets.
China is now saddled with a serious excess capacity problem, which forces down the marginal returns on investment; effectively, investment is now stoking inflation and spawning bubbles rather than contributing to GDP growth or employment. This is a serious sign of overinvestment and overheating.
According to David M Kotz and Andong Zhu's research, China's exports and fixed asset investments together contributed almost 70 percent of GDP growth since 1999; the domestic consumption contributes accounted for the rest of about 30 percent. Using export/investment combo to power economy ahead – what's called the Beijing Consensus – worked beautifully during the past decade when the world was prospering on the wing of globalisation and free trade. But now its good run is finished for good.
To overcome the current economic malaise, the US and Europe must check their deficit-fueled consumption economies into rehab. They must increase their chronic low saving rate, produce more and import less. That means the export-led growth engine for Chinese economy may be gone for good.
Consumption-led economy is the only way out
The dire situation in the US and Europe calls for another round of quantitative easing (QE) there. With both Japan and the UK firmly committed to QE and deteriorating market conditions, the embattled US and Europe will be more and more reduced to monetary aggressiveness. In the end, we will see a global competition of currency devaluation. China will lock horns more frequently with the US, Europe and other export nations over currency issues. Trade tension will flare up.
The only way out for China is to turn its economy around into one that is led by consumption – or fight for overseas markets in vain and prepare for trade wars – or try to reignite the economy with more wasteful investment and prepare for a colossal asset bubble and epic hard landing.
The outlook for China's inflation and economic bubble
China's CPI tumbled to 4.2 percent, the lowest level since September 2010 but there's no reason to be optimistic about China's inflation prospects. The battle against inflation is far from over. China is the world's biggest importer of food and commodities. With the global competition of loose monetary policies, food and commodity inflation will be persistent and volatile.
China will face the serious threat of imported inflation and cost-push inflation regardless of what monetary policy it adopts. That, combined with negative real interest rates and diminishing marginal return in industries, will push more and more money into asset investment and speculation. Inflation will continue to lurk if these structural problems persist.
Overall, there are both internal structural factors and external global factors that are contributing to the making of an epic hard landing in China. China will be particularly vulnerable when the US and Europe both unleash QE.
The best that China can do to avoid the worst is to continue the painful structural adjustment: marketise the banking industry dominated by the "big four" banks to allow for more efficient monetary allocation; transform the labour-intensive, low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honour its promise of a consumption-led economy.
China's hard landing will be a tragedy not only for China but for the entire world. Without China's growth in its consumption economy, the global economic recovery will be a prolonged and painful process. Hedge funds and the Fed's QE2 are not all to blame for all these. The Chinese economy already stands close to the edge. What speculators may try to do is to push it over and profiteer handsomely from the chaos.
While the US enjoys the luxury provided by the dollar's world currency status and diplomatic alliance with many major trade partners to export its liquidity and inflation, China enjoys none of that. Chinese authorities will perhaps be looking at the dollars in their hands with fear and doubt. The so-called Beijing Consensus makes little sense because the world is changing fast, and pegging a country's growth to a certain set of policy tools or a certain reserve currency (the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proved that the only constant is to adapt and change.
Right now China needs to adapt and change fast. Or this could be the best time in history to short China.
Dee Woo is a Beijing-based economic commentator.
http://www.firstpost.com/economy/storm-warning-china-is-headed-for-an-epic-hard-landing-183774.html/2
17th Jan, 2011 - Dee Woo
Beijing: For the better part of the past year, my concern about the Chinese economy was constantly aggravated by the depressing stories of entrepreneurs who committed suicide, fled the country or emigrated to the West in droves. Much of the media has blamed the credit crunch and monetary tightening for these unsavoury episodes. The public outcry over the deteriorating conditions for Chinese entrepreneurship climaxed with the seemingly positive step that the People's Bank of China(PBOC) took to alleviate the liquidity crisis: it cut the reserve requirement ratio in early December 2011.
Right now, the outlook for the Chinese economy is confusing: should it continue the painful structural adjustment to burst the economic bubble built up after so many years of high growth? Alternatively, should it adopt expansionary policy to reinvigorate the flagging economy? Either way China is approaching dangerously close to an epic hard landing.
The real problem
It's easy to blame tight monetary policy for China's problems — but nothing can be more wrong. The main overseas markets for Chinese goods — Europe and the US — are both battling a possible recession. To make matters worse, cost-push inflation in China, especially wage inflation, is eating away the comparative advantage of China's manufacturing industry. All this has nothing to do with tight monetary policy – and everything to do with the structural change of the Chinese economy.
Contrary to what many assume, China now is not even close to suffering a liquidity crisis because of tight monetary policy. Reuters
In any case, for Chinese private small and medium businesses (SMBs), the driving force behind China's manufacturing industry, securing access to credit is a chronic problem they faced long before the monetary tightening began. More than 70 percent of the Chinese banking market is controlled by the "big four" — Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China.
