Dee Woo first gained international attention by writing a personal letter to Barack Obama in October 2010, attempting to dissuade the US from initiating a trade war with China. As a result, he was featured in much of the Mainland Chinese media, as well as in Hong Kong, Singapore, Macao, Malaysia, Canada and the US, including by the Wall Street Journal. Now he is an Economics columnist for many prominent magazines and newspaper cross the east and west.
Dee Woo has very kindly sent his 'take' on the situation in China and given us permission to re-print his views which are encapsulated in the following article:
The Making of China's Epic Hard Landing
1. The unsavory episodes of China's economy
For the better part of 2011, my concern about Chinese economy was constantly aggravated by depressing stories of entrepreneurs who committed suicide, fled the country or emigrate to the western world in droves. Most media have blamed the credit crunch and monetary tightening for all of these unsavory episodes. The public outcry for the deteriorating conditions of Chinese entrepreneurship climaxed with the seemingly positive step taken by the PBOC(the People's Bank of China) on Dec 5 2011 to alleviate the liquidity crisis: reduction of the RRR (reserve requirement ratio) - 21 percent from a record high of 21.5 percent.
Right now the outlook for Chinese economy is looking rather confusing: should it continue the painful structural adjustment to prick the economic bubble built up by a decade-long obsession with excessive growth? Should it adopt the expansionary policy to reinvigorate the flagging economy? Either way China is approaching dangerously close to an epic hard landing.
2. It's not a liquidity crisis but a structural problem
For one, it's easy to lay blame on the tightening monetary policy. Nevertheless, nothing can be further from the truth. The main overseas markets for chinese goods - Europe and the US, are both battling a possible double recession, which greatly tightens their purse strings. To make matters worse, the cost push inflation, especially the wage inflation, is eating away the comparative advantage of China’s manufacturing industry. All this has nothing to do with the tight monetary policy but the transformative structural change of China's economy.
(The manufacturing sector is bleeding. The Purchasing Manager Index (PMI) has dropped to 49, lower than market expectation. This is the first time since Feb 2009 that PMI contracted. The orders are declining, especially overseas orders, and the stocks are piling up.)
In any case, the difficult access to credit for Chinese private small and medium businesses (SMBs), the driving force behind China’s manufacturing industry, has been a chronic problem long before monetary tightening. More than 70% of China’s banking market is controlled by the “Big Four”- Bank of China, theChina Construction Bank, the Industrial and Commercial Bank of China, and the Agricultural Bank of China. These state-owned commercial banks skew the monetary resource towards the state-owned enterprises or other privileged corporations. This resource misallocation of China's banking system provides the breeding ground for China’s huge and complicated shadow banking network, where most credit-starved private SMBs seek costly funding. The shadow banking system is hardly regulated and monitored, and is awash with cash that flees the negative real interest rate in the commercial banks. In April 2011, 467.8 billion yuan of residential deposits left the commercial banks. We all can guess where the money ended up. Money is chasing positive yields into the wild west of shadow banks.
Contrary to what many might like to assume, China is not even close to suffering a liquidity crisis. There is more than enough liquidity to go around. China’s M2 has surpassed that of the US or that of Japan, as China’s M2 is around US$ 11.55 trillion, exceeding the U.S.’s $ 8.98 trillion and Japan’s $ 9.63 trillion. Regardless of all the hype of tight monetary policy, n 2010i, Chinese banks issued 7.95 trillion yuan of loans, breaching the government's target ceiling of 7.5 trillion yuan. In 2011, the total new loan stood comfortably close to 7.5 trillion. As of October 2011, the outstanding balance of RMB deposits totaled 79.21 trillion yuan, whose year on year growth rate is 13.6%. The PBOC's rate hike only removed 4.75 trillion yuan from circulation. According to Fitch ratings, China's total social financing in 2011 might top 18 trillion yuan (US$2.8 trillion), a rise of 3.5 trillion yuan from the official target due to inflow of non-banking liquidity. Meanwhile, the PBOC claimed the total social financing of the first three quarters in 2011 as 9.8 trillion yuan, 1.26 trillion yuan less than that of the year before. The PBOC's data suggests an effective tightening monetary policy while the Fitch report implies the opposite. The PBOC proves to be an inadequate central bank to rein in the liquidity binge which Beijing has indulged in for far too long. Under such a gloomy context, China's credit expansion against all odds is still breathtaking.
