China: the world’s next great economic crash
Like Dubai at the beginning of last year, China is now reaching the peak of a bubble.
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Moreover, essentially flat consumer prices last year belie official reports of roaring retail sales. So does the full-year 11.2 percent decline in imports, another sign of sluggish domestic demand. And if the economy is really growing by double digits, why is Beijing insisting on continuing its stimulus?Skip to next paragraph
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Yet however fast the economy is growing, China’s policies are unsustainable. First, the central government will be hard pressed to find the money to continue the spending spree. Budget deficits are going up fast, a constraint on additional expenditures. More important, Beijing’s regulators are concerned that the state banks, the primary source of stimulus funds, are overextending themselves and accumulating bad loans.
New York Times columnist Thomas Friedman, however, thinks none of this will be a problem. Arguing that China is not the next Enron, he gives this advice to Mr. Chanos: “Never short a country with $2 trillion in foreign currency reserves.”
Yet Beijing’s record-setting reserves – now $2.4 trillion – are essentially unusable for this purpose. Why? China’s leaders need local currency, the renminbi, to deal with domestic needs. If they convert reserves into renminbi, they will cause the currency to zoom up in value and choke off the critical export sector. Foreign reserves have only limited uses in domestic crises.
Second, the state’s stimulus plan is taking the nation in the wrong direction. It is favoring large state enterprises over small and medium-sized private firms, and state financial institutions are diverting credit to state-sponsored infrastructure. Over the past three decades, China’s economy has expanded at an average annual rate of 9.9 percent because of the private sector, but now Beijing is renationalizing the economy with state cash.
Third, Beijing’s flooding of state enterprises with government cash will undermine their competitiveness, as a similar tide of money severely damaged Japan’s corporations during the bubble years.
Japanese managers discovered they could make more money managing cash than from anything else, and they therefore neglected their underlying businesses. Essentially the same thing is happening in China.
About a fifth of state bank loans have found their way into the country’s climbing stock markets, and another large portion is fueling property market bubbles. Worst of all, Macau casinos have enjoyed a recent boom, apparently attracting high-rolling Chinese cadres betting diverted stimulus money.
Finally, stimulus spending, as time goes on, becomes less effective in creating growth. The country already has one empty new city – Ordos in Inner Mongolia – and thousands of vacant facilities, especially shopping malls. New factories are underutilized.
For all its faults, the State Council’s spending program is just about the only thing generating growth at this moment. Unfortunately for the government, its plan is also creating imbalances and dislocations that will be difficult to handle this year.
Chinese officials, working in a state-led economy, once had the ability to defer problems. Yet the challenges they face have grown over time as they have pursued pro-growth policies instead of implementing structural change.
And that is why, when their growth policies run out of steam – as they soon will – China will become the next Dubai. Only bigger.
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