Chinese economic slump on the horizon?

Is a Chinese economic slump on the horizon?

By Robert J.
Samuelson, Published:
January 8

Even China? Could the world’s economic juggernaut, having grown an average of
10 percent annually for three decades, face a slowdown or what for China would
be a recession? Does it have a real estate “bubble” about to “pop”? What would
be the global consequences? Treasury Secretary Timothy Geithner visits China and
Japan this week. These questions form a backdrop. With Europe’s slump and America’s
sluggish economy, a sizable Chinese slowdown would be bad
news.

China inspires ambivalence. Its policies — especially its undervalued
exchange rate — are skewed to give it an advantage on world markets. This has
cost jobs in the United States, Europe and developing countries. Still, China is
now such a powerful economic force that an abrupt slowdown would ripple beyond
its borders. Trade would suffer. China’s protectionism might intensify to offset
job loss. If surpluses of steel and other commodities were dumped on world
markets, prices and production elsewhere would fall.

There are warning signs. Economist Nicholas Lardy of the Peterson Institute
cites three. First, Europe’s slump has weakened China’s trade; Europe buys about
a fifth of its exports. Second, housing is showing signs of a bubble and is
deflating. Finally, China’s government will have a harder time deploying a
stimulus than during the 2008-09 financial crisis. Government debt rose from 26
percent of gross domestic product in 2007 to 43 percent of GDP in 2010.

How all this affects China’s growth is controversial. “Most likely, China
will have a soft landing,” says Justin
Yifu Lin, the World Bank’s chief economist. “Growth goes to 8 percent or 8.5
percent.” That’s down from about 9 percent in 2011. Government debt is still low
enough to permit ample stimulus, Lin thinks. Many forecasts agree.

But skepticism is mounting. The Japanese securities firm Nomura
sees a one-in-three possibility of a “hard landing” — a drop in growth to 5
percent or less. To Americans, now experiencing annual economic growth around 2
percent, this may seem fabulous. But for China’s modernizing economy and huge
labor force, a 5 percent growth rate would raise unemployment and social
discontent. The adverse GDP swing would roughly equal the U.S. decline in the
2007-09 recession.

Housing may settle who’s right. China has vastly overinvested in housing,
argues Lardy in a new book (“Sustaining
China’s Economic Growth After the Global Financial Crisis”). The main
reason, he says, is that financial policies prevent savers from realizing
adequate returns on their money. The stock market is seen as rigged. Government
regulations keep interest rates on bank deposits — the main outlet for savings —
low. From 2004 to 2010, they were less than inflation. Frustrated savers invest
in housing, where prices are not regulated.

The result seems a classic speculative bubble. People buy because they
believe prices will go up; and prices go up because people buy. A 2010 survey
found that 18 percent of Beijing households owned two or more properties;
another 2010 survey of all cities found that 40 percent of purchases were for
investment. Many units, Lardy reports, are vacant because rents in Beijing,
Shanghai and other major cities are low.

Unfortunately, booms breed busts. Buyers ultimately recognize that rising
prices reflect artificial demand. Purchases slow. Prices fall. New building
declines. The process feeds on itself. With modest imbalances, the result is a
correction. Otherwise, there’s a crash.

Which does China face? A popped real estate bubble could exert a big drag.
Housing construction exceeds 10 percent of GDP. That’s historically high, says
Lardy. At a similar stage of economic development, Taiwan’s housing investment
was 4.3 percent of GDP. In the recent U.S. real estate boom, housing peaked at 6
percent of GDP. In China, housing stimulates much consumer spending (furniture,
appliances) and accounts for 40 percent of steel production, notes Lardy. Land
sales are also a big revenue source for local governments. All would suffer from
a housing bust.

There are mitigating factors. Outside Beijing and Shanghai, it’s unclear that
housing prices are “out of line with household income growth,” says economist
Eswar Prasad of Cornell University. Chinese buyers also typically make large
cash payments for their properties. Compared to United States, a housing bust is
less likely to become a banking crisis as mortgages sour.

Whatever happens, China’s economic model is reaching its limits, as Lardy
argues. It has relied on exports, promoted through the controlled exchange rate,
and investment, including housing, subsidized by cheap credit. Meanwhile,
Chinese savers have been punished by the low returns on deposits. This dampens
their incomes and consumption spending. The trouble is that the global slowdown
threatens exports and housing’s excesses threaten investment. Unless China can
switch to stronger consumption spending, its economy will slow — or it will
achieve growth by becoming even more predatory toward other countries.