"The Cracks in China’s Foundation" - Asia Sentinel

[onebir]

Summary:

- the Chinese economy may look like it's weathering the crisis ok, but it's being propped up by incredibly wasteful government spending & investment by companies with good relationships with banks (ie mainly state-owned enterprises).

- huge overcapacity will strongly discourage private investment for years

- the capacity of the Chinese govt to fund spending is much lower than published figures (eg govt debt = 20% of GDP) suggest, because of the government is implicitly guaranteed huge amounts of 'private sector' bad debts.

- unless world demand for Chinese exports has picked up a lot by the time the government stimulus measures end - which isn't looking likely - the economy will go into a recession. (or at least grow too slowly to absorb the growth in the labour force)

Asia Sentinel article here

I'd add that in a recession, social unrest could tempt the government to divert attention away from the economy. Perhaps increasing tensions with Taiwan/Japan/perhaps even the USA (which Wen criticised for 'irresponsibility' a few weeks back). Along with a slowdown in China, this would be bad for global confidence & recovery.

[gato]

http://www.bloomberg.com/apps/news?pid=20601208&sid=aSp4o1MTaq04

China New Loans May Top $1.6 Trillion in 2009, BNP Paribas Says

By Bloomberg News

July 24 (Bloomberg) -- China’s new loans may surge to a record 11 trillion yuan ($1.6 trillion) this year as the government refrains from tightening lending rules to protect economic growth, according to BNP Paribas SA.

New credit supply will account for 33.9 percent of China’s gross domestic product this year, the Paris-based bank said in a report today, raising its 2009 loan forecast from an earlier estimate of 8.5 trillion yuan.

Yes, all the new loans to local governments and state-owned enterprises made this year may come back to haunt China. It will be difficult for the local governments to pay back the loans as their power to raise taxes is limited and are very reliant on "selling" land as a way to raise revenue.

[wushijiao]

I'd add that in a recession, social unrest could tempt the government to divert attention away from the economy. Perhaps increasing tensions with Taiwan/Japan/perhaps even the USA (which Wen criticised for 'irresponsibility' a few weeks back). Along with a slowdown in China, this would be bad for global confidence & recovery.

I think that China will most likely continue to try to improve its relations with major powers, as its international standing has increased considerably during this financial crisis. They's be hesitant to switch away from their current policy (韬光养晦), and I think just about everybody knows that. As far as creating 1984-like enemies for domestic purposes, they already have the DL and Kadeer, which seems to be working out well. But then again, I could be wrong.

But, I do think China faces a lot of domestic problems, as the article points out.

However, what if world investors see that China will have the best growth potential in the short and media terms? Might they not pour in FDI into good sectors, from a arket point of view, spuring real, sustainable growth?

[onebir]

As far as creating 1984-like enemies for domestic purposes, they already have the DL and Kadeer, which seems to be working out well.

They've done it before. There was a period of tension with Taiwan a couple of yeara back & the whole Japanese history books thing...

Might they not pour in FDI into good sectors

I'm not sure what the good sectors would be... My impression is most past FDI has been aimed at the export sector, which is unlikely to look attractive for a couple of years. Overcapacity in sectors targetting domestic sales seems pretty huge. & tho FDI into China has been big compared to global FDI flows, it's always been pretty small compared to the scale of domestic investment.

So even if the 'good sectors' were able to attract FDI flows comparable to the credit-boom/China-bullishness-fueled peak in 2007 - which I strongly doubt - they'd probably be more than offset by scaling down of state funded/sponsored domestic investment.

(This logic, incidentally, pretty much precludes the existence of chunky 'good sectors' for FDI: it suggests organic domestic demand won't recover strongly; meanwhile demand for Chinese exports looks shot for a couple of years minimum. The good sectors that exist will have to depend on micro factors; promising firms/products etc. Partly because of structural impediments China's not exactly replete with these...)

It will be difficult for the local governments to pay back the loans as their power to raise taxes is limited and are very reliant on "selling" land as a way to raise revenue.

Which often causes conflict between local government & the populace... People will also get very upset when they lose their shirts on the stock market. A Chinese economist on TV last night estimated 97% of some class of state-sponsored lending was finding its way into the stock market. Property also seems to be benefiting.

So I think the withdrawal of the stimulus could lead to unrest urban as well as rural areas.

