Is China the Biggest Risk to the World Economy?
November 17, 2009
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There was an interesting article published in The Telegraph today. It argues that, for a variety of reasons, China has actually become the greatest risk to the world’s financial system
"Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next.
Pivot Asset Management said lending has touched 140pc of GDP, "well beyond" levels that have led to crises in the past. With the revolution's 60th birthday out of the way, the central bank has begun to tighten. New yuan loans halved in October. So be careful. Pivot said a hard-landing in China could prove as traumatic for world markets as the US sub-prime crash.
The world economy is still skating on thin ice. The West is sated with debt, the East with plant. The crisis has been contained (or masked) by zero rates and a fiscal blast, trashing sovereign balance sheets. But the core problem remains. The Anglo-sphere and Club Med are tightening belts, yet Asia is not adding enough demand to compensate. It is adding supply"
Not exactly original thoughts here, commentators have long been questioning the run-up in the Chinese stock markets, and whether the surge in bank lending has led to other bubbles in its economy.
Yet, I question what effect these actions will really have on a global scale. For example, the author brings up fixed investment being up 53% year-over-year, but his cited examples don’t exactly stand out to me as reasons for panic. Sure, they’re instances of misallocated resources, as any government pumping massive amounts of capital into an economy would be prone to. However, misusing accrued surplus capital on stimulus programs that needn’t be paid back by local governments shouldn’t have large external impacts. Further, analysis shows that most of the fixed investment China spent on its stimulus package was used on relatively effective infrastructure building.
What scares me more is the actual bank lending which will need to be paid back. For example, check out the chart on this Financial Times Blog Post which gives a nice graphical representation of the massive surge in bank lending. Combine this with the fact that more than 70 percent of real estate investment in China comes from bank loans, and there's a strong case that this massive flow of bank lending has given an artificial boost to property levels.
The kicker in all this is that local governments in China are dependent on the property market for their tax revenues. As stated by Statfor:
“According to estimates by the State Council’s Development and Research Center, tax revenue from the land in some jurisdictions accounts for 40 percent of local budget. Moreover, net income from land sales accounts for more than 60 percent of local governments’ extra-budgetary revenue. The soft budget and lack of accountability to the people reinforces the local government’s incentive to expand their real estate investments without much concern for the cost or impact on public services.”
What we have is a situation where massive inflows of capital propped up real estate values to unsustainable levels, but the government will now be incentivized to keep prices elevated, lest some of its regional governments lose their major main form of taxation.
To me, that either spells trouble ahead shortly, or a persistent bubble that could grow out of control before popping – with even more dangerous effects.
Any thoughts from the community?
- Eric Bleeker (TMFRhino)
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