I've been an optimist on China. But I‘m starting to worry

[shan]

FT NEWS

On the surface, China appears to be leading the world from recession to recovery. After coming to a virtual standstill in late 2008, at least as measured quarter-to-quarter, economic growth accelerated sharply in spring 2009.

A back-of-the envelope calculation suggests China may have accounted for as much as 2 percentage points of annualised growth in inflation-adjusted world output in the second quarter of 2009. With contractions moderating elsewhere, China's rebound may have been enough in and of itself to allow global gross domestic product to eke out a small positive gain for the first time since last summer.

That's the good news. The bad news is that China's recent growth spurt comes at a steep price. Fearful that its recent economic short- fall would deepen, Chinese policymakers have opted for quantity over quality in setting macro-strategy, the centrepiece of which is an enormous surge in infrastructure spending funded by a burst of bank lending.

Sure, developing nations always need more infrastructure. But China has taken this to extremes. Infrastructure expenditure (including Sichuan earthquake reconstruction) accounts for fully 72 per cent of China's recently enacted Rmb4,000bn ($585bn) stimulus. The government urged the banks to step up and fund the package. And they did. In the first six months of 2009, bank loans totalled Rmb7,400bn – three times the pace in the first half of 2008 and the strongest six-month lending surge on record.

This outsized bank-directed investment stimulus leaves little doubt as to how bad it was in China in late 2008 and early 2009. An unprecedented external demand shock, stemming from rare synchronous recessions in the developed world, devastated the export-led Chinese growth machine. That triggered sackings of more than 20m migrant workers in export-intensive Guangdong province. Long fixated on social stability, Beijing moved to arrest this deterioration. The government was determined to do whatever it took to restore rapid growth.

Yet there can be no avoiding the destabilising consequences of these actions. Surging investment accounted for an unprecedented 88 per cent of Chinese GDP growth in the first half of 2009 – double the average contribution of 43 per cent over the past decade. At the same time, the quality of Chinese bank lending most assuredly suffered from the rash of credit disbursements in the first half of this year – a trend that could sow the seeds for a new wave of non-performing bank loans. Just this week, Chinese regulators told banks that new loans must be used to bolster the real economy and not for speculation in equities and real estate.

A little over two years ago, premier Wen Jiabao warned of a Chinese economy that was becoming increasingly “unstable, unbalanced, uncoordinated and ultimately unsustainable”. Prescient words. Yet rather than act on those concerns by implementing a pro-consumption rebalancing, growth-hungry China was seduced by the boom in global trade and upped the ante on its most unbalanced sectors. By 2007, investment and exports accounted for about 80 per cent of Chinese GDP. And now, in the face of a severe global recession, China has compounded the very problems the premier warned of: aiming a massive liquidity-driven stimulus at its most unbalanced sector.

This is not a sustainable outcome for any economy – or sustainable support for the world economy. China must redirect economic growth towards internal private consumption. This may require a compromise on the quantity dimension of its growth outcome. But to the extent that leads to improved quality in the Chinese economy, a short-term growth sacrifice is well worth the effort.

Unlike most, I have been a steadfast optimist on China. Yet I am starting to worry. A macro strategy that exacerbates worrying imbalances is ultimately a recipe for failure. In many respects, that's what the global crisis and recession of 2008-09 are all about. China will not get special dispensation from the most critical lesson of this post-crisis era.

The writer is chairman of Morgan Stanley Asia and author of ‘The Next Asia' (Wiley), due out in September

[Polly]

"The writer is chairman of Morgan Stanley Asia"

Ha *scoff, scorn, snicker*

Lately I have been contemplating this story, tell me if it is tenable.

A big American and 5 small Asians find themselves stranded on a remote island.  To survive they all do what they can, some cut firewood and kindle a fire, some collect fruits and water, some fish, some build a small shed. 

And they manage to survive.  Life becomes easier.

But over time the Asians discover that the America stops helping with anything, and spends his day lazing around, consuming most of everything. 

The Asians also reckon that without the consumption of the big fat American, the 5 of them have more fish, more fruits, more water and more space amongst themselves.

So a plan is made to cut the American out. 

Is this theory tenable?

[The Smoking Man]

Maybe you should listen to the professor of economics from Beijing University then who stated on CCTV 9 last week that he wishes the Chinese government would back off because they have created a bubble that has warehouses filled with stock.

When the crash finally does fade, the Chinese recovery will be slower because they have warehouses of stock they must unload before they need to actually produce anything more.

You have not weathered the storm.

You have merely slowed the progress and ensured a delayed recovery due to overproduction in lean times.

[Polly]

  I am glad you mentioned this very popular view and gave me a chance to rebut it.

The USA has been printing money.  As a result of not wanting the RMB to appreciate in value thereby thwarting export and employment, the Chinese government has no other way but to step on the printing press as well, in the hope that the resultant inflationary pressure will not be as strong as in the USA as idle production capacity in China will be activated by the abundance of liquidity.

It's going to be tricky for China but if everything goes like the theory, and barring other political intervention, the USA should go kaput (much) earlier than China does. 

What we see from the stock market and the property market is testimony of this abundance of liquidity, they are like two giant tanks holding huge amount of water.  In time IPOs and new property developments will spring up to take advantage of the excessive liquidity.  More raw accumulation of capital will take place, many will come out of the game losing their savings, a few will become richer etc etc etc.

It will be a cruel game but the only thing the government can do is to keep the game orderly and fair.

[The Smoking Man]

Helps when you are actually reading what is written.

The government is subsidizing industry and they are warehousing stock that has not been ordered.

Got it yet?

[Polly]

If China does not print RMB as fast as the USA prints USD, the RMB will appreciate, making export even more difficult and causing massive unemployment and possible social turbulence.

I understand it's not ideal, but the game plan is to have the USA kaput before China does, as painlessly to all as possible.

[The Smoking Man]

"The game plan?!"

Polly... you have some serious problems.