Last year there were concerns about a “hard landing” in China. Those fears have dissipated with 7.8 percent growth in the fourth quarter. Now there is widespread optimism that China’s growth will continue inexorably: the recent spike in iron ore prices (which had plunged when concerns about the Chinese economy were most acute) is a very visible sign of that.
But . . .
It appears that this rebound is the result of another dose of stimulants, notably an injection of credit. Which (a la Michael Jackson) gives less of a lift each time it is applied. Now it takes about 3 RMB of credit to generate a RMB of GDP growth. Moreover, this application of stimulus has deepened the investment-dependence of the Chinese economy, and delayed its transition to a more balanced, natural system. Furthermore, to the extent that the projects funded by this debt don’t generate sufficient returns, the borrowers will not be able to repay; this risks a solvency crisis, and of course, a liquidity crisis that can break out when lenders are solvent, but at elevated risk of becoming insolvent.
A few articles in the last few days suggest that the optimistic turn may be quite overdone, and that there are dangers lurking beneath the sea of debt. Chinese banks are rolling over local government debt that was used to fund stimulus spending. Chinese heavy manufacturing enterprises are becoming increasingly indebted, and are staying afloat with borrowing. The shadow banking system is growing and mutating.
The Chinese economy is still largely centrally planned. Not directly, but through subsidies and especially through subsidized credit. Admittedly, my priors are that centrally planned economies are doomed to difficulty, even though they can produce spurts of measured growth. With sufficient coercive powers, such governments can keep things going for quite a while. But there’s a point when they can’t. I wouldn’t be surprised if China is approaching that point. In other words, the further injection of credit may have just deferred the hard landing . . . and made it all the harder.