APRIL 3, 2014
POSTED BY JOHN CASSIDY
Martin (Two Brains) Wolf, the Financial Times’ venerable economics commentator, doesn’t always have the correct answers. But he invariably poses the right questions, which, in a journalist, is often more important. In his column this week, Wolf asks, “Is China different? Or must its borrowing binge, like most others, end in tears?”
That the Middle Kingdom’s transformation from a Communist command economy is a great success story cannot be doubted; it’s one of the wonders of modern history. Since 1991, according to the World Bank’s database, its inflation-adjusted growth rate has averaged about ten per cent a year. Rapid growth has dragged hundreds of millions of people out of grinding poverty and turned China, according to some measures, into the world’s second-largest economy. (In terms of G.D.P. per capita, the performance is a bit less impressive. In 2012, according to the World Bank, China’s was $6,091, placing it among places like Peru, Serbia, and Thailand.)
In the past few years, however, China’s growth rate has slowed down a bit, and the country has racked up large debts. How large? Wolf provides a disturbing chart, based on figures from the International Monetary Fund, that shows overall debts rising from about a hundred and twenty-five per cent of G.D.P. in 2008 to two hundred per cent in 2013. That’s quite a leap. As anybody who has visited China recently can confirm, it has coincided with an enormous building boom, which has left many cities festooned with empty apartment buildings and shopping malls.
The worry is that large parts of China now resemble Arizona, Florida, and Nevada circa 2007, when the great Greenspan-Bernanke real-estate bubble was going “pop.” “Signs are mounting that the housing market in a number of cities is not just cooling but actually cracking,” Wei Jao, an economist at Société Générale, wrote recently. According to a lengthy report from China in Thursday’s F.T., which quoted Jao, developers are already slashing prices by up to forty per cent in selected areas. But that hasn’t been sufficient to prevent some of them from having trouble keeping up interest payments on the loans they took out to finance construction. And that, in turn, is raising concerns about the Chinese financial institutions that did much of the lending, such as banks, “shadow banks,” and trust companies. (Shadow banks are unregulated finance companies that borrow and lend at interest rates higher than those available in the regular banking system.)
To some observers, particularly fans of Hyman Minsky, the late Keynesian economist, it looks suspiciously like China may be approaching a Minsky moment—that dreadful instant at which most of the participants in the boom recognize that the game is up, credit stops flowing, one or more financial institutions moves to the verge of collapse, and panic ensues. Figures released last month show that credit from China’s shadow banks has virtually dried up. In January, about a hundred and sixty billion dollars’ worth of new loans were issued through shadow banks; in February, virtually none were.
The optimistic reading is that, for all the changes it has gone through, China is still China—an authoritarian country where the government ultimately dictates the flow of money and credit. And the government, unlike the corporate sector, is not overly indebted, so it has room to maneuver. (The International Monetary Fund reckons that the over-all ratio of public-sector debt to G.D.P. is about forty-five per cent, which is much lower than the ratios in the United States and most other Western countries.) If the biggest developers get into serious trouble, the authorities will step in and quietly bail them out, the optimists say. If liquidity dries up in the banking system, the central bank will supply it. If the public starts to fret about the banks, and an incipient run develops—always a danger in a country, such as China, that doesn’t have a deposit-insurance system—the government will bring forward its plans to set one up.
Since everybody involved knows all these things, the argument goes, there won’t be a Minsky moment to begin with, and China will escape the sort of shock that plunged the United States and other Western countries into the Great Recession. Backward induction will save the day. Indeed, the rate of growth might pick up, as the government relaxes some of the credit restrictions it had imposed to cool down the property market and possibly even introduces a new fiscal stimulus.
Certainly, the financial markets don’t seem to be concerned. On Wednesday, global stock markets hit their highest levels since the end of 2007. The Shanghai market, after falling sharply between December and February, has bounced back a bit in the past few weeks. Pronouncing judgement, Wolf comes out for the optimists. “China will not have a financial meltdown,” he says bluntly. But, like many other analysts, he sees a period of lower growth ahead, as the Chinese government seeks to rebalance its economy away from debt and capital investment, and toward consumer spending and services. “The accumulation of debt is likely to end not with a financial bang but with a whimper, as growth peters out,” he writes.
Even if China can avoid the immediate danger of a crash, the move to a newer, more durable growth model represents a tremendous challenge. Some China hands, such as Stephen Roach, the former chief economist at Morgan Stanley who is now at Yale, believe the authorities in Beijing have a handle on the task, and are making progress. Other observers, such as George Soros, are more dubious. At the beginning of the year, Soros said that using stimulus policies to boost growth would only postpone the day of reckoning, because “restarting the furnaces also reignites exponential debt growth, which cannot be sustained for much longer than a couple of years.”
Since China is one of the many areas on which I am alarmingly inexpert, I’m going to remain agnostic on this one, at least for now. I would note, however, that if China manages to muddle through and achieve a “soft landing” it will be one of the few countries on record that have escaped a big credit and real-estate boom without a wrenching recession. If you want more reasons to be skeptical, I suggest reading “Avoiding the Fall: China’s Economic Restructuring,” by Michael Pettis, an economist at Peking University who also maintains a lively but irregularblog, where he has consistently warned that the challenges facing China are much bigger than many outsiders realize. If you want a more upbeat take, or you have recently bought calls on the Shanghai composite, you might consult the analysis of Roach, who has a new book out on the economic co-dependency of the United States and China.
One thing is certain: what happens in China will have a big impact on the rest of the world, the United States included. It’s not just that China is now America’s third-biggest export market (and its largest source of imports). It’s the world’s biggest importer of oil, iron ore, copper, and many other commodities. For the past decade or so, it’s been the biggest source of global growth. A big shock to China would be a big shock to everybody.
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