China's bloated economy needs a dose of reality
Hans Black and Olivia Gong urge leaders to deflate its asset bubble
Hans Black and Olivia Gong
While China's higher-than-expected July exports may fuel recovery hopes, it may be false optimism for a country that is finding itself in deep economic and social distress. To that, the Margaret Thatcher portrayed in the biopic The Iron Lady has something to say to the Chinese leadership: "Yes, the medicine is harsh, but the patient requires it in order to live."
China's bubbles may provoke a crisis in the near term, and Beijing may treat the patient with hard-to-swallow medicine in two ways. First, it could allow the bubbles to pop. Second, it could find a way to let the air out carefully, for a soft landing. Either option would be painful, but necessary.
Unsustainable surges in real estate prices and local debts, along with growing concerns over the shadow banking system and worrisome declines in both export and import figures, suggest there is trouble ahead.
Financial markets, and all those with vested interests in the economy, fear that there are worrying similarities to the bubble economy that triggered the US crisis in 2008.
Recent data shows evidence of a growing bubble, although expansion rates are slowing. As the economy slows, and other industries weaken, investors seek out property investments for reasonable returns. Average home prices in China's 70 major cities rose 6.8 per cent in June from a year earlier. Sixty-three of the 70 cities saw month-on-month increases in home prices, versus 65 cities in May.
Moreover, the true extent to the housing bubble remains unclear; China began withholding nationwide home price data in 2011.
In June, the National Bureau of Statistics also announced that China's gross domestic product growth in the second quarter had slowed to 7.5 per cent, compared to 7.7 per cent in the first quarter and 7.9 per cent in the final three months of 2012.
The past quarter marks the ninth quarter in the last 10 that expansion has weakened. In spite of all this, the leadership says the country is still on target to meet the full-year growth target of 7.5 per cent, which would be China's slowest pace in 23 years.
Despite the storm flags, Premier Li Keqiang continues to reassure the public that China can continue sustained and healthy social and economic development. The government's main explanation for weakening data, it seems, is that China cannot succeed without the success of other major economies.
Li Zuojun, an economist who consults with various local governments, said in a 2011 speech that politics might have played a role in delaying the potential crisis. China's policymakers went all out to maintain stability during the once-in-a-decade leadership change.
With the change now complete, the new government has two alternatives. The first is to protect the bubble - but it may burst of its own accord by 2015 or 2016. Thus the price of less pain now may be greater pain in the future.
The second option is to pop the bubble. This may be the wise choice for the leadership.
First, it could build from the ground up; new ideas are founded on solid ground, not frothy, effervescent foam. Second, the new leaders could blame previous regimes; saying they needed to correct the mistakes.
China faces unprecedented challenges. If new leaders' policies prove to be inadequate, social unrest could erupt. Economically, the international outlook is not on China's side. We cannot expect China, while the global economic climate is still gloomy, to grow as fast as it did during the golden days. Unfortunately, China cannot and will not be the world's saviour.
What happens next in China will largely depend on Beijing's ability to treat the ailing patient.
Hans Black is the chief investment officer for Interinvest, a global asset manager. Olivia Gong is a research analyst at Interinvest