Come tumbling down?
Britain is in deepening recession. Growth in the United States is slowing. The prospects for the euro darken by the day. The global economy is not so much waiting for the other shoe to drop as bracing itself for an entire branch of Foot Locker to land on its head.
One particularly precariously perched size 14 is China. The country which, since abandoning the immiserating economic madness of socialism and moving towards capitalism, has seen unprecedented increases in wealth for its people, now faces a bust.
In the first quarter of 2012 the Chinese economy grew at a rate of 8.1 percent, spectacular by western standards but China’s slowest in three years. The World Bank’s predicted growth for China in 2012, 8.2 percent, would be its lowest since 1999.
It is dangerously close to the 8 percent China watchers generally consider sufficient to absorb workers moving to towns and cities from the countryside, and maintaining social stability.
How has China come to this pass? Since the mid-1990s the People’s Bank of China, the central bank, has kept the yuan pegged to the dollar. This has had the effect of keeping Chinese goods competitive with US produced goods in spite of a depreciating dollar.
This has prompted angry outbursts from Congress about currency manipulation, a bizarre charge coming from the country which counts Quantitative Easing and Operation Twist among its bag of monetary tricks.
Another effect, however, has been to foster a credit boom in China. In order to follow down a dollar being eroded by constant monetary expansion the Chinese have been driven to initiate their own expansion to keep pace and maintain parity.
In other words, in return for all those clothes and consumer goods they export to the United States, China imports the Federal Reserve’s monetary policy.
The People’s Bank put their pedal to the monetary metal in 2008 to combat the post Lehman global downturn. Interest rates were slashed and borrowing rocketed, loan growth totalling 87 percent of GDP in the following five years.
American style monetary policy has had American style effects. As interest rates fell property looked a better place to stash you’re your wealth and a real estate boom got under way. According to the IMF the average ratio of house prices to earnings reached 20 in Beijing and 14 in Shanghai, “triple the levels in US cities during the subprime bubble”
With such returns available, and the funds readily accessible to fund it, construction boomed. The BBC reports that since the start of 2009 China has built 2.3 billion square metres of residential property space with another 3.2 billion in the pipeline. This is floor space for between 200 million and 250 million people but, according to the World Bank, even with China’s rapid urbanisation, it will take 15 years for 200 million Chinese to make the switch from rural to urban life.
The orgy of over construction is most starkly seen in newly built but deserted cities like Ordos City, built for 1 million but housing no more than 28,000.
In October 2010 the People’s Bank set out to do what no monetary authority has ever managed: engineer a soft landing from a credit boom. Interest rates rose and the property boom cooled. In November new home prices in Beijing fell by 35 percent from October.
But the problem with a credit boom is that it fosters malinvestments which will never generate a return sufficient to cover their funding costs if credit conditions are ever allowed to tighten (let alone reflect the economy’s underlying time preference).
So it is with China. An economy which had loaded itself with cheap debt on such a massive scale couldn’t cope with higher interest rates.
The People’s Bank thus finds itself caught in the same ratchet as many western economies. Interest rates decline and spur a boom. Inflation follows and interest rates rise but not to the previous levels. Even so, the boom turns to bust and interest rates are cut again leading to another boom…
As in Europe, Britain, and the United States, China might well find that its interest rates only move in one direction: downwards. Convergence wasn’t supposed to be like this.
The People’s Bank has reacted by lowering the official one-year borrowing rate and the one-year deposit rate by 0.25 percent each to 6.31 percent and 3.25 percent respectively. Industrial activity is picking up and prospects have brightened for now.
But how long before we are back where we were in October 2011 when pressure grew for China’s monetary authorities to tighten?
When China wakes the world will tremble said Napoleon. Let’s hope the same isn’t true when it nods off
This article originally appeared at The Commentator