Roubini Calls for Hard Landing in China (After 2013)

During the financial crisis, pronouncements by Nouriel Roubini would move markets. Even though he still commands attention, in a investment environment driven by blind faith in the munificence of central banks, being focused on the real economy isn’t as relevant as it once was. And Roubini may have erred in trying to maintain his high profile when the trajectory of the economy was hard to discern (recall the seemingly unending debates over V versus U versus W shaped recoveries? The net result is the new normal has been designated a recovery when it it looks more to be a sideways waffle).

By contrast, China has trends underway that simply cannot be sustained, but a command economy can keep that sort of thing going well past its sell by date. The biggest is the staggering dependence of its economy on investments. No major economy has had investment as a percent of GDP at 50% for a sustained period. This is a textbook case of Austrian malinvestment. We’ve catalogued some of it here. For instance:

Similarly, the expansion of debt is also proving less effective in generating GDP growth. From 2000 to 2008, it required $1.5 in debt to produce $1 of GDP. By contrast, credit efficiency in the US became poor right before our bubble imploded, with it taking $4 of credit to produce $1 of GDP. China now is even less efficient than the US in 2008, with it now taking $7 of credit to yield $1 of GDP increase.

And that’s before we get to Michael Pettis’ ongoing commentary about the dangers of China’s debt levels, or the ongoing sightings of bridges to nowhere and underutilized factories.

So Roubini’s call is interesting, in that he sees an ugly end in China as inevitable but not imminent. From Roubini via an e-mail alert:
I’m writing on the heels of two trips to China….My meetings deepened my own impression and RGE’s long-standing house view of a potentially destabilizing contradiction between short- and medium-term economic performance: The economy is overheating here and now, but I’m convinced that in the medium term China’s overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible—most likely after 2013—China is poised for a sharp slowdown. Continuing down the investment-led growth path will exacerbate the visible glut of capacity in manufacturing, real estate and infrastructure. I think this dichotomy between the high-growth/inflation pressures of the next couple of years and growth hitting a brick wall in the second half of the quinquennium is far more important than the current focus on a “soft landing” amid double-digit growth. A number of local scholars close to policy circles agree that this is the biggest challenge of the next few years, as we’ve been saying for months.

Despite policy rhetoric about raising the consumption share in GDP, the path of least resistance is the status quo. The details of the new plan reveal continued reliance on investment, including public housing, to support growth, rather than a tax overhaul, substantial fiscal transfers, liberalization of the household registration system or an easing of financial repression.

No country can be productive enough to take 50% of GDP and reinvest it into new capital stock without eventually facing massive overcapacity and a staggering nonperforming loan problem. Most likely after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP.

China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in brand-new empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, massive new government buildings, ghost towns and brand new aluminum smelters kept closed to prevent global prices from plunging.

It will take two decades of reforms to change the incentive to overinvest. Traditional explanations of the high savings rate (lack of a social safety net, limited public services, aging of the population, underdevelopment of consumer finance, etc.) are only part of the puzzle—the rest is the household sector’s sub-50% share of GDP.

Several Chinese policies have led to a massive transfer of income from politically weak households to the politically powerful corporates: a weak currency makes imports expensive, low interest rates on deposits and low lending rates for corporates and developers amount to a tax on savings and labor repression has caused wages to grow much less than productivity.

To ease this repression of household income, China would need a more rapid appreciation of the exchange rate, a liberalization of interest rates and a much sharper increase in wage growth. More importantly, China would need to privatize its state-owned enterprises so that their profits become income for households and/or massively tax SOEs’ profits and then transfer those fiscal resources to the household sector.

It will be interesting to see whether Roubini is overcorrecting from his experience with the US housing/credit bubble, where he was so early to predict a bad end as to be a Cassandra.

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23 comments

  1. Uncle Billy Punctuator

    He bought himself a $5M Manhattan love-nest recently. Between that and the Hamptons, Constantinople, Berlin, Lantau, Davos, Tehran, etc., he’s probably overdoing a number of things. He’s a good guy, deep down, just don’t ever kid him about his command of English.

  2. BrianSJ

    HS Dent have said (a while ago) that China hits a brick wall around 2014 because of the one-child policy.

    1. Κασσάνδρα τριάντα


      one-child policy.

      It is going to be all-right. Chinese lack of labor can be easily supplemented with 60 million unemployed Hindus and 30 million unemployed Americans after value of our retirement funds gets drained off by inflation which detonates when Gross and Buffet sell off all of their T-bonds, all the Tea-bonds in China. Whoops — they sold off already.

      Hunker down
      !

