Beware Beijing’s Bursting Bubble
HERB Stein famously said that if something cannot go on forever it will stop. If ever that were true, it has to be in the context of China’s unsustainable economic-development model. With data released Wednesday showing clear signs that model is rapidly running out of steam, the rest of the world should brace itself for a deflationary shock from the Middle Kingdom.
Anyone doubting that China has pursued an unsustainable growth model need only look at its property and credit market bubble. Over the past decade, credit to Chinese households and nonfinancial corporations grew by almost 100% of its gross domestic product. That’s a faster credit growth rate than that preceding Japan’s lost economic decade in the 1990s — and that preceding the 2008 bursting of the US subprime credit and housing market bubbles that caused the Great Recession.
Much of China’s credit surge went to finance a housing market bubble of epic proportions. China’s property sector has increased to almost 30% of its economy, Harvard’s Kenneth Rogoff finds.
This share is more than 50% larger than that in most other countries, including the United States. House prices in relation to income in major Chinese cities, meanwhile, are higher than in London and New York.
An even more worrisome indication is the massive amount China has directed at investment. Whereas the rest of the world devotes around 25% of its output to investment, China devotes more than 40%, per the World
Bank. With domestic consumption so low, China is heavily reliant on global ex- port markets to absorb the output generated by its outsized investment.
There can be no gainsaying that, unbalanced as it might have been, China’s growth model propelled it to become the world’s second-largest economy and the main engine of global economic growth. It also allowed China to lift around 800 million people out of poverty.
But it’s run out of steam, as underlined by the recent marked slowing in economic growth. It’s far from clear what might replace this spent model.
The starkest sign China’s economicgrowth party is over is the bursting of its property and credit market bubble. With an estimated 65 million vacant housing units, housing demand has slumped, major property developers like Evergrande have defaulted on their loans, and home prices have been declining steadily over the past year. Those declines have been particularly challenging for the many Chinese households that used housing as an investment vehicle and banked on housing prices continuing to increase forever.
Also troubling is China’s unhealthy combination of high debt and falling prices. Chinese debt’s rise to close to three times the size of its economy has prompted Moody’s to downgrade Beijing’s credit rating. Meanwhile, both consumer and producer prices are falling as consumers become more wary about the country’s growth prospects. That raises the specter of China succumbing to a debt-deflation spiral as falling prices increase the debt burden in real terms.
In the past, the Chinese government has either spent or exported its way out of economic trouble. Alas, both those escape routes are no longer readily available.
The government’s room for fiscal maneuver is seriously constrained by its need to prop up local governments whose finances have been decimated by falling land-sale revenues. At the same time, a struggling world economy is in no position to absorb yet more Chinese exports.
All this has real implications for Federal Reserve policy. Less import demand from China and falling Chinese export prices heightens the chances that the Fed has been overly aggressive in raising interest rates to contain domestic inflation.
We have to hope the Fed is closely monitoring China’s unfolding deflationary developments and avoids the mistake of engaging in monetary-policy overkill at a time when the US economy is exposed to a deflationary Chinese economic wave.