CHINA: by Patrick J. ByrneNews Weekly
Looming credit crisis could stymie China's growth
, October 29, 2011
China’s policy to avoid the global financial crisis (GFC) was to generate easy credit. However, a looming credit crisis is exposing structural flaws in the Chinese economy.
China’s phenomenal double-digit growth has been dependent on its cheap manufactured exports to the West. Intervening to keep its currency low and stop wages from rising was part of its export growth strategy.
Exports may have generated huge savings for China, but it has also led to severe imbalances in world trade, in turn helping to precipitate the GFC, and leading to unbalanced growth back home in its own domestic market.
China’s response to the collapse of its export market, when the GFC struck in 2008, was to unleash credit on a massive scale to stimulate its economy.
Much of that money consisted of loans from state-owned banks to local governments, which were supposed to invest in new roads, railways, power plants and other projects to help maintain China’s rapid pace of economic growth.
Last year, infrastructure expenditure accounted for 55 per cent of the Chinese economy, according to Carl E. Walter, an American investment banker and co-author with Fraser J.T. Howie of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise (John Wiley & Sons, 2011).
Now, China’s spending spree has created a credit bubble on the scale of America’s sub-prime credit crisis. A collapse could precipitate political unrest and threaten the power of the Chinese Communist Party, whose legitimacy has been based on being able to deliver enduring rapid economic growth.
To gain an idea of the scale of the credit bubble, the volume of China’s lending since the GFC began has jumped from the equivalent of 100 per cent to 200 per cent of gross domestic product (GDP) today, according to Zhu Min, the deputy chief of the International Monetary Fund.
By comparison, according to a study by Fitch Ratings, credit in the US rose by just 42 per cent of GDP in the five- year period before the American sub-prime crisis hit, says Ambrose Evans-Pritchard (UK Telegraph, September 18, 2011).
It rose by 45 per cent in Japan before the Japanese economic crisis of 1990, and 47 per cent before the Korean crisis of 1998.
Home construction is running at 10 per cent of GDP, about the same as in Spain before its crisis of 2006 and higher than in Japan and Korea in their rapid development stages.
Adding to the speculative bubble, investors have been purchasing multiple new apartments and houses, hanging onto them unrented, anticipating major capital gains when they are sold on a rising market.
When the bubble bursts, these properties are likely to flood the market and exacerbate a property downturn.
Local governments have added to the bubble. As well as being beneficiaries of infrastructure funding, they have benefited from the rising property market. Around 40 per cent of their revenue comes from land sales.
The upshot of China’s stimulus measures is a credit bubble of epic proportions. Loans have reached $1.7 trillion, according to China’s audit office.
While some of this has been used for much needed infrastructure, a large part has fuelled unbridled construction with dubious economic benefits.
Adding to the vulnerability of China’s banks, local governments have circumvented bond insurance for their lending by creating more than 6,000 arms-length companies to get around these regulatory requirements.
These arms-length companies have also allowed local governments to create a huge patronage system for Communist party officials.
According to Fitch Ratings, “China’s banking system is the largest, fastest-growing, but most thinly capitalised among emerging markets.”
Consequently, the economic boost from each extra yuan of credit has collapsed from 0.75 per cent to 0.18 per cent since the GFC began and has yet to recover, comments the UK Telegraph’s Evans-Pritchard.
The downturn may have already started in the property market. A major property company, Guangzhou R&F Properties, has slashed property prices by 20 per cent, and other property companies may soon follow, according to Caixin Magazine, a Beijing-based financial and business news media group.
To reduce its reliance on export-driven growth, Beijing has begun raising workers’ wages to create a larger domestic market.
It may be facing an uphill battle. According to the China Data Centre at the University of Michigan, China’s per capita income doubled from 1991 to 2001, then doubled again by 2008.
However, consumption has been falling as a proportion of GDP. In the late 1990s, it fell from 48 per cent to 36 per cent.
Further, rising wages have resulted in manufacturing industries moving to lower-wage countries such as Vietnam, while some have returned to the US.
China may face a double economic hit — a second-round depression in the West, further cutting China’s exports, and a credit crisis in China’s own banking system.
Its unbalanced growth has created structural economic problems that will be a challenge to solve and which could undermine the political legitimacy of the Communist Party.
Patrick J. Byrne is vice-president of the National Civic Council.