These state-owned commercial banks skew monetary resources towards state-owned enterprises or other privileged corporations. This allocation deficiency provides the breeding ground for China's huge and complicated shadow banking network, where most credit-starved private SMBs seek costly funding. The shadow banking system is awash with cash that fled negative real interest rates in the commercial banks. It is hardly regulated and monitored.
Contrary to what many assume, China now is not even close to suffering a liquidity crisis because of tight monetary policy. There is more than enough liquidity to go around. China's M2 has surpassed that of the US or Japan. In fact, if anything, the PBOC failed to rein in the liquidity binge that Beijing indulged itself in for so long. Given such a gloomy context, China's continued credit expansion against all odds is breath-taking.
We can't blame tight monetary policy for the sorry state of China's economy. Likewise, we can't pin our hopes on loose monetary policy to turn around the fortunes of China's economy either.
The undoing of the Beijing Consensus
Monetary policy alone won't fix the structural deficiencies of the Chinese economy, which is hugely leveraged on the consumption economy of the US and Europe. The economic turmoil in the US and Europe puts a massive strain on the demand for Chinese export. The substantial and increasing wealth gap in China has shackled domestic demand so much that it cannot pick up the slack from the US and European markets.
China is now saddled with a serious excess capacity problem, which forces down the marginal returns on investment; effectively, investment is now stoking inflation and spawning bubbles rather than contributing to GDP growth or employment. This is a serious sign of overinvestment and overheating.
According to David M Kotz and Andong Zhu's research, China's exports and fixed asset investments together contributed almost 70 percent of GDP growth since 1999; the domestic consumption contributes accounted for the rest of about 30 percent. Using export/investment combo to power economy ahead – what's called the Beijing Consensus – worked beautifully during the past decade when the world was prospering on the wing of globalisation and free trade. But now its good run is finished for good.
To overcome the current economic malaise, the US and Europe must check their deficit-fueled consumption economies into rehab. They must increase their chronic low saving rate, produce more and import less. That means the export-led growth engine for Chinese economy may be gone for good.
Consumption-led economy is the only way out
The dire situation in the US and Europe calls for another round of quantitative easing (QE) there. With both Japan and the UK firmly committed to QE and deteriorating market conditions, the embattled US and Europe will be more and more reduced to monetary aggressiveness. In the end, we will see a global competition of currency devaluation. China will lock horns more frequently with the US, Europe and other export nations over currency issues. Trade tension will flare up.
The only way out for China is to turn its economy around into one that is led by consumption – or fight for overseas markets in vain and prepare for trade wars – or try to reignite the economy with more wasteful investment and prepare for a colossal asset bubble and epic hard landing.
The outlook for China's inflation and economic bubble
China's CPI tumbled to 4.2 percent, the lowest level since September 2010 but there's no reason to be optimistic about China's inflation prospects. The battle against inflation is far from over. China is the world's biggest importer of food and commodities. With the global competition of loose monetary policies, food and commodity inflation will be persistent and volatile.
China will face the serious threat of imported inflation and cost-push inflation regardless of what monetary policy it adopts. That, combined with negative real interest rates and diminishing marginal return in industries, will push more and more money into asset investment and speculation. Inflation will continue to lurk if these structural problems persist.
Overall, there are both internal structural factors and external global factors that are contributing to the making of an epic hard landing in China. China will be particularly vulnerable when the US and Europe both unleash QE.
The best that China can do to avoid the worst is to continue the painful structural adjustment: marketise the banking industry dominated by the "big four" banks to allow for more efficient monetary allocation; transform the labour-intensive, low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honour its promise of a consumption-led economy.
China's hard landing will be a tragedy not only for China but for the entire world. Without China's growth in its consumption economy, the global economic recovery will be a prolonged and painful process. Hedge funds and the Fed's QE2 are not all to blame for all these. The Chinese economy already stands close to the edge. What speculators may try to do is to push it over and profiteer handsomely from the chaos.
While the US enjoys the luxury provided by the dollar's world currency status and diplomatic alliance with many major trade partners to export its liquidity and inflation, China enjoys none of that. Chinese authorities will perhaps be looking at the dollars in their hands with fear and doubt. The so-called Beijing Consensus makes little sense because the world is changing fast, and pegging a country's growth to a certain set of policy tools or a certain reserve currency (the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proved that the only constant is to adapt and change.
Right now China needs to adapt and change fast. Or this could be the best time in history to short China.
Dee Woo is a Beijing-based economic commentator.
http://www.firstpost.com/economy/storm-warning-china-is-headed-for-an-epic-hard-landing-183774.html/2
. It is the Hang Seng thats down 35% from the peak. Its a transparent market. The Shanghai SSE on the other hand is down 60% from its peak.
