International | Jun 29 2006
By Greg Peel
China’s GDP growth is running at 10%. Industrial output was up 17.9% in the year ended May. Exports increased by 25.1% in the same period, domestic retail sales jumped 14.2% and the Chinese money supply has exploded by 19.1%.
China’s economy is out of control.
The problem is, as noted by Gary D. Halbert of InvestorsInsight, that with economic and monetary growth China is facing an inflationary spiral at some point. This is somewhat ironic, as it has been China’s influence that has largely fuelled global inflation on the one hand (demand for resources) while keeping a dampener on it on the other (cheap exports).
This is the problem that Halbert outlines: Chinese banks have been lending openly in order to support the great Chinese economic dream. Their motives have been as much political as commercial. However, whereas the Chinese banking system was already burdened with non-performing loans, mostly to state-run organisations under the old communist ethic, a lot of more recent loans have also become non-performing. An awful lot.
The reason is simple. There has been a mad capacity rush in China. Every man and his dog has frenetically jumped on the industrialisation bandwagon and opened factories, smelters, manufacturing plants of all denominations, all in order to join in the miracle that has been the Chinese economic growth explosion. And Chinese banks have been falling over themselves to lend money.
With an enormous weight of household savings behind them, the strategy did not seem misplaced. The result was overcapacity. In order to survive in an oversupplied market, Chinese producers have been forced to lower prices in order to compete. Why has it taken the inflationary effect of oil prices and other commodity prices so long to flow through to the rest of the world? Because on the other side of the equation the prices of goods were coming down fast.
The prices of finished goods have now met, or in some cases fallen below, cost. Some Chinese manufacturers continue to sell goods at below cost for the simple reason of maintaining their interest payments on loans. Banks have been lending more money to troubled producers in order to keep them afloat.
While the Peoples’ Bank of China has acted by inching up rates it has not been enough to quell activity. And the PBoC can’t simply let companies go under. If it does, the banks will go under too. This cannot continue forever. To make matters worse, the government has attempted to address global imbalance by encouraging domestic consumption. Well it’s worked, as the aforementioned retail sales figure suggests.
The problem is, if the Chinese are spending they’re not saving, and if they’re not saving then bank deposits are being reduced. With more loans being shifted to the non-performing ledger, the banks are being hit from both sides. When Ernst & Young put out a report recently warning of the bad loan problem, the Chinese authorities were apoplectic.
When similar reports followed from Price Waterhouse, McKinsey Global Institute and Fitch Ratings, there wasn’t much the Chinese could do to respond.
Halbert believes the recent spate of reports suggest a turning point has been reached. Halbert also points out that the global press has been very slow to pick up on the story. The effects have not yet been felt in the stock market. The perception is that China’s economy is booming and so it must be okay.
The Bank of China’s IPO has seen its shares soar. But the US economy was enormous before the Great Depression, notes Halbert, as was the Japanese economy prior to entering a decade of stagnation. South East Asia was roaring along just before 1997.
Chinese authorities are in a difficult position. Attempts to cool the economy more stringently than to date (and to date hasn’t worked obviously) risks forcing a hard landing. Failure to achieve any form of cooling risks a total implosion. Such an implosion would reverberate across the West.
