On Tuesday, the National Bureau of Statistics will release its estimate of China’s gross domestic product for the third quarter. Dow Jones’s MarketWatch reports that the consensus estimate is 9.2% growth. This means NBS, in all probability, will tell us that growth came in at 9.3%, maybe even 9.4%.
In any event, Tuesday’s official figure will show that the economy is slowing. Second-quarter growth was officially pegged at 9.5%, off from Q1’s 9.7%. This downward trend is generally seen as a positive sign, a signal that Beijing’s recent tightening efforts are working.
Chinese technocrats have been, in various ways, draining money from the economy to rein in inflation. On Friday, Beijing announced that the consumer price index rose 6.1% in September, down from the 6.2% increase in the previous month and a 6.5% jump in July.
So far, the official numbers point to a “soft landing” for the Chinese economy, which means growth around 8% and inflation about 5%. “China will not experience anything like the Asian financial crisis of 1997,” wrote Yiping Huang in the Wall Street Journal last week. Why not? The Barclays Capital economist points to the country’s “large” current account surplus, “gigantic” foreign exchange reserves, and its “undervalued” currency.
Huang assumes that Beijing can reverse course and pump money into the economy if needed. He asks this: “If conditions continue to deteriorate, does the government still have the resources to stimulate the economy and prevent a hard landing?”
Of course it does. Although its $3.2 trillion of foreign exchange reserves are of limited use in a local-currency crisis, Beijing can still print renminbi and take other steps to expand the money supply. But Huang asks the wrong question. The correct one is this: Can Beijing pump prime without aggravating existing economic problems?
Most analysts assume it can. Forbes contributor Kenneth Rapoza recently quoted Cong Li, chief investment officer in Hong Kong with Mirae Asset Global Investments, to the effect that Beijing still has the flexibility to reverse its tightening policies.
That conclusion is debatable for two principal reasons. First, if Beijing were to reverse its tightening policies, it would reignite inflation, which could be running twice the government’s numbers. The assumption in China-watching circles is that, as growth slows, inflation will cool as well. Growth has fallen precipitously in recent months and the economy may even be contracting, yet inflation has declined only marginally.
For instance, critically important food inflation—China’s poor spend almost half their disposable income on edibles—has remained high in recent months despite drastic government measures. It was 14.4% in June, 14.8% in July, and 13.4% in both August and September. Most forecasts indicate food prices will not decline much—if at all—through the end of the year.
Second, a loose policy would ultimately add to the woes of the state banks, which are already burdened by questionable loans after being forced to go on a multi-year lending spree to build the now-famous “ghost cities” and all the other unviable projects in the country. At the end of June, the People’s Bank of China said that the nonperforming loan ratio of China’s banks was about 1%, but nobody really believed that.
Investors, for one thing, were dubious. The stocks of Chinese banks fell this year and were trading at price-to-book ratios that assumed these institutions would suffer substantial losses on their loan portfolios. Beijing’s sovereign wealth fund had to launch a rescue last week by announcing open-market share purchases of Chinese banks.
The move triggered a short rally, but it did not solve the fundamental problem: Credit Suisse last week said that bad debt could be as much as 60% of bank equity. The 60% figure assumes that bad loans constitute only 12% of loan portfolios, but as in the bank crisis at the end of the 1990s, questionable assets are probably multiples of this figure.
The problem for Beijing is that this time, unlike the end of 2008, it has little flexibility to dump money in the economy to restart growth and save borrowers. It already did that and has, in addition to inflation, created historically high property prices, vacant apartment buildings, and debt-swollen local government financing vehicles. Yes, increasing liquidity would aid borrowers in the short-term, but that tactic would only make the debt bomb bigger.
Beijing could take foreign currency out of its reserves to recapitalize its largest banks—as it did in early 2004—but that just pushes the People’s Bank of China, the country’s central bank, deeper into insolvency. In any event, recapitalization would buy only a little time.
The Chinese central government has, in past crises, sustained the momentum of the economy by creating circular flows of cash, using money from one state institution to bail out other ones. Yet all artificial situations eventually end. State-dominated economies have more ability to postpone the inevitable, but the corrections they suffer are often worse as a result of continual deferrals.
Like 2008, the Chinese economy is now emitting strong signals it wants to correct. Last time, Beijing, flush with cash, chose to override the market and postpone the reckoning with its “tidal-wave” spending. Now, Chinese technocrats are almost out of options.
As a result, the downturn in China this time is probably the one history remembers.