THERE has been a fair amount of anxiety over the state of the Chinese economy of late. News of unexpectedly large debt burdens among Chinese local governments generated a wave of concern that recent Chinese growth has been entirely unsustainable. As the government was forced to turn off the credit tap, some supposed, property prices would fall and a hard landing would result.
That seems an unlikely scenario to me. Chinese debt burdens are manageable and its property market dynamics are quite different from those that prevailed in western bubbles markets prior to the crash. That doesn’t mean that all is entirely well in China, however. Many observers have taken some comfort in the latest GDP report from China. Output rose 9.5% year-on-year in the second quarter. That constitutes a moderate slowdown from growth in the previous quarter, and was a little above expectations. It would seem that the government’s efforts to slow credit growth have not precipitated an uncontrollably rapid downturn in activity.
Other economic data is a little more disconcerting, however. China’s trade surplus surged in June. Its exports to America have been growing and its imports falling. At the same time, Chinese inflation continues to rise; the latest reading is 6.4%. And accumulation of foreign-exchange reserves persisted in the second quarter, to the tune of $153 billion. Meanwhile, a closer look at the GDP report indicated that the contribution of fixed-asset investment to growth tumbled in June, with industrial activity offsetting the fall. Retail sales of consumer goods have held at a constant growth level for most of the year.
What does this tell us? China’s leaders recognise the need to rein in the country’s building boom, but they are likely concerned about the prospects for other sectors that might provide a cushion against a falling growth contribution from construction. One hope was that a boom in affordable-housing construction might offset declines in market-rate property development, but the affordable-housing effort continues to run into delays.
The long-run hope is that household consumption begins to pick up and drive economic growth. But as the GDP data indicate, China is struggling to mobilise its consumers. That therefore leaves the industrial export channel to pick up the slack, and that, seemingly, is what’s occuring.
Too much emphasis is placed on the yuan’s peg to the dollar, but the relationship tells a useful story here. China allowed the yuan to begin appreciating against the dollar last June, but after a first tick upward it leveled off and even declined against the dollar through last summer. Why? China appeared to be troubled by the slowdown in global economic activity. In the fall, when the data turned positive again, the yuan embarked once more on a steady appreciation.
But the yuan has once again leveled off in recent months. And this pause in appreciation is particularly curious given the problems China is having with inflation, which are being exacerbated by the reserve accumulation that accompanies its currency management. In short, now would seem to be a very good time to allow the yuan to rise a bit more. But the yuan isn’t rising. I think that’s because China sees little choice but to use exports to offset the impact of falling fixed-asset investment.
The rub is this: an artificially cheap yuan is one of the ways China suppresses household purchasing power and consumer spending. Its support for exporters is discouraging households that might otherwise be flexing their muscles and leading a rise in domestic-demand growth.
Couldn’t China just let the currency rise and count on households to provide the growth that exporters no longer can? A new paper by Barry Eichengreen and Andrew Rose suggests it’s not that simple. They assemble a sample of countries that left pegged currencies with the expectation that appreciation would follow, and they find that in most cases economic disaster does not result. But:
[I]t is possible to pinpoint the kind of circumstances where the decision to move to greater flexibility is likely to be followed by a significant economic slowdown. The slowdown‐prone economies are those with exceptionally low consumption rates and high investment rates. They are economies where exports and domestic credit have been growing most rapidly. To put it simply, they are economies with Chinese characteristics.
China needs a way to rebalance its economy without undergoing a big slowdown, of the sort that might lead to political instability (highly undesirable as a power handover looms). Until now, China managed to take steps in this direction by revving up fixed-asset investment, but it now finds itself forced to pull back on that front. Seemingly short of ideas, it has since returned to the model of big surpluses and reserve accumulation.
It’s going to end at some point. Maybe not with an economic crash. Amid a growth slowdown, however, the political system could prove somewhat more brittle.