  3. Andrew DeWit

    Maybe. But the Pew Center tells us in its clean energy report that the Chinese invested USD 54 billion in renewables and are accelerating. With conventional energy prices climbing, their sustainable energy and smart grid investments may give them an edge in growing. They’ve also increased their commitment to renewables as a result of watching Japan’s nuclear meltdown.
    By contrast, America has its “energy revolution” in unconventional and cheap gas…until that bubble bursts.

  4. Max424

    I agree with Roubini, China will know troubles — at some point — either in the near, middle, or distant future.

    Now, here’s my startling prediction: someday, the universe will stop expanding, and start contracting. All matter will consolidate (again), and then, BOOM, another Big Bang; and the cycle will begin anew.

    I will be reborn (as will we all!), in the year 12 billion and 33 (or thereabouts), and 50 years after that, I will write this very same comment.

    1. paper mac

      If we have to go through this all over again, I’m going to need that 12 billion years to recover from the hangover this lifetime is giving me.

    1. Foppe

      Actually, when Egypt was building the pyramids money hadn’t been invented yet, and it certainly wasn’t in broad circulation. As a consequence, all surplus labor that wasn’t used in a year (nowadays it can be turned into goods and money that doesn’t decay appreciably) was lost. So it didn’t really matter that the Pharaos spent some time during the growing season on building stuff.

      1. Tim

        Surplus labor which is not used is still lost, as in ancient Egypt. Or have I misunderstood your point?

        To come back to the original blog: to make those economists at ease, just call all that overinvestment* “consumption”. Indeed, what is really the difference between a bridge going nowhere** and a batch of cheap electronics?

        *I do not agree with this qualification.

        **Chinese tend to construct bridges well before the actual road to connect them.

      2. DAN G

        Sounds right. Everything working in cycles. Therefore, the analogy drawn out further, shows the artificial expansion of the universe beyond the normal expansion cycle. The overuse of time travel,and nuclear explosions by Federal League of Planets will expand the universe more than normal, thus the contraction must be more fierce.

    2. MyLessThanPrimeBeef

      Just because Egypt couldn’t keep on buidling pyramids for a long time, you shouldn’t think the Chinese couldn’t.

      Just look at the Great Wall – they monkeyed around with that thing for over 2,000 years. I suspect after the empty shopping centers, airports, etc, they will take up that hobby again…it’s the mother of all overinvestments.

  5. financial matters

    As a somewhat tangential point I thought this was very interesting…

    “and/or massively tax SOEs’ profits and then transfer those fiscal resources to the household sector.”

    According to a recent link (GE tax affairs put Immelt in political spotlight Financial Times ) GE didn’t pay any taxs on $14 billion of profits in 2010…. That could help with SSN and Medicare shortfalls… And they are also outsourcing a lot of jobs overseas.. And Obama picked the GE CEO as his job czar… jeez

  6. Jim Haygood

    ‘In a [sic] investment environment driven by blind faith in the munificence of central banks, being focused on the real economy isn’t as relevant as it once was.’ — YS

    Whoa, talk about complacency! ‘I’ve got a pocket full of POMOs; who cares about butchers, bakers and candlestick makers?’ I know I’m exaggerating your meaning, but it sounds awfully la-di-da … like something Robert Rubin would say. The ‘munificence of central banks’ at best gives a one or two year sugar jolt, followed by an inflationary or contractionary hangover.

    America’s counterpart to China’s vast collection of empty airports, trains, and new cities is its towering $2.4 trillion domestic monetary base, coupled with the Fed’s off balance sheet $3.4 trillion custody account, representing its international check kiting operations conducted with foreign central banks, in a simplistic game of fiat currency patty-cake. Now these two monetary pools amount to 40% of U.S. GDP, when a few decades ago they were a fraction of that amount.

    Just as China cannot continue absorbing investment of 50% of GDP, it’s idle to think the U.S. central bank can continue pyramiding excess reserves at 22% annually and the custody account at 13% annually without producing an inflationary holocaust. The Continuous Commodity Index (the former CRB) has blown well past its July 2008 peak, with crude oil now in the danger zone of causing another global slowdown. But the Fed intends to grind on with QE2 for three more months, even as they claim sustainable growth already has been achieved. What is wrong with these freaks?

    The only moral distinction between Charles Ponzi (who served time for his swindles) and Ben Bernanke is that the Bernank has a license to steal from the U.S. Congress. Needless to say, an economy managed by institutionalized criminals has no future whatsoever.

  7. deeringothamnus

    The Chinese have to eat. China is rapidly building highways and adopting a car culture. You can even see people driving Humvees!. This is going to continue to cause food and energy inflation, which will cause inflation worldwide.

