The New Economic Model
China’s importance to the world cannot be undermined any more. According to Morgan Stanley’s recent report, China contributes to 34% of global growth as compared to 17% of the United States. These numbers were exactly the opposite before 2008, the year the world witnessed the last recession. These numbers only signify China’s impact and growing influence on the world economy.
The scintillating growth China witnessed, in the early 1990s and early 2000s, was primarily due to its increase in exports. From our economics class we all know export is not the only factor that adds to the GDP but also do consumption, investment and government spending. The Chinese government over the last 20 years has invested heavily across the real estate, energy, high tech (technology) and various other industries. “Ghost Cities” were built for a purpose. Not only will China’s urban population hit 1 billion over the next 15 years but it was also the right step in moving the rural population into a well-developed society. So the why did his fail? Is this an indication of a faulty plan or poor execution? Therein lies the crux.
To keep up with the growth post 2008, Beijing directed the local government to pump in more money into the economy through building public infrastructure and creating more jobs. This started the debt binge. This phenomena has risen to severe heights today. I just read an article by McKinsey who believe that the debt to GDP ratio may be as high as 346%. But as a matter of fact we know it hit 280% in 2014–2015 which is higher than all of the emerging markets.
China is no doubt more than capable of handling a pitfall. The government has been taking steps by implementing stringent laws but I feel this has come a little too late. The government is in the middle of tackling a shadow banking problem as well. The implication of trying to counter this by providing more loans through banks might create more problems- more avenues of loans which create more debt. The impact of the government demanding more details regarding the loans and debt holders can be seen with the decreasing rate of debt growth.
The debt binging model was never going to sustain. The most common steps the Chinese government can take to tackle these problems are reducing interest rates, rolling over the debt (as debt holders have also invested into government bonds), increasing taxes or reducing government spending. The latter would just not sit well with the government as they look to increase their GDP. The Chinese shift from an export led economic model to one that is more consumption oriented signifies the change in stance at the helm.
As an ardent (economist) and concerned person, the aforementioned facts scare me. Lack of forward guidance has brought about an end of many asset management funds and with them the countries too. Everest hedge fund earlier last year went bust when the Swiss national bank abruptly unpegged the Swiss franc against the Euro. Perhaps you could argue that asset management funds should be smarter as they can make a windfall when things look bright and lose everything when a wrong choice is made, i.e., the risk is inherent. But when a fund to the tune of 830$million dollar disappears it is bound to hamper the economy. If not, at least when a handful of funds disappear they will definitely have an impact on the economy like when the recession was triggered by a handful of investment banks in the United States.
The Recession in the United States was triggered by a combination of toxic assets and bad (subprime) loans. China may also suffer from the latter. Data out of the country does not indicate the quantity of debt being repaid back. The debt binge has grown at a much higher rate than that of the United States before 2008.
China’s attempt to promote themselves as a super power may force them to take many stressful steps. The yuan devaluation is one such step. To repay the loans this might seem as a solution. But a currency war hits everyone together. Given the drop in oil prices most countries lack the financial prowess it once possessed, but this is a debate for another time.
Fang Xinghai’s and Li Yuanchao’s, the Chinese securities regulator and vice president, meeting with Christine Lagarde only substantiated the importance of communication between China and rest of the world. China alone may not be able to sustain the hit, but collectively if countries work together, a host of the largest economies can fare “survive” this year. The Federal Reserve’s decision not to increase the interest rates indicates that the world is not ready for an increase in interest rates just yet. Speculation that the data out of China (as well other emerging markets) is distorted must be put to rest. Triggering the closure of “those big to fail” and accompanied with distress in most economies is the perfect recipe for disaster. The Chinese government has acknowledged that there is a communication gap and now I hope they will put the discussion to rest by taking the right steps, else we are headed for a very eventful year.