(Over the past decade, China's M2 surges past the US's M2 by a wide margin from as low as nearly one-third of the US's.)
We obviously can't blame the tightening monetary policy for the sorry state of China's economy. We can't really be too optimistic on the loose monetary policy to turn around its fortune either.
3. The Undoing of Beijing Consensus
Monetary policy alone won't fix the structural deficiencies of China's economy. The well-being of China's economy is hugely leveraged on the consumption economies of the US and Europe. Both American and European economic turmoil together puts a massive strain on the demand for China's exports. The increasing substantial wealth gap in China has shackled the domestic demand so much that it fails to pick up the tab left over by the US and European markets. China is now saddled with a serious excess capacity problem, which forces down the marginal returns on the investment and makes investment more effective in incurring inflation and bubbles rather than propel GDP and employment ahead. This is a serious sign of over-investing and overheating. In 2010, China's export/GDP ratio was ~ 37% , and Investment/GDP ratio ~45.8%. According to David M. Kotz and Andong Zhu's research, China's export plus fixed investment contributed almost 70% of GDP growth since 1999 while domestic consumption contributed roughly 30%. Using the export/investment combo to power the economy ahead, is what has become known as the Beijing Consensus. It worked beautifully for the past decade when the world was prospering in globalization and free trade. However, now it appears that the good run is finished for good.
To overcome the current economic malaise, the US and Europe must check their deficit-fueled consumption economies into rehab. They must increase their chronic low saving rates, produce more and import less. That means the export-led growth engine for China's economy may be gone forever.
(According to Economist Intelligence Unit and US bureau of Economics Analysis, China will depend on an export-led economy late until 2030.)
4. The consumption-led economy is the only way out
The dire situation in the US and Europe calls for another round of quantitative easing (QE). With both Japan and UK firmly committed to QE and market conditions deteriorating, the embattled US and Europe will be more and more reduced to adopt monetary aggressiveness. In the end, we will see a global competition of currency devaluation. China will lock horns more frequently with the US, Europe and other export nations over currency issues, thus leading to potential trade tension flare-ups The only way out for China is transforming its economy into a consumption-led one. The other two options are: fight for overseas markets in vain and be prepared for trade wars. Or try to reignite the economy with more wasteful investment resulting in a probable colossal asset bubble and epic hard landing.
5. The outlook for China's inflation and economic bubble
Don’t be too optimistic about China's inflation prospects. Indeed, China's CPI tumbled to 4.2%, the lowest level since September 2010. Nevertheless, the battle against inflation is far from over. China is the world's biggest importer of food and commodities. With the global competition of loose monetary policies, the food and commodity inflation will be persistent, to say volatile the least. China will face the serious double threats of imported and cost-push inflation regardless of whatever monetary policy it adopts. That combined with negative real interest rates and diminishing marginal returns in industries will push more and more money into asset investment and speculation vehicles. Inflation will be lurking if these structural problems persist.
Overall, there are both internal structural and external global factors that would contribute to the making of an epic hard landing in China. China will be really vulnerable when the US and Europe both unleash the quantitative easing. These are things China has no control of. Nevertheless, the best China can do to avoid the worst is to continue the painful adjustments: marketize the “Big Four”-dominated banking industry to allow for more efficient monetary allocation; Continue transforming the labor intensive low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honor its promise of a consumption-led economy.
China's hard landing would be a tragedy not only to China but to the world. Without China's growth of consumption economy, the global economic recovery will be a prolonged and painful process. The icing on the cake for this article would be what I said in “The Boom And Bust Of China's Rise” - Hedge funds and the Fed’s QE2 are not all to blame for all of the current uncertainties. China's economy has already stood close to the edge. What speculators do is to push it over the edge and profit handsomely from the chaos.
While the US enjoys the luxury provided by the dollar’s world currency status and diplomatic alliances with many major trade partners to export its liquidity and inflation, China enjoys none of that. They should look at the dollars in their hands with fear and doubt. The so called Beijing Consensus makes little sense, because the world is fast changing, and pegging a country’s growth to a certain set of policy tools or a certain reserve currency (the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proven the only consensus is to adapt and change. Right now China needs to adapt and change fast. Or else, this will be the best time in history to short China.
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