Chinese recession is coming

For the last couple of years the talk has been of a Chinese ‘hard landing’, meaning growth dropping below the 6-8% we have witnessed the last few years. But that’s not in the cards, if you believe the Communist Party. The new 5-year plan recently unveiled, the 13th such plan, calls for 6.5% growth over the next half decade, increasingly relying on services, which is to grow from 50.5% to 56% of the economy. The economy is to transition from investment-led to consumption-led growth. The World Bank agrees that the whole thing sounds plausible and they have reasons to be confident: in blatant examples of reverse engineering, China has a tradition for delivering its growth targets. The December 15 GDP growth figures showed 6.8%, just above the new target. Convenient.

A World Bank economist obviously buys into the premise that you can dictate growth from a conference hall in Beijing. To an Austrian economist however, it sounds suspicious. In the Austrian theory of the business cycle, over-investment, which by definition cannot be in response to real consumer demand, eventually leads to recession. And China is over-investing! Big time! (Incidentally, in a paper from 2012, the IMF identified a 10% of GDP over-investment but now a few years later the World Bank seem to think that there are no consequences of continuous over-investment.) The investment rate has been running at around 50% of GDP for years. Empty shopping malls and skyscrapers are the most obvious examples. The flip side of this is obviously rising indebtedness. Government debt is low by international standards, at just over 41% – but total debt stands at over 280% of GDP, mainly corporate (household debt is just under 40%). And the debt is going bad. State banks have been forced to extend credit to countless zombie companies to keep them afloat. Officially, only 1.5% of bank lending has gone sour, but few believe this is true. Estimates are as high as above 20%.

Even if the economy succeeds in transitioning to a more consumption-based growth model, that will not rectify years of malinvestment. It is a classic case of a credit fuelled bubble amplified by state mis-direction of resources. There is only one way out.

China is heading for recession. How long can it be staved off? Well, if the People’s Bank of China engages in the same mad experiments that has become central bank orthodoxy elsewhere, maybe the music can continue playing for a while longer. The base rate is 4.35%, so there is room for accommodation, which has been forthcoming: rates have been cut from a high of 7.5% in 2008 and then 6% in 2014. With a “low” government debt/ GDP ratio, there may also be room for fiscal policy, providing another temporary boost whilst amplifying the problems. But the end result is inevitable, even the World Bank should be able to see that.

Posted March 29, 2016

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