Like the Federal Reserve, the Chinese government continues to pump in money, but the real problem is that both are facing “structural problems that counter-cyclical remedies cannot fix, so the private sector cannot find areas to make enough profit to justify its investment”
Over the past few years markets have been wild for any sort of economic stimulus that central banks and governments can dole out. The whole idea is that stimulus leads to economic growth. This may been true at one time have, but, at this point, investors may have placed too much faith in the capacity of central banks and governments to counteract economic weakness. The stimulus may in fact be counterproductive, because it is misleading, encouraging investors to take risks when those risks are not warranted. This problem is most acute in China, where the government has an institutional ability to mislead; a strong motive to do so and where the risk is greatest.
Economists and analysts have long been predicting that China would have a soft landing because the Chinese would stimulate to prevent a hard landing. The political background is especially reassuring to this thesis. Once every decade the Communist Party holds a Congress. The purpose of this gathering is to change leadership at all levels. In the past the new leaders, especially at local levels, have outdone themselves in spending money to grow the local economies. Most western commentators believe that this year will be no different. But times change and sadly the commentators did not ask the Chinese.
According to a commentary published by the official Xinhua News Agency, “a massive stimulus is not only unlikely, but would be detrimental to the country’s sustainable economic growth.” So another stimulus package like the Rmb 4 trillion ($632 billion) package issued in 2008 is not on the cards. One of the reasons is that like the most recent stimulus attempts by western central banks, it probably wouldn’t work. According to one highly respected Chinese economist quoted in the Financial Times: “I believe China is going to experience a very serious economic downturn and I think it has already started. The government is trying now to stabilize the economy but the instruments they have are very limited. If it can’t turn things around then I expect huge and widespread social unrest.”
In a way it is hard to blame the commentators. Like their western counterparts the Chinese have been falling all over themselves making pronouncements of vast projects involving untold billions. The central government has approved 25 urban rail projects, 13 highway construction projects, seven waterway projects, nine waste water treatment plants and plans for energy conservation and carbon emissions. The total cost would be Rmb 3.4 trillion ($537 billion), which is not far from the 2008 numbers. Not to be outdone the presumptive local leaders have advertised Rmb1.5 trillion ($236 billion) investments in large industries such as petrochemicals, automobiles, electronics and advanced equipment.
All of this sounds great, but there is one problem: no money. Approval of a specific project by the central government does not mean that the central government will pay for it. It means that the central government has approved a loan by a state-owned bank to a local government to pay for it. This process has been going for the past four years on a massive scale and unlike taxpayer-funded stimulus or new money from a central bank; loans eventually have to be paid back. This is a problem for local governments because their main sources of income have been dwindling.
Most of the local government revenues come from local land sales to developers, who then sell the houses. These sales have been restricted by the central government to cool prices, but the restrictions have also reduced the income of the local governments by about 25%. Local governments do collect taxes from local business, but these are not the huge state-owned businesses that are often in the news. Those businesses are owned and taxed by the central government. Often the local firms are smaller and involved in exports have been plummeting thanks to slow or negative growth in the global economy. So, local governments have between Rmb 11 trillion and Rmb 14.5 trillion worth of debt. With declining revenue, it is doubtful that many of these loans will be paid back.
Besides most market experts have assumed that the Chinese slowed their stimulus last year to control inflation. This is simply false. If you look at the graphs below it is obvious that Chinese have been issuing new bank loans at a relatively steady rate since 2010. If anything, the Chinese have been pumping out new money faster since the beginning of 2012. Despite all the cash the growth rate of the Chinese economy has steadily declined since the end of 2009.
So like the US Federal Reserve, the Chinese government continues to pump in money, but the real problem is that both countries are facing “structural problems that counter-cyclical remedies cannot fix, so the private sector cannot find areas to make enough profit to justify its investment.”
is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected]
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