  8. TC

    Does not that last paragraph go some way toward uncovering the source of Mr. Roubini’s payroll? Starting with colorful sophistry about “repression of household income,” we move right to the oligarchical formula for wrecking nation states.

    Per the viability of experiments never before attempted in history, one would be remiss to overlook Alexander Hamilton’s national banking policy whose effect hastened development of this nation’s economic backbone. That, too, had never been tried before. No doubt, the policy had its intellectually and morally challenged detractors (as does any new thing).

    On this note, China’s joint venture with Russia to develop the mineral resources of Siberia using revenue streams from its U.S. Treasury holdings as capital backing credit assigned to this joint venture is a notable manifestation of Hamilton’s idea. (It’s along these lines, too, state governments might be wise to cut in on the insurance industry for a source of capital backing state development banks: POOF! Budget shortfalls no more.)

  9. AnjonR

    I remember back in 2005 I was on a China trip, and it smelt like Bubbles all the way, and a hard landing was eventually coming. I think the big question is still the “eventually” part. I think Roubini might very well be over-correcting after being a bit early on the 2008 global bust. OTOH, command economies can, as Yves said, “keep that sort of thing going well past its sell by date”. I think it’s entirely possible that it could be beyond 2013, perhaps well beyond.

    Does Yves or anyone have any remote idea how we can estimate the moment in time when the “Minsky moment” hits and the bubbles reverse themselves? Would be the holy grail if somebody can figure that one out!

    Reminds me of Keynes’ quote: “the market can stay rational longer than you can stay solvent”

    1. Tim

      Surely, china has its share of bubbles.

      But as long as the Chinese government keeps filling any emerging output gap, as it did through the 2008 crisis, a bubble popping should not necessarily affect aggregate levels of output.

  10. Alex

    Pettis has already argued, convincingly, that China’s GDP and growth are likely overstated to the point that its economy may actually be only the size of France or the UK (roughly $3 trillion at current exchange rates). Most Westerners have no idea just how unsophisticated and inefficient China’s financial system is, nor do they appreciate the degree to which China’s fixed asset investment has overstepped its usefulness (read: these new construction projects do not coincide with actual demand/need). The glut of malinvestment is remarkably akin to Japan in the 80s and 90s: while it stokes high growth today, the repayment of losses will be a drag on the financial system for years to come. Hence Pettis’ contention that such malinvestment out to be subtracted from China’s GDP.

    Someone else mentioned China’s investment in renewables: renewable energy in China makes up a miniature share of its overall energy consumption and is in a losing race with China’s growing investments in coal and natural gas, much of it imported from the US. China is the world’s largest sovereign user of energy, yet its output is barely a third of the US: its push in renewables simply cannot outstrip its woeful inefficiency in energy usage.

    While I am no fan of the tired “well China may be in trouble, but just look at the US!” since it really opens the floodgates for unhelpful apples vs. oranges comparisons, I would point out that in the long run, the Anglo-Saxon finance system has done a fair job of allocating capital, esp. when compared to its Asian counterparts. If it had not, there is no way that a previous backwater like England, or a tabula rasa like America, could have become global economic powerhouses in such a short time-frame. The Fed has made a ton of mistakes, but every central bank does at one time or another: China’s banking crisis in 2000/1, for example, cost 50% of GDP and set the stage for the nation’s long-term decline in consumption as a share of GDP.

    China’s government cannot fix every problem, either. Believing that it: 1) has the instruments to do so, which is doubtful in light of how large China’s “gray” economy is; 2) has the willpower to do so when adhering to the current model is so lucrative/profitable for the elite, is a classic exercise in moral hazard.

    1. MyLessThanPrimeBeef

      …China’s GDP and growth are likely overstated…

      …how large China’s gray economy is…

      ——————

      Is the gray economy large enough to make the GDP overstating problem go away?

  11. Mandarin

    The real worm in Roubini’s analysis is the “two decades of adjustment” he says will be required to redress the investment/consumption imbalance. In fact the mechanism for redressing that balance already exists and is in operation: the expansion of consumption by credit. Compared to the US the process is still in its infancy; but the same state-mandated low interest rates that have been available for investment are also being extended to households. The real constraint on China’s ability to make the transition is not the investment/consumption “contradiction” as they are ultimately financed the the same source: the state. It isn’t even the supposed inertia of the political system or the planned growth paradigm.Rather, it is the susceptibility of the economy to inflation, especially in a context of rising global prices for food and commodities. This is a constraint that the planners cannot control, one that will push the overall growth curve down.

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