Chancellor: China’s economic miracle is coming to an end
LONDON, Nov. 11 (Reuters Breakingviews) – Chinese President Xi Jinping understands the economic challenges his country faces better than most investors. In recent years, the lifelong leader has warned of the dangers posed by the housing bubble, excessive debt levels, widespread corruption and rising inequality. These problems are not unique to the People’s Republic. In the past, all of the countries in the region that have adopted the so-called Asian development model have faced similar problems. Xi’s dilemma is that there is no easy way for China to overcome them.
The Asian development model has several characteristics in common: state-controlled banks provide cheap loans to favored industries; the currency is kept at an undervalued level in order to boost exports; domestic consumption is suppressed to create savings for investment; and rapid modernization is achieved by adopting foreign technologies. Since World War II, this policy mix has proven remarkably effective in narrowing the development gap between Asia and the West.
But growth in Asia is inherently volatile. Artificially low interest rates fuel real estate bubbles, as in Japan in the late 1980s and Thailand in the following decade. Easy money also leads to the accumulation of excessive debt, as happened in Southeast Asia in the early 1990s. Cheap capital encourages unnecessary investments that undermine productivity growth. The policy of suppressing domestic consumption creates an unbalanced economy. In addition, opportunities for corruption abound when credit is distributed through public banks, as Indonesia experienced under the kleptocratic regime of Suharto.
Japan’s long period of economic expansion came to an end when the Bank of Japan decided at the end of 1989 to burst the housing bubble. The Asian “Tigers” – as the fast growing economies were called – rose off the cliff a few years later. As economist Paul Krugman demonstrated at the time, the economic â€œmiracleâ€ could only be sustained with ever-increasing inflows of capital and labor. When foreign creditors started withdrawing their capital in the mid-1990s, the region experienced a financial crisis.
Now consider the current situation in China. Since the Communist Party adopted economic reform in the late 1970s, it has pursued what Michael Pettis of Peking University calls the â€œAsian development model on steroidsâ€. China’s savings and investment have reached higher levels, and consumption has fallen to a level lower than any other Asian economy. The People’s Republic has swallowed up debt, which has grown by around 100 percentage points (relative to GDP) since the global financial crisis. The value of Chinese real estate was matched only that of Japan in 1989. While the land of the Emperor’s Palace in Tokyo at the height of the bubble was worth more than all of Canadian real estate, China would have enough vacant properties to house all of Canada. population of 38 million and over.
No wonder President Xi laments that property is for a living rather than for speculation and that the country’s â€œunbalanced and inadequate developmentâ€ has not improved the quality of life for many Chinese nationals. He now calls for “common prosperity” which involves a reduction in inequalities. At the same time, the president wants to reduce excess capacity, reduce debt and make housing more affordable. All of this must be achieved while “promoting smooth economic growth” and avoiding a “black swan”, or financial crisis.
To appreciate the challenges China faces, think about what happened to its neighbors when their economies abruptly changed direction. After the Japanese real estate market fell in 1990, residential properties became more affordable. But the crisis produced two banking crises and persistent deflation that weighed on the economy for decades. It is true that Japan increased its share of consumption during these years, but it happened at a time when economic growth itself was at a standstill. Beijing understands Japan’s lost decade well enough not to want to repeat this experience.
When the Asian Tigers ran into trouble in the mid-90s, they were forced to take a different path. After the emergence of problems in Thailand, foreign creditors rushed to exits. The contagion is spreading from country to country, including countries like Taiwan and South Korea which boast of current surpluses and foreign exchange reserves. It was not a time of “soft economic growth” but of collapsed currencies, widespread bankruptcy, bailouts from the International Monetary Fund and, in Indonesia’s case, civil discord that brought Suharto and his cronies down. Malaysia has introduced capital controls to trap foreign speculators.
The Asian crisis had at least a silver lining. Countries that have experienced severe currency devaluations have become much more competitive. In 1999, South Korea’s economy grew by more than 10%. Investment strategist Russell Napier, who has witnessed these events firsthand and describes them in his new book, â€œThe Asian Financial Crisis,â€ believes China will follow the Tigers. Currently, the yuan is loosely pegged to the US dollar, giving the Federal Reserve inordinate influence over China’s monetary policy. This is all the more problematic given that the Fed is expected to increase the cost of money next year, while China, with its deflating housing bubble, must relax. The abandonment of monetary parity, according to Napier, would restore monetary independence to Beijing.
If China devalues â€‹â€‹the yuan, then its economy should experience an export-led growth spurt. Whether this is tolerated is another matter. China is already the world’s largest exporter. In his book, Napier describes the acquiescence of Western governments to the manipulation of Asian foreign currencies, which boosted the region’s exports after 1997 at the cost of millions of manufacturing jobs in the United States and Europe, as “the one of the biggest political mistakes in history â€. . This error will not recur. If Xi opts for devaluation, he will face a setback from the United States and its allies.
Never underestimate Beijing’s ability to come up with policies that move the Chinese economy forward. But with household and corporate debt at higher levels than in the United States on the eve of the subprime mortgage crisis and the bursting of the largest real estate bubble in history, Xi appears to have little to do with it. options. After four glorious decades, China’s economic miracle finally seems to be coming to an end.
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Editing by Rob Cox and Oliver Taslic
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