The overstated great fall of China

CHINA has issued its latest set of economic figures.

They reveal that in the first quarter of 2014, annual growth in GDP stood at 7.4% — down slightly from the 7.7% growth recorded in the preceding quarter.

What’s not to like? Many nations would chew off their right arms, so to speak, to be able to come up with such figures. But, can we trust the statistics? Many say that we cannot, and that the books have been cooked.

The markets, nevertheless, were reassured. Share prices rebounded on the news.

Investors have returned to fretting about the prospect of a sanctions war between the West and Russia. The China ‘bubble’ is not about to burst, blowing the global recovery right off course.

Well, not for now. As things stand, commentators appear to be split down the middle between sino optimists and sino pessimists.

The optimists consider that China, under its new leader, Xi Jinping, is beginning to redirect its economy away from one based on investment in heavy industry and construction and reliance in commodities such as copper, and towards consumption.

This should, in time, result in more opportunities in sectors from education to foreign travel to food.

Indeed, we are witnessing such openings already, with Irish food and drink exports to the ‘Middle Kingdom’ already on the rise.

The pessimists retort that the much-touted switch has barely begun and that the government in Beijing is riding a horse that it simply cannot control.

Investment bank JP Morgan has estimated the country’s ‘shadow’ or unofficial banking sector doubled in size to $6 trillion between 2010 and 2012 and by early 2013, amounted to around 70% of GDP.

The problem is that the central government cannot control the activities of the local economic overlords, many of whom have sponsored much wasteful investment driven by corruption.

Mr Xi may be less all-powerful than we like to assume.

Michael Schuman of Time.com insists: “The Chinese financial sector presents a threat to global financial stability ... What is happening, right now, is among the most important developments in the global economy. If China’s economy destabilises, shockwaves would be sent around the world that would dampen global growth and cost many people their jobs.”

A sharp decline in the Chinese currency, the yuan, or renminbi, would result in deflationary forces being unleashed, just at the point when policymakers are grappling with the threat of deflation in the eurozone.

Any rapid downturn in China would be rapidly transmitted across Asia and to commodity-exporting countries, with inevitable ratchet effects on the global economy. There could be political ramifications.

Since the Ukrainian crisis blew up, China has behaved with caution and responsibility, adopting a posture of non-alignment and refusing to provide the support of backing at the UN Security Council that Russian leader Vladimir Putin had been counting on.

Faced with a domestic economic crisis and an explosion in discontent among the population, the leadership might be tempted to go for easy wins in the China Sea against weaker neighbours.

India is about to elect as its ruling party the nationalistic BJP, adding to the caustic mix in the region.

So, how likely is it such a blowout could occur? Certainly, significant sums have been lent through the shadow banks towards dodgyreal estate investments.

Adair Turner, Britain’s former financial regulator, has expressed concern at the dramatic expansion in credit in China from around 120% to 200% of GDP. Speaking at a conference in Shenzhen, Mr Turner reminded his audience of the sad cases of Spain and Ireland. He pointed out that the Irish countryside is now populated by empty hotels, industrial parks and housing estates, some of which would have to be bulldozed.

Ireland experienced a similar expansion in credit between 2002 and 2007, as we all know only too well.

In China, following the credit crunch in 2008, the message went out from on high to state banks to “open your wallets wide” and the message went out to local government that it was to invest.

As a result, investment has surged to almost 50% of GDP. This is a “historically unique level of investment,” Mr Turner observed, surpassing the 40% level recorded in Japan and South Korea when they were in the early stages of their respective economic miracles.

South Korea, for example, managed to build global leader industries. Its capital was put to good use, in large part, although the country would become engulfed in the 1997-98 east Asian financial crisis.

The concern is that, in the case of China, much of the investment may have been frittered away on the equivalent of those empty Spanish airports and Irish ghost estates with which we have become familiar.

Those in charge of policy in Beijing must try and take the wind out of the sails of the investment boom, without provoking a collapse of firms exposed to heavy debts in the process.

According to Mr Turner, concerns about debt exposures in China may be overplayed, given that a significant proportion of the debt is owed by one state entity to another. He warns, however, that the longer the problem is allowed to persist, the greater the prospect of a spillover into the private sector and wider international economy.

He sums up the dilemma of the central government thus: “A higher interest rate would promote greater discipline when it comes to the use of credit, but given the accumulation of debt, it would also produce an increase in the debt service burden that, in turn, could precipitate a crisis.”

Some commentators are sceptical about the quality of data emerging from Beijing on the Chinese economy, believing that much of it is historic, concocted and tending towards overstating activity. Data on trade, shipping, or the use of particular inputs — such as steel — may be more reliable.

Economists such as UBS’s George Magnus suggest the economy has slowed more rapidly than is indicated by those sunny 7% growth stats.

However, he does not believe a crash is in prospect. In his view, the economy has matured and will grow much more slowly, after a spurt over the past two decades that has been almost without parallel. US academic Bill Janeway characterises China as a classic innovation-follower society which now faces the challenge of transitioning to a position where it is capable of “innovating at the frontier”.

Janeway questions those who believe that China will not be capable of being truly innovative unless it adopts a constitutional-liberal form of government.

He points to the example of late 19th century Germany, which developed a successful economic model complete with the development of a science and technology-based economy, despite being run along autocratic lines. In his view, the state could continue to play a leading role in the ongoing transition of the economy into one that is innovative and technologically sophisticated.

As Janeway also observes, speculative bubbles often occur in economies making the leap to a position of global leadership.

China’s momentum is such that it is unlikely its economy will go off the rails altogether, but it seems we can expect some juddering halts along the way.

Overseas traders and investors would be well advised to keep their safety belts on, and even consider going into the crouch position.