[bhchao]

China's one-child policy will adversely impact its economy over the long term. Unless there are reforms in population policy and social safety net programs, these one-childers will drag down the economy when they reach elderly age.

It's possible that China may run out of water within 50+ years. The effects of an aging population and environmental degradation will not impact China's economy now. But their constriction on economic growth could make its mark within 50 years.

[aljensen]

Wouldn't it be fairly simple to extend the working age? It seems like with a privatizing economy less people will be willing / able to retire at the traditional age anyways.

The main problem China will face, it seems to me, is rising expectations - the young generation has been raised to expect a first world standard of living, which is simply not materially possible given the current level of technology. How will this current generation of "little emperors" adjust to becoming everyday workers?

[roddy]

Extend the working age and you're going to have an even larger problem with unemployment. If you're going to keep anyone out of work, make it the old folk - they riot less.

[imron]

Reforms in the population policy do occur e.g. now that many of the first batch of children to grow up under the one-child policy have reached marriageable age, if two only-children marry, they are allowed to have two children instead of just the one.

[gato]

Andy Xie says that the bubble will burst by 2012.

http://english.caijing.com.cn/2009-08-05/110220584.html

Andy Xie: China Counts Down to the Next Bubble Burst

08-05 08:28 Caijing

[Outofin]

I learned some things that aren't immediately obvious about economists predicting future .

The policymaker is like a driver, while the economist is like a passenger. The passenger may occationally warn the driver, "we're going to crash into that car." This prediction is based on the current status and trend and the best knowlege of the passenger. However,

1. An accident may not happen. Maybe the driver changed lane, or maybe the car in front of them speeded up.

2. Even if the accident doesn't happen, it doesn't mean that the passenger/economist was wrong.

The caveat of the story is that it make it sound like that policymakers have the full control and ultimate responsibility of the economy, like the driver has that of the car, that's not true. So the third point is,

3. Even if the accident happens, it doesn't mean that the passenger can do a better job than the driver.

[wushijiao]

Or you could even say that the passenger doesn't even know how to drive a car sometimes (ie. doesn't know the details of how to politically work an economy, with tons of competeing interests and internal politics, central vs. local...etc).

According to the latest Zhengming, Wen Jiabao has come under tremendous internal heat (from inside the Politburo, from the SC of the NPC, from departments within the State Council, and from local politicians), and on July 18th in a 政治局常委會 session he offered to 退居二線(pull back to the second line of work), and offered to allow Wang Qishan to make the key decsions on the economy.

[realmayo]

economists predicting future

And often the is employed by the same companies that provide all manner of services, fuel, repairs, to the owner of the car.

That said, I like reading Andy Xie, thanks for the link. Interesting hypothesis about a housing market collapse and possible ramifications.

[bhchao]

The first lawsuit by an environmental group against a local government has been accepted by a court in Guizhou: http://www.guardian.co.uk/environment/2009/jul/31/china-residents-prosecute-government-environment

Edited August 9, 2009 at 07:35 PM by bhchao

[onebir]

Here's a small collection of related links.

On the Andy Xie piece, he seems a bit incoherent in places. If the dollar were stronger the Chinese could hold more diversified reserves. In any case, what are a few foreign reserve losses when holding the renminbi down is necessary to preserve 和谐.

I also think there's a huge bubble &/overcapacity in the property market. China's probably quite a bit closer to 'absolute oversupply' than the article suggests, because it doesn't factor in speculative holdings of empty property. I haven't seen figures for these, but for recently completed blocks around here the percentage seems pretty high; if property prices start to drop consistently, the holders want to unload these.

*Although the idea of 'Absolute oversupply' seems difficult to define - can't prices drop until people want more than 28 sq meters per person? 28 sq meters may be quite high by international standards, but studio flats here are often 40-60 sq m (with v small bathrooms/kitchens)

The first lawsuit by an environmental group against a local government has been accepted by a court in Guizhou

Interesting to see how that goes, but apparently the courts aren't terribly independent. Given that the main polluters are probably SOEs with strong local govt ties, how many will rule against them?

[gato]

On the Andy Xie piece, he seems a bit incoherent in places. If the dollar were stronger the Chinese could hold more diversified reserves. In any case, what are a few foreign reserve losses when holding the renminbi down is necessary to preserve 和谐.

