Will China Avoid a Hard Landing?

The editors of the New York Times call China’s policy responses to a plummeting stock market and slowing economy “obsolete”:

The Chinese economy, the world’s second largest, is growing at nearly 7 percent a year — down from 10.6 percent in 2010 but still a healthy pace for a country at its stage of development. The problem is that the boom was fueled by lavish investment and spending as well as profligate borrowing, a lot of which will probably not be paid back. China’s central government orchestrated that binge by pumping billions of dollars into the economy in the aftermath of the 2008 global financial crisis and by failing to enact needed reforms that would make it easier for private and foreign companies to compete with inefficient state-owned enterprises.

Beginning last year, Chinese officials also used state-owned media to encourage individual investors to pour their savings and borrowed money into the stock market, leading to a massive bubble. When the market started to tumble over the summer, the government blamed rumormongers and speculators, and ordered securities firms and state-owned companies to keep buying, which simply disguised the underlying problems.

The lesson here is clear: Instead of trying to micromanage stock prices, Chinese officials ought to be strengthening the economy, foremost by shifting its emphasis from investment to consumer spending and services. This is important because China can no longer grow by taking people off the farm and putting them to work in factories. It needs to move people into white-collar jobs. To take one example, officials could help create more such jobs and make the economy more competitive by easing the way for private companies to get into industries like telecommunications and insurance that are currently dominated by a handful of state-owned corporations.

China also has to clean up its financial system. Many businesses and local governments have borrowed billions of dollars to build high-speed rail lines, real estate developments and other projects, many of which are not going to produce the returns needed to pay off those debts. The government should encourage lenders and borrowers to quickly restructure loans that paid for those projects so that banks are not crippled by bad debts and can continue making new loans. Officials also need to shut down highly inefficient state-owned businesses.

while the editors of the Wall Street Journal think they’re “in disarray”:

But monetary easing is complicated by capital flight. The U.S. Federal Reserve’s interest-rate rise last month has caused the dollar to strengthen, and aggressive PBOC easing could exacerbate capital outflows and put more pressure on the yuan. China’s reserves stand at $3.3 trillion, but it used $108 billion defending the yuan in December, the biggest monthly drop since 2003. In theory capital controls should limit money leaving, but China’s wealthy can bypass them.

Meanwhile the slowing economy has exposed the excesses of the post-2008 credit boom. In response to the global panic, Beijing deployed $586 billion in stimulus, largely on infrastructure. It also encouraged lending for housing construction and purchases, creating a bubble in smaller cities. The borrowing pushed China’s debt-to-GDP ratio above 240% from 160% in 2007. Star banking analyst Charlene Chu predicted last year that nonperforming loans will top 20% of total assets during this deleveraging cycle.

This looming bill explains why Beijing’s economic policy is in disarray. Some officials want more stimulus and industrial policy, while others realize that structural reform and less government intervention are key to sustainable growth. In recent months Mr. Xi has endorsed the latter point of view, but as the short-term pain intensifies he will be tempted to return to Keynesian pump-priming that would only postpone the day of reckoning.

I think the characterization I’d use is that they’re late. These are the steps they should have taken a decade ago:

• Divest state-owned enterprises
• Live up to the obligations they assumed when they joined the WTO, particularly with respect to their banking system.
• Stop subsidizing exports and limiting imports.

If they had started this process a decade ago, the SOEs would not have been as large as they are now, there wouldn’t have been so much air in the economy, their trading partners would have been stronger, and there wouldn’t have been nearly as far to fall.

But China’s leaders had conflicting objectives. They wanted to hold onto their own wealth and power, they wanted China to be more prosperous, and they wanted China’s economy to be the largest in the world. Their dilatory behavior has placed all of those at risk.