The end of the Chinese century

by Gordon G Chang

The end of the Chinese century

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This year, we will finally see the end of the “Chinese century.”

Most people still assume that the 21st century will belong to China, which is projected to soon become the world’s largest economy. The International Monetary Fund, for instance, believes China will take over the top spot from the US by 2016.

Yet the country’s fate seems to be shifting rapidly. Since the IMF made that bold-sounding prediction in April last year, the Chinese economy has stalled. It began to stumble in September, and by December the signs of flat-lining growth were unmistakable: stagnant car sales, declining electricity consumption, plunging industrial orders and slowing exports. Container throughput has been flat, and air cargo has plunged.

The deterioration has been as rapid as it was unexpected. In short, after 35 years of virtually uninterrupted growth, the wheels are coming off the Chinese economy.

Boom goes bust

It is not hard to see why. To avoid the worst effects of the 2008 global downturn, Beijing applied too much stimulus.

In 2009 alone, Chinese technocrats and their state-owned banks pumped about US$1.1 trillion into a US$4.3 trillion economy. The maneuver added to GDP, but it also triggered stock and property market bubbles and runaway inflation.

The stock market boom of 2009 began to unwind in 2010. Beijing avoided the worst effects of that, but it has yet to deal with the other dislocations.

Inflation, in all probability, is still running at twice the official rate. And while inflation is cooling fast, that decline indicates an economy in distress.

Meanwhile, property prices are collapsing – developers are offering double-digit discounts in many coastal cities. That trend could create a negative wealth effect, ravage bank balance sheets and decimate revenues of local governments.

Most analysts assume that Beijing’s technocrats merely need to “fine tune” the economy to restart growth. To add to the optimism, observers note the Chinese have already started making adjustments. In November, China’s central bank abandoned its tight-money policies by cutting the reserve requirement ratio for 20 cooperative banks by half a percentage point. The limited move was soon followed by half-point reductions in the ratio for both large and small banks. And just about every expert believes Beijing will continue turning on the tap.

But this time, China’s leaders face more severe challenges than they did in 2008. For one thing, they have increased the money supply about as much as they can. Consider this: at the end of November, China’s M2 was 34% larger than that of the US, even though the Chinese economy was less than half the size of America’s. China’s money supply ballooned in the last three years, and it is not clear that relatively small additions in the coming months will have much expansionary effect.

If monetary tools prove ineffective, Beijing’s only real option will be direct spending – what some call “tidal wave investing.” The biggest risk for the economy this year is that this stimulus spending fails.

First, China has already built its “ghost cities” and other unviable projects. Second, prior spending has burdened banks and local governments. In 2010, for instance, about 85% of Liaoning province’s 184 financing companies (de facto government agencies) defaulted on debt service payments. The world has already seen the Japanese try spending their way out of a bubble and debt crisis – and we know how well that worked out.

Third, China’s once-in-a-decade political transition, which formally begins in the fall and continues for perhaps two years, looks like it is already undermining efforts to revive the economy. In 2008, the central government acted quickly and decisively to forestall economic crisis. This time, however, political paralysis in Beijing means that officials can adopt only modest steps that seem inadequate in light of the evident severity of the downturn.

Finally, there is growing pessimism among Chinese people that Beijing can turn the economy around. Perhaps the worst sign is that the rich are illegally transferring funds out of the country. As a result, Beijing’s foreign reserves are now decreasing every day, according to some reports. The Chinese obviously sense that the end of their economic miracle is near.

Gordon G Chang is the author of “The Coming Collapse of China” and a columnist at Forbes.com