His point is there is a lot of foreign money flowing into China's property and stock market with the expectation that the RMB will continue to appreciate versus the dollar, and if the exchange rate starts moving in the other direction, foreign money will start leaving and the local money might follow, as well.

[Outofin]

I think the damage that foreign hot money could cause in China should be much less severe than in other countries, because it's tightly controlled. Stock market's A shares are not open to foreign investors. There could be some ways in, but they're not as free as in other countries.

That said, I'm as concerned as anyone else. The stock and property market are not healthy at all.

On the up side, the US economy seems to be picking up. That's a good news to everyone. At least to make Asia Sentinel's article's point about world demand "- unless world demand for Chinese exports has picked up a lot by the time the government stimulus measures end - which isn't looking likely - the economy will go into a recession. (or at least grow too slowly to absorb the growth in the labour force)" more likely to happen then before.

[bhchao]

Interesting to see how that goes, but apparently the courts aren't terribly independent. Given that the main polluters are probably SOEs with strong local govt ties, how many will rule against them?

If officials were previously being promoted by bringing in development, it's hard to see this as a breakthrough in environmental enforcement, especially when the global downturn makes development more urgent.

This case might be a good, first experiment in the judicial review of environmental cases, but as long as the philosophy "To get rich is glorious" is embedded in local officials, it will probably make little impact on the future enforcement of polluting laws.

I believe there needs to be a fundamental change in the system itself. Officials know they can keep their jobs even if they pollute, as long as they produce economic growth. Local officials will be more inclined to enforce if the people decide whether they can keep their jobs.

Or there needs to be more oversight at the local level from China's Ministry of Environmental Protection. The organization only has about 300 employees, most of them being confined to Beijing rather than dispersed at the local level. In contrast the US EPA employs about 18,000 people.

Edited August 10, 2009 at 07:40 PM by bhchao

[bhchao]

On the up side, the US economy seems to be picking up. That's a good news to everyone. At least to make Asia Sentinel's article's point about world demand "- unless world demand for Chinese exports has picked up a lot by the time the government stimulus measures end - which isn't looking likely - the economy will go into a recession. (or at least grow too slowly to absorb the growth in the labour force)" more likely to happen then before.

There's one problem though for Chinese manufacturers. American attitudes toward saving have changed as a result of the recession. You won't see US personal savings drop to 0% again even if the economy recovers. That's because many Americans' retirement and 401k savings have been wiped out from the bear market.

So when the economy recovers, the focus will be on rebuilding nest eggs and paying down debt rather than buying non-necessities from China.

Another reason is psychological change caused by hardship. People's maturity and personal growth benefit more from chaotic times than they do during happy, easy times. Just like the Great Depression created a lifetime culture of frugality for those who lived through it, this recession is likely to produce a similar shift in attitude toward money among the Generation Xers and the retiring Baby Boomers.

[onebir]

His point is there is a lot of foreign money flowing into China's property and stock market with the expectation that the RMB will continue to appreciate versus the dollar, and if the exchange rate starts moving in the other direction, foreign money will start leaving and the local money might follow, as well.

Oh - I see, thanks! Your explanation is a lot clearer than Andy Xie's...

But isn't it quite difficult to take money out of China/RMB, for foreign citizens at least? Presumably the regulations could be tightened further too.

Another crack showing signs of opening recently -

increasing hostility to rule of law, which is pretty fundamental for development along capitalist lines...

[gato]

China's foreign currency controls are definitely one of the toughest in the world, and it's not easy to get money in or out. But those who care less about the law can do it for a fee. Supposedly the underground banks (地下钱庄) in Shenzhen can help you get your money out of China for a 4-5% fee. GOME's chairman, once the richest man in China, is rumored to have used them, though who knows. They are just accusing him of everything under the sun right now.

See article below.

http://www.atimes.com/atimes/China_Business/JB28Cb01.html

China turns up heat on hot money

By Olivia Chung

HONG KONG - China's foreign exchange regulators, after smashing more than 30 underground banks with 10 billion yuan in illegal funds last year, have pledged tighter supervision and management of cross-border capital flows.

The foreign exchange regulator, the State Administration of Foreign Exchange (SAFE), said this month it will step up checks on cross-border capital flows, particularly on how foreign currency is sneaked into the country and converted into yuan and how such funds are spent, according to the Financial News.

Last year's haul compared with 70 underground banks involving illegal funds of US$3.03 billion in 2006, according to SAFE figures.