Is China’s Economy A Runaway Train?
By Martin Hutchinson
Share prices on the Shanghai Stock Exchange closed at record highs last week. The Hang Seng Index closed up 275.7 points, or 1.2% after reaching an all time high of 23,301.93. As a result Morgan Stanley has upgraded its forecast for China’s economic growth this year from 10.5% to 11.3%.Â
Chinese economic growth hit a staggering 11.9% in the first half of 2007, according to the National Bureau of Statistics, while inflation rose to 4.4%. That brought worldwide calls for the authorities to act to stem the “overheating” of the Chinese economy. However nobody has suggested a plausible method by which the Chinese authorities might do this.
Chinese growth has been accelerating for over three years now. The Shanghai stock market, quiescent for four years in 2001-05, took off around the end of 2005 and is now up about 300%, 130% since the end of 2006. The People’s Bank of China has raised interest rates several times, but only by around 0.25% each time (to be precise, normally by 0.27%, presumably for some arcane numerological reason). Saturday, it raised rates again, taking its one-year lending rate from 6.57% to 6.84%. The one-year Yuan deposit rate went from 3.06% to 3.33%. The Yuan has been allowed to appreciate, but only by about 8% against the dollar in the two years since it was first floated – and since the euro is up 15% in the last year, the Yuan has been weak in euro terms.Â
These moves have had no visible effect. Instead, the Chinese trade surplus has continued to increase and government reserves have accumulated, so that the Chinese government is now sitting on about $1.3 trillion of foreign exchange reserves, nearly six months’ output of the Chinese economy and nearly 2 years of imports.
Chinese consumption has grown rapidly, and Chinese investment even more rapidly – at an annual rate of 25.9% in the first half of 2007 – but nothing seems to stop the rapidly accelerating increase of wealth in Chinese state coffers. Thus, even though the Chinese authorities have taken several modest steps to cool the Chinese economy, it’s only getting hotter.
Western commentators are shrill about the need to stop the boom, threatening protectionist moves in Congress or by France, or the withdrawal of China’s privileges under its World Trade Organization membership, but it’s not clear that the Chinese people care. Suffering under real Communism for half a century, and with memories of chaos and civil war rather than economic progress before that, the Chinese people have no memory of an economic boom and rapidly improving living standards. The idea that this miracle should for some reason be aborted is slightly bizarre to them.
Thus, over a million new brokerage accounts are opened per month, and the Chinese passion for gambling expresses itself in ever more extravagant valuations on real estate and the limited float of the Shanghai and Shenzen stock exchanges. If Chinese savers wanted to put their money in a safe haven outside China they couldn’t legally do so anyway.
The Chinese authorities dare not take any actions draconian enough to stop the boom. Indeed, any development that actually threatens to end the boom is to them deeply unwelcome. For one thing, there are about $1 trillion of bad debts in the Chinese banking system that are being covered up by the accountants, and which are growing monthly as more money is lent to the bankrupt companies and hopeless projects that incurred the debts. Thankfully, Western investors in 2006-07 have poured over $100 billion of new capital into the Chinese banking system, which has delayed any day of reckoning. The Chinese authorities know that the bubble must some day burst, but from their point of view, the later the better.
Moreover, even if the Chinese government wanted to stop the boom, it’s not clear how it could do so. There is no proper domestic money market; so raising interest rates only affects the bookkeeping entries by which banks lend dud customers enough money to pay their interest charges. Taxes could be raised, but tax evasion is rife and would become even more so, counteracting any economic effect.
The exchange rate could be strengthened, but that would attract even more speculative capital into the country, raise Chinese workers’ living standards and spending, and probably crash the banking system. The last thing the Chinese government needs is to be seen by its people as having ended their newfound prosperity.
At this point, the express train of the Chinese economy is out of control and the brakes are inadequate. The Chinese authorities and investors in China will just have to wait until it hits something, and accept that the crash will be extremely unpleasant. Meanwhile, the longer the crash can be deferred, the longer everyone has to make money in the Chinese stock and real estate markets – and who knows, we might find a way to keep some of the profits!Â
