Yves here. Below we are featuring an important comment from PlutoniumKun, where he weighs in on the debate over how serious China’s current and prospective economic problems are. We have pointed out that a Chinese economic crisis has been overpredicted for a very long time. But being early does not make one wrong; recall some experts like William White and Claudio Borio of the BIS, and Nouriel Roubini were warning of a housing bubble and the prospects of a very ugly implosion years before it happened.
However, as we have pointed out (following Michael Pettis and Marshall Auerback, among others) and PlutoniumKun highlights, China seems not just to be having what would be expected difficulty in changing from an investment/export led growth model to one with domestic consumption being far more important. But China also appears to have an ideological, or one might say political problem in making this shift. Higher consumption would require lower savings rates. Not only do Chinese consumers not feel secure enough to do that (too much history of crises in China and its neighbors) but China under Xi is unwilling to implement the social safety nets that would encourage more spending.
I don’t want to take up too much time with this intro, but some relevant recent sightings. Note that Setser among other things is the man on dollar holdings and flows outside the US:
I suspected that parts of China’s top leadership objected to a household focused stimulus. Turns out the epicenter of opposition is Xi himself: “Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse”
— Brad Setser (@Brad_Setser) August 27, 2023
Beijing’s mind seems made up — but Chinese policy makers have this backwards.
Using the central government’s clean balance sheet to support household demand would actually make it easier for households, property developers and local governments to delever.
— Brad Setser (@Brad_Setser) August 27, 2023
A hypothesis: there can be no durably stable Chinese and global economy so long China’s national savings rate stays around 45% of GDP …
(note that, contrary to the IMF’s forecasts, savings has been rising since 2020 …)
— Brad Setser (@Brad_Setser) August 28, 2023
China’s shoppers hesitate to spend big in face of deflation via @FT
”Excess savings in China have increased in the first half of the year compared with the same period last year, and there is still a gap between pre-pandemic and current consumption” https://t.co/dvQvhP1lrU
— Iikka Korhonen (@IikkaKorhonen) August 29, 2023
Don’t focus on GNP growth, it’s not a relevant measure for comparing developing and developed countries, especially how it’s measured in China. Pettis gives a long form explanation here. It terms of assessing what the ‘real’ economy is doing in China, it’s a pretty much useless measure.
Only time will tell if this is an existential economic crisis for China or just a very unpleasant blip. But the reality is that a crisis is inevitable for any country pursuing an unbalanced growth model – i.e. by focusing on investment and exports over domestic/consumer led growth. This is baked into the standard model – and the Chinese are fully aware of this, and have been since at least the 1980’s and 1990’s when I started following (from afar) the Chinese economy from a development economics perspective. Back in the 1990’s the Chinese devoted very significant resources to studying the Japanese late 80s collapse, later the 1990s Asian crisis, and the multiple crashes which foiled numerous countries over the past century or more from crossing the threshold from upper-developing to developed country status. There is a line of thought among some China analysts that Xi was selected and given extraordinary powers specifically to deal with what was foreseen to be a very difficult transition from a the current development model to ‘developed’ status, which has always overtly been the holy grail for the CCP.
I don’t think there is much doubt that the current situation in China is very serious. In my opinion, the housing crisis is a symptom, not the cause of the current problems (in reality, the Chinese economy started showing signs of strain even before Covid). The core problem being several decades of internal debt build up and chronic mal-investment along with an overdependence on rising property values to underpin spending at a local level. But the housing issue alone is gigantic – by any objective measurement it is vastly greater as a proportion of the economy’s size than the Irish and Spanish crashes of 2007-9. When you add in demographic issues and climate induced strains, this is potentially much more than just a cyclical downturn.
It is highly unlikely for there to be a financial crash as the Chinese banking and finance model is very different from in the west, or for that matter, most other Asian economies. In simple terms, Beijing has plenty of tools to stabilize the finance side of the economy, and not having external debt is a huge advantage – not to mention the enormous strides made in just the last decade in gaining competitive advantage in a wide range of important manufacturing sectors. But it is increasingly recognized within China (this is very obvious reading between the lines in various statements from Beijing) that the current model has finally run out of steam and needs fundamental overhauling.
The problem is that this has been pretty obvious for some time, but despite numerous policy statements going back at least 2 decades (the big ‘change’ was supposed to happen after the 2008 Olympics), very little has been done, it’s always been easier to open up the spending spigots and kick the can down the road. In particular, the funding model for local government – which has always been the big driver of growth – is now not fit for purpose and must be replaced by either a proper local taxation system or direct funding from Beijing. But that is easier said than done. There has to be a very significant transfer of wealth to ordinary citizens through higher wages and better social welfare provision in order to boost consumer spending (one of the few things orthodox and heterodox economists agree on when looking at China). And as for debt – in theory, this is a simple problem to address (i.e. monetize/forgive it in one form or another), but there appears to be an unwillingness to even discuss this option within high level circles in China.
The irony to me is that having studied the Japanese crash intensively, the Chinese may somehow manage to replicate exactly the mistakes the Japanese made. There appears to be a lot of pressure to go for yet more concrete pouring and refinancing of debt as a ‘solution’. This will risk deflation, zombification and/or a greater crisis further down the line.
While it can be argued that the current property/investment boom is not as bad in China as it was in Japan, in other respects the Chinese economy may be a lot weaker than Japan was at the time – for all its modernity, China is still essentially a poor country – significantly poorer than, for example, Russia or Turkey, and probably not even matching Mexico. What is unique about China is its enormous size, which allows it to mobilize resources and dominate economic sectors in a way small developing countries can’t. But then again, this has never helped India, which also has some very advanced technological sectors.
The other huge problem – ironic given demographic problems – is youth unemployment. This seems to be a characteristic of fast growing export-led economies once they rise above the sweatshop levels of development – both Japan and South Korea have had huge problems in keeping up employment levels even at times when their economies have been seen to be healthy when measured in GNP. In simple terms, I don’t think you can keep up a high level of employment if you insist on suppressing wages and consumer demand. But this is integral to an export/investment model of development.
If you want to understand what’s happening in China its important I think to forget the whole China vs US thing (the US has almost no direct or indirect influence on what is happening in China) and look at it as it is – a typical, if unprecedentedly large, example of a country pursuing very rapid growth using what used to be called the ‘American’ system (later refined by the Germans, South Koreans, Taiwanese and Japanese). Each of those economies have unique features, but the underlying advantages and disadvantages of combining high levels of internal wage/spending suppression in the domestic economy with an insistent on export and investment led growth all seem to lead in the same direction. The only question is whether they can achieve the transition to a more balanced economy (i.e. ROK and Taiwan or even Russia) or end up butting their heads against the ceiling Argentina or Brazil style, or perhaps end up in some sort of Japanese style limbo, albeit at a much lower level of development than Japan.
A few years ago, I would have been fairly confident that the CCP could pull it off, especially with someone as impressive as Xi at the helm. But more recently there are increasing signs of inept leadership, groupthink and poor decision making at higher levels of government in Beijing, going right to the top. There is a lot of rot among our leadership classes everywhere, not just in the west.