China: The Next Big Crash
Gordon G. Chang is the author of The Coming Collapse of China (2001) and Nuclear Showdown: North Korea Takes On the World (2006).
New York—Has the global economy recovered? Forecasters say there will be an uptick this year of 2.4 percent, but they’re forgetting something. China could fail soon, and, if it does, the world’s most populous state will drag the rest of us down.
At this moment, a Chinese crisis seems like the last thing we should be worried about. After all, last year China overtook America as the planet’s largest car market and passed Germany as the biggest exporter. Beijing recently announced that growth for the fourth quarter of 2009 was 10.7 percent and 8.7 percent for the entire year. Some analysts said the numbers were so strong that the country zoomed past Japan to become the world’s second-largest economy. Stock markets, property prices, you name it: Everything Chinese is soaring.
Dubai was once soaring, too. Global markets, therefore, shuddered in November on the news that Dubai World, Dubai’s state investment firm and biggest corporate debtor, had asked for an extension on its $59 billion of obligations. Troubles in the booming emirate had been evident for some time, but stock investors were nonetheless caught unaware, apparently thinking a default would not occur.
They were obviously wrong. Global markets, for the time being, got past the shock, in part because the emirate is small. China, on the other hand, is not. Legendary short-seller James Chanos, who predicted the failures of Enron and Tyco, calls the country “Dubai times 1,000—or worse.”
Like Dubai at the beginning of last year, China is now reaching the peak of a bubble. At first glance, there is not much that connects the tiny city state with the continent-sized nation. Yet both of them suffer from over-expansion.
China’s export-led economic model delivered spectacular growth in the post-Cold War period of seemingly never-ending globalization and economic development. Yet global trade is now stagnant after dropping significantly last year. As a result of troubles abroad, Chinese exports declined 16 percent in 2009. There is little prospect for a sustained recovery this year.
Beijing, ignoring advice from Washington and other capitals, did not, in the boom times, try to restructure its economy to favor consumption. Instead, the Chinese government sought to take maximum advantage of then-surging foreign demand. The role of consumption, therefore, declined, falling from an historical average of 60 percent of the economy to about 30 percent last year. No country has a lower rate.
To make up for slumping demand abroad and sluggish consumer spending at home, the State Council, the central government’s cabinet, announced a stimulus plan in November, 2008. Beijing originally said it would spend $586 billion through 2010. In the first full year of the program, however, it has, directly and through state banks, disbursed about $1.1 trillion in stimulus.
The plan, not surprisingly, is creating gross domestic product, but growth is an artificial “sugar high.” For one thing, Beijing’s stimulus spending last year was around a quarter of the total economy. Now, perhaps as much as 95 percent of China’s growth is attributable to state investment, as a Chinese analyst noted recently.
Despite the massive state spending, the country’s economy is not particularly robust. Power consumption statistics, a crucial indicator of economic activity, show the economy expanding at only two-thirds the announced rate. Moreover, essentially flat consumer prices last year belie official reports of roaring retail sales. So does the full-year 11.2 percent decline in imports, another sign of sluggish domestic demand. And if the economy is really growing by double digits, why is Beijing insisting on continuing its stimulus?
Yet however fast the economy is growing, China’s policies are unsustainable. First, the central government will be hard pressed to find the money to continue the spending spree. Budget deficits are going up fast, a constraint on additional expenditures. More important, Beijing’s regulators are concerned that the state banks, the primary source of stimulus funds, are overextending themselves and accumulating bad loans.
New York Times columnist Thomas Friedman, however, thinks none of this will be a problem. Arguing that China is not the next Enron, he gives this advice to Chanos: “Never short a country with $2 trillion in foreign currency reserves.”
Yet Beijing’s record-setting reserves—now $2.4 trillion—are essentially unusable for this purpose. Why? China’s leaders need local currency, the renminbi, to deal with domestic needs. If they convert reserves into renminbi, they will cause the currency to zoom up in value and choke off the critical export sector. Foreign reserves have only limited uses in domestic crises.
Second, the state’s stimulus plan is taking the nation in the wrong direction. It is favoring large state enterprises over small- and medium-sized private firms, and state financial institutions are diverting credit to state-sponsored infrastructure. Over the last three decades, China’s economy has expanded at an average annual rate of 9.9 percent because of the private sector, but now Beijing is renationalizing the economy with state cash.
Third, Beijing’s flooding state enterprises with government cash will undermine their competitiveness, as a similar tide of money severely damaged Japan’s corporations during the bubble years. Japanese managers discovered they could make more money managing cash than from anything else, and they therefore neglected their underlying businesses. Essentially the same thing is happening in China. About a fifth of state bank loans have found their way into the country’s climbing stock markets, and another large portion is fueling property market bubbles. Worst of all, Macau casinos have enjoyed a recent boom, apparently attracting high-rolling Chinese cadres betting diverted stimulus money.
Finally, stimulus spending, as time goes on, becomes less effective in creating growth. The country already has one empty new city—Ordos in Inner Mongolia—and thousands of vacant facilities, especially shopping malls. New factories are underutilized.
For all its faults, the State Council’s spending program is just about the only thing generating growth at this moment. Unfortunately for the government, its plan is also creating imbalances and dislocations that will be difficult to handle this year.
Chinese officials, working in a state-led economy, once had the ability to defer problems. Yet the challenges they face have grown over time as they have pursued pro-growth policies instead of implementing structural change. And that is why, when their growth policies run out of steam—as they soon will—China will become the next Dubai. Only bigger.