the great fall of china

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The great fall of China
Monday, April 23, 2007
China's economic boom will come to an abrupt and painful end, the question is when.
Two years ago I told a gathering of Australian businessmen that China was headed into an economic slowdown which would see the end of the surge in commodity prices.

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Inevitably that would impact on both the Australian economy and our stockmarket.

You could say that was a spectacularly wrong call.

In my defence all I can say is that I was doing no more than taking the Chinese authorities at their word; that policies would be introduced to take the "runaway" element out of China's growth.

That economy grew at 9.5% in 2004; then by 9.9% in 2005 and 10.7% in 2006.

Last week it released the figures for the first quarter of 2007. Growth in China during the Mach quarter was running at 11.1% on a year-on-year basis.

To put it bluntly the Chinese economy is unstable, unbalanced, uncoordinated and unsustainable.

That is not my description.

It is how China's Premier Wen Jiabao characterised his country's economy a month ago.

Could you imagine what would happen if John Howard made a similar statement about the Australian economy? The stockmarket would go into freefall as the nation prepared itself for tough purgative fiscal and monetary policies.

Back in late February a one day 9% fall in the Shanghai stockmarket did send shockwaves around financial markets. The Shanghai fall was caused by the prospect of tighter monetary policy.

Last week when the latest growth figures showed the Chinese economy overheating even further, the Shanghai exchange fell by 7% at one stage but only by 4.5% on that day's trading.

But the market is still up by 25% since that February correction.

It is not just the speed with which China is growing that causes concern; it is the unstable, unbalanced and uncoordinated nature of that growth.

China's economy is being driven by cheap finance funding an explosion in business investment and exports. The bank's one-year lending rate is 6.4%.

As the economy is growing at a nominal rate of 14.7% the spread between the return on funds and the cost of borrowing those funds is a licence to print profits.

Except for Web Jiabao's final "U"; the pattern of growth is unsustainable.

The flood of Chinese exports into the US is already causing a backlash and next year's presidential election looks like developing into a protectionist auction.

Even if the US maintained its open door policy to Chinese imports the economy cannot keep growing investment at more than 25% a year without developing excess capacity and rapidly shrinking profitability.

One way or the other China's investment/export driven economic model will hit a wall.

It's likely to be a very messy accident because it is impossible to restructure an economy of more than a billion people painlessly overnight.

Of course, the longer the present model is fuelled by easy and cheap finance, the bigger the ultimate accident.

Just as they did two years ago the Chinese authorities make threatening noises - but the thunder of their rhetoric is not matched by boldness on the policy front.

To a significant degree the Chinese government is a hostage to its centralised, autocratic political system. Lacking a popular mandate its prime concern is to maintain social stability.

This makes it reluctant to implement unpopular, disruptive economic policies. However, if an economic model is unsustainable, as Wen Jiabao has described the Chinese one, then you minimise political and social upheaval by moving sooner rather than later.

However, having been burnt once by taking the Chinese authorities at their word I'm not confident that they are yet prepared to move decisively to address their problems.

Compounding their dilemma is the fact that the Beijing Olympics are designed to be a showcase of China's economic success.

What the recent past has demonstrated is that a nuanced approach to tightening policy and restructuring the economic model has so far proved totally ineffectual.

Hardly surprising, engineering a soft landing for an economy that is seen as unstable, unbalanced, uncoordinated and unsustainable is a tall, some would say, impossible order.

Consequently there will be a strong temptation to hold back the nasty medicine until after the 2008 Olympics.

But there is always the possibility that such an economy could succumb to natural-caused remedy before the necessary treatment was forthcoming.

The bottom line is that one way or another China's investment/export boom will end - most probably with a bust, not an extended swoon.




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