Bigger can mean a harder fall for emerging global giant
To prevent adulation going to the head of a victorious general, a servant would stand behind him in his chariot as he paraded through the streets of ancient Rome and by whispering in his ear, remind him he was mortal.
In the same way, amid all the triumphalism surrounding Wednesday's news that China's gross domestic product has overhauled France's and very likely that of the United Kingdom, a new book reminds us that the mainland's economy is a lot more fragile than the official data depict.
And, as Charles Dumas and Diana Choyleva, the authors of The Bill From the China Shop*, point out, in the era of globalisation any cracks in the mainland's growth story threaten not just China's economy but the economic stability of the world.
The main culprit, according to Mr Dumas and Ms Choyleva, who are economists at the respected London-based outfit Lombard Street Research, is China's under-developed financial system. Although China's savings rate of 45 to 50 per cent of GDP means the mainland has plenty of money to fund its development, state control of the banking system means overly-cheap capital is misallocated to short-term projects in the manufacturing and property sectors.
The result, says Ms Choyleva, is a vicious boom and bust cycle. Inefficient investment leads to over-capacity in specific sectors which both depresses output prices and drives up input costs, especially for energy. The inevitable result is an economic slowdown.
This is already happening. Ms Choyleva dismisses the official 'real' or inflation-adjusted GDP figures as suspiciously smooth. Instead she points to the nominal data as more reliable. These indicate a sharp slowdown in quarterly growth rates from a peak of 18 per cent in mid-2004 to 11 per cent late last year (see chart).
Worse, if nominal growth is to maintain its long-term sustainable trend rate of 10 to 11 per cent, quarterly growth will have to fall as low as 4 to 5 per cent during the next two years, says Ms Choyleva.
That is not a recession but for China it certainly means a hard landing.
Ms Choyleva's argument is supported by China's trade figures. In 2004, at the height of the boom, exports and imports grew by roughly the same amount, around 36 per cent. Last year, however, while exports continued to power ahead, import growth crashed to 17.6 per cent, reflecting the slowdown in the domestic economy.
The result was a blow-out in China's trade surplus to US$102 billion and an accompanying rise in international trade friction, especially with the United States.
The tension is likely to come to a head either late this year or in 2007, warns Mr Dumas.
As US interest rates rise, America's debt-laden consumers will be forced to cut back their spending from 106-107 per cent of their incomes, to something closer to 100 per cent. The result will be a steep decline in US living standards, possibly leading to recession.
'In such situations people do not blame themselves and in this case the easy target will be China,' writes Mr Dumas.
Specifically, the targets will be China's trade surplus which he describes as 'a red rag to the US congressional bull' and its yuan policy, which 'looks like crude, muscle-bound mercantilism: a simple, zero-sum-game attempt to grab export market share by exchange rate manipulation'.
There are two possible outcomes. 'At best, the result will be a huge yuan revaluation,' writes Mr Dumas. 'In that case US exports would do well and adjustment could be quite rapid.'
At worst, there would be a sharp rise in protectionism as the US turns its back on globalisation and enters a long period of stagnation.
Either way, the authors say, 'a severe trans-Pacific crisis is forecast for 2007'.
Remember you are mortal.
The Bill From the China Shop, Profile Books, February 2006.