The editors of the Wall Street Journal, observing the fall of China’s stock markets and the attendant decline in stocks elsewhere in Asia, in Europe, and, yesterday, in the United States, recognize that China has a problem:
hose advantages have also created new vulnerabilities, however. Since capital controls kept domestic savings from seeking better returns abroad, the government was able to harness savings to keep interest rates artificially low. That created higher levels of investment, about 50% of GDP, and faster growth than the world has seen in a major economy.
This growth and a highly motivated workforce also attracted global capital. In order to keep these inflows from forcing up the value of the yuan and creating inflation, the People’s Bank of China bought foreign currency with yuan, and then removed those yuan from circulation. It did so by issuing bonds or raising the level of reserves banks are required to keep, a process known as sterilization.
The result was a Goldilocks economy that for much of the 2000s grew quickly without overheating. The sterilized inflows drove the deepening of the financial system and expansion of the money supply. That underpinned loans for investment as well as speculation, especially in real estate. And the pressure on the yuan to appreciate created a virtuous cycle of more capital inflows.
This investment boom on steroids started to unravel during the 2008 crisis, after which Beijing extended it with financial stimulus and then a stock market bubble. But as confidence in rapid growth has ebbed, capital flows have reversed and begun moving out, turning a virtuous cycle into a vicious one.
but I doubt they have apprehended the scope of the problems. Too much of China’s “internal demand” has been directed towards building airports in which no planes land, roads to nowhere, cities without populations, and idle factories whose capacity not only exceeds China’s needs but the world’s needs. IMO what China’s economic slowdown and its stock market crash reveal is that China has reached the end of the road on the approach they have taken towards growth over the period of the last 35 years or, said another way, they know no other way.
The end of that road will have implications not only for the Brazils and Australias of the world that have supplied the raw materials for China’s capital malinvestment but for Germany which has supplied its factories and industrial tools. Look for Germany’s economy, powered too long by China’s industrial build-up, to decline as well.
So do the tea leaves read that where China’s economy drifts, so drifts the world economy?
China has been propping it up the last few years, as the US had done for a long time. But no one wants to fix their own problems.
I don’t think so. I think that the better conclusion would be that those who have banked on China’s buoying the world economy should probably recalculate.
I don’t think so. I think that the better conclusion would be that those who have banked on China’s buoying the world economy should probably recalculate.
Psychology (and huge fucking pumps from central banks) are what’s been holding things together for the finance guys. China has been the talisman for good psychology, and thus is central to propping up the world economy.
If that fails I don’t expect them to recalculate, I just expect them to look for a different talisman – and to demand more from the central banks, of course. As you said, we’re already hearing calls for that.
More interestingly, what happens to China if their internal route becomes complete? Does this current regime has what it takes to hold things together? And what happens if the Chinese political situation collapses? I’ve got no answers, and neither does anyone else. But it’ll be fun! Peter Turchin’s prediction of 2020 being the point of maximum instability looks more optimistic every day!
Also? Buy the fucking dip.