February 8, 2011
Somewhere in China, an economist lost his job today… it was the poor guy who had been predicting manageable levels of inflation despite rapid headline GDP growth and even more rapid monetary expansion.
Yet, staring at reports which show inflation at a 28-month high, officials at the People’s Bank of China realized that they need to do something about inflation. Now. Especially in light of what’s going on in the world… hence today’s 25 basis point rate hike.
Inflation in China is coming from all sides. Certainly there is the country’s speedy economic growth, commonly reported in the press as ‘overheating’. Then there is the constant battle against America’s #1 export (inflation) as many of Bernanke’s trillions of new dollars have found their way into China’s economy.
Moreover, what a lot of people forget is that China has heavily engaged in its own stimulus programs, which, as a percentage of GDP, dwarf the stimulus packages in most developed countries (including the United States).
Given these genuine inflation fears and the brakes that Chinese policymakers are applying in terms of interest rates and property taxes, it is now almost a “consensus view” in the financial markets that China will face an economic crisis sometime in the next few years.
A recent survey of market participants published by Bloomberg indicated that 45% of those surveyed believe it’s inevitable that China’s boom will turn to bust sometime in the next 5 years. Another 40% said they expect it to happen sometime after 2016.
The arguments for why China’s economy is a train-wreck waiting to happen are not new. Prominent short-sellers such as Jim Chanos cite forests of empty apartment towers, deserted shopping malls with no stores or customers, and the empty city of Ordos as proof that China has massively overbuilt.
They argue that the economy is built on a foundation of quicksand, as construction accounts for the biggest single slice of GDP, and at some stage there simply won’t be a need to build anymore.
I can’t disagree. At some point, perhaps in the not-too-distant future, building in China will slow, and subsequent rate hikes will curtail new expansion.
The way I view it, China has compressed 100 years of economic growth into 30 or 40 years, so naturally the annual growth rate has been fast. One thing that history has taught us, though, is that the free market cannot be continually outperformed by a central planning authority that inflates its money supply.
Rapid credit expansions can definitely give the appearance of strong economic growth, but no credit expansion has ever lasted permanently. In the long run, an economy can only continue to move forward at strong growth rates via increases in savings, productivity, technology, and innovation.
China’s technology sector is advancing rapidly– the country has developed the world’s fastest supercomputer and churns out three times as many engineers as the United States. China’s manufacturing sector has also shifted away from unskilled production to high tech manufacturing based on homegrown designs.
Knowledge is cumulative, however, so it will still take some time for China to be the genesis of the next generation of technological breakthroughs… and hence justify its huge growth rates based on innovation and technological advances.
For now, we can continue to marvel at the rapid pace of economic development in China. But, let’s not make the same mistake people made with Japan in the 1980s and assume that the Chinese have stumbled across some superior economic perpetual motion machine.
The truth is, nobody knows what China’s real growth rate is. I remember spending time in the country’s gray markets– huge roadside, makeshift shopping malls with tens of thousands of people engaging in off-the-books transactions– thinking to myself ‘no way GDP numbers account for this…’
The fundamentals for growth are definitely there… but we would be foolish to not consider the disastrous effects of a cleverly disguised credit bubble masquerading as ‘the Chinese miracle’, or the consequences of an unsustainable exchange rate policy.
Nothing goes up or down in a straight line, and in the words of one of my most influential mentors, “All booms bust. The only question is ‘When?'”
The reality is, nobody knows when… and more importantly, what happens next.