Streetwise Professor

February 5, 2013

Hard Landing-Deferred and Made Harder Still?

Filed under: China,Commodities,Economics,Financial Crisis II,Politics — The Professor @ 10:01 pm

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.

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  1. My priors are that ALL economies are doomed to difficulty and mal-investment. Human behavior. Centrally planned economies like Japan (and soon china) however never recover from their difficulty… and highly regulated economies like the current USA limp along with a modest recovery.

    The degree of central planning affects the recovery from a crisis (on the backend), but typically do not hasten a financial crisis or meltdown. Crises are endogenous, and Euroland is perfect example. Things move so slowly on the continent, and nobody has the appetite or intellect to even consider making a risky choice. Yet, the credit crisis from Lehman was imported, and their financial institutions (centrally planned in Brussels) are crumbling under their inability to adjust.

    China is unlikely to sow the seeds of its own destruction, but an endogenous crisis will arrive someday/somehow and I fully agree that the economy will face a crash-landing. Due to centrally planning it will be unable to adjust to mal-investment, and the rent-seekers will advance at the expense of productivity-seekers. The chinese pols will protect their own bank accounts, and the numerous chinese companies that supply the world with excellent goods will suffer.

    Comment by scott — February 6, 2013 @ 2:36 pm

  2. Scott agreed but with the added twist.

    By and large this is an aborted version of Lenin’s NEP

    The Commanding heights however are basket cases.

    It is administered by an already corrupt or corruptible administration

    The NEPNIKS now have influence undreamed of in 1921 Russia.

    The issue as you pointed out is how the crisis will arise, and the bigger question is how the people will react.

    This Brings to mind an old joke about Brezhnev. After attaining power he took his old Babushka around to show her his new Dacha. She nodded but said nothing. He then flew her on a jet to a Black Sea resort that was emptied for his personal use. Still she didn’t say anything. Finally, in frustration he took her to the Kremlin, where he had his car collection brought to the main courtyard, which was filled with ½ a division of Guards who, when Brezhnev and his Grandmother appeared, all cried out” Long live Brezhnev, hero of the Soviet Union!!!”.

    When this still didn’t get a reaction, B turned and said” Aren’t you impressed with what I have
    accomplished? Why are you silent?

    To which she replied: “Well, it is all very nice, Leonid, but what happens if the Reds come back?”

    Comment by Sotos — February 6, 2013 @ 3:03 pm

  3. How will the upcoming Chinese economic crisis effect the US economy? What financial instruments can we, private investors, buy to hedge against this upcoming crisis?

    Comment by Vlad R — February 8, 2013 @ 8:56 pm

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