That is a Problem
HONG KONG (MarketWatch) — China’s era of rapid economic growth is drawing to a close, with a great moderation now inevitable, according to economist and author Richard Duncan.
“I don’t think [China] will be able to achieve their current rates of growth in the next five years,” Duncan told MarketWatch in a telephone interview from Bangkok.
Among reasons for the changes, he said, Beijing won’t be able crank up credit growth further without inflicting self-damage, nor is its export-led growth model viable as the taps tighten on worldwide easy money.
Duncan believes it’s only government life-support in the form of deficit spending that’s kept the global economy from falling into a depression since the 2008 credit crisis, and if the slowdown spreads as he expects, China won’t have an easy time shielding its economy from a slump in consumer demand.
“The whole story of the global economy is that there’s too much supply of everything and insufficient global demand,” said Duncan.
China managed to avoid a recession thanks largely to rapid credit growth, as its state-controlled banks expanded their loan books by 60% over a 24-month period.
Meanwhile, millions of Chinese factory workers who were laid off during the crisis were eventually hired back as global trade slowly normalized.
Duncan isn’t so sure that China can look to rapid credit growth this time if there’s a another serious slowdown, or that global trade will recover without a protectionist backlash, as economies such as the U.S. and Europe suffer high unemployment.
China “will be singled out by the U.S. and forced to stop growing its trade surplus ... and that will be the death blow to China’s era of rapid economic growth,” Duncan said.
Huge trade surpluses with the U.S. were among factors in China’s bubble-like economic growth over the past decade, Duncan said.
According to Duncan, China’s banking system is just beginning to grapple with the aftereffects of its previous round of easy credit.
“It’s like guy who drank a gallon of Red Bull,” he said, describing a post-credit-binge hangover now settling over the economy. “It [China] has the choice of letting the credit wear off and being extremely sick, or drinking two gallons.”
Much of the credit pumped into the economy was channeled into building empty skyscrapers or other non-productive assets now getting “heavier and heavier” in terms of problem loans within the banking system, Duncan said.
In fact, the toxic-loan problems could just be emerging. Reuters reported last month that the central government would take responsibility for $463 billion of loans extended to local-government financing vehicles for infrastructure projects.
If true, Societe Generale says the bailout would amount to 1.5 times the size the U.S government’s Troubled Asset Relief Program (TARP) plan to rescue banks in 2008, if adjusted for the smaller size of China’s economy.
“It is more than likely that China has one-and-a-half times the 2008 crisis ahead of it,” said SocGen strategist Dylan Grice.
Meanwhile, recent gains in wages won’t translate into higher domestic demand as some economists had hoped, said Duncan, who believes the higher salaries are part of an overall inflationary trend triggered by the surge in bank lending, and are set to fall back as the stimulus wears off.
“I don’t really see anything that makes me optimistic,” Duncan said.
He said that factory wages could fall dramatically as they did when nearly 20 million migrant workers were laid off as production lines shuttered during the crisis.
There’s no question the U.S. economy will slow once the Federal Reserve winds down its daily bond-buying program on June 30, Duncan said.
Asset prices will come under further pressure, with equity and commodities poised for more declines, eventually taking bond prices down too, as liquidity conditions tighten, he said.
Gold prices should outperform other assets classes, helped by currency debasement worries as it becomes clearer that more quantitative easing is needed, Duncan said.
As a result, he believes the Fed may be unveil a third round of quantitative easing, likely in the fourth quarter, in an effort to turn the coming slowdown into more of soft patch.
In his 2009 book “The Corruption of Capitalism,” Duncan forecast the U.S. would run large annual deficits in an effort to prop up its economy in the wake of the housing bubble, much as Japan has done since its credit bubble popped in the late 1980s.
Some economists think China too may see to drink that second gallon of Red Bull to keep its economy from suffering.
China’s central bank will expand credit by 8 trillion yuan to 8.5 trillion yuan ($1.23 trillion to $1.31 trillion) this year, up from its earlier loan-growth target of 7 trillion yuan to 7.5 trillion yuan, according to Standard Chartered forecasts released last week.
The credit will help boost growth to around 9% to 10% next year, the bank said.
“The worse the news out of the U.S. is, the quicker and more meaningful the loosening will be,” wrote Standard Chartered’s Economist Stephen Green in Shanghai in a note.
Chris Oliver is MarketWatch's Asia bureau chief, based in Hong Kong.