A Chinese hard landing is about as likely as a comet destroying earth

THERE are two types of asset bubble: those which are easy to isolate and deal with, and those which pose significant systemic risk to an economy.

China, like many economies from time to time, has some bubbles of the first type. They also have the policy tools to deal with them, and the wherewithal to employ them.

They do not have systemic risk problems of the kind currently still faced in the deleveraging West.

The chance of a Chinese hard landing, while technically possible, is up there with being hit by a comet big enough to cause dinosaur extinction. It is as near to a fantasy as economic prediction gets, albeit a convenient fantasy for those wanting to hang onto the tenuous argument that the developed world is still safer than the emerging world.

For example, some balance sheet analysts worry about Chinese nonperforming loans. But if we re-name banks “social expenditure departments” and these banks are bailed out from central government, then there is no sudden stop, only a drain from central government – a quite affordable drain.

Likewise with the problem of local government debt to banks. The banks are being instructed to rollover loans, so – again – there is no sudden stop, just a cost which gets centralised.

Yes, a lot of investment is wasted, but that’s to be expected. A country with over 50% of gross domestic product invested is clearly wasteful if it only grows at 10% a year, not 20%. Such waste does not imply a looming crisis.

This is not to say that China does not face challenges. After Lehman Brothers collapsed, China faced two problems: a short-term problem of how to boost aggregate demand and replace lost export demand, and a longer-term one, identified long before Lehman, of moving from an export-model of growth to one more driven by domestic demand.

The first problem was met with a massive Keynesian fiscal stimulus. Though, unlike in the West, one that had a high multiplier, expected to generate future income in excess of the cost. At the same time banks were encouraged to lend new credit. Companies faced with this bonanza borrowed – many borrowing enough for several years’ worth of investment needs.

Later, when inflation needed dealing with, conventional monetary policy lost some of its effectiveness – raising interest rates or restricting credit does not prevent investment by companies with cash stashes. The answer is to let the currency appreciate, squeezing out inflation that way instead.

Raising the currency also incentivises companies to invest for domestic demand rather than for export capacity, which also conveniently fits China’s long-term goal – the country’s second challenge.

The yuan will have to appreciate about 30% against the US dollar over the next few years. This is despite China’s concern that companies might invest their cash stashes overseas in the short term – a concern which is the main reason for a slow opening of the capital account.

The reason for the 30% move is global imbalances, dating back to the creation of the current international monetary system at the Bretton Woods conference in 1944. Imbalances built up in the 1960s and the system crashed in 1971.

Imbalances have since recurred as emerging markets and commodity producers started building massive foreign exchange reserves after the Asian crisis in the late 1990s.

Just like in the 1960s, this cannot go on indefinitely and when change occurs, either gradually or suddenly, emerging currencies will appreciate. Also just like in 1971, the whole process will be driven by the decisions made by emerging market central banks.

The timing of this will largely depend on domestic inflation dynamics in emerging markets, especially China. As growth in those markets is robust, inflation pressure will return.

Fortunately, China has a long-term view and is a stabilising force in the global economy. The hope is that it will move the yuan up slowly. Other emerging central banks will follow.

Having very large foreign exchange reserves means that most large emerging central banks can move their exchange rates any time at will. This is entirely different to the more limited policy options facing those in the deleveraging developed world.

One should be much less worried about China and emerging markets than the crash zone of the European Union, United States and United Kingdom.

Jerome Booth is head of research at Ashmore Investment Management.