Why China Will Suffer a Hard Landing

Global economies are struggling.  Europe’s economy is stalling out.  The Japanese economy’s shrinking at an annualized rate of 7.1 percent.  But we won’t dwell on Europe or Japan at the moment.  For today we set our sights on a Chinese bull’s eye; namely, China’s miracle engine of growth that appears to finally be slowing down.

Naturally, when an economy slows many problems that had been covered up by new growth are exposed.  For example, after years and years of stimulating the Chinese economy with borrowed money, the mistakes and distortions have literally piled up as far as the eye can see.  There’s a gross overcapacity of property.

“According to Chinese data, cities have built enough for 97 million new city residents, but over the past 5 years, only 35 million people have moved into these cities, a gap of 62 million people.  These are the potential ghost cities.”

Typically a ghost city appears following a long period of economic prosperity.  Overtime the fundamentals that supported the prosperity change.  Population flight – like in Detroit where the population peaked out at 1.8 million in 1950 is now at just 688,000 – follows.

As an economy declines the services and entitlements made during better times are no longer affordable.  Investments made with an anticipated return don’t pan out.  Bankruptcies follow.

Chinese Delusions

However, in China’s case the cities were never prosperous to begin with.  The government provided cheap money and credit to development projects that never would’ve penciled out on their own merit.  Yet for the Chinese central planners, development was a matter of policy…even if the development didn’t make sound fundamental sense.

But not to worry says The Economist in what must be, without a doubt, an extended episode of delusion…

“China has a big debt problem.  But it is unlikely to cause a sudden crisis or blow up the world economy.  That is because China, unlike most other countries, controls its banks and has the means to bail them out.  Instead, the biggest risk is complacency: that China’s officials do too little to clean up the financial system, weighing down its economy for years with zombie firms and unpayable loans.

“Half of China’s debt is owed by companies, and most of that, in turn, is owed by state-owned enterprises and property developers.  As the economy slows and housing prices fall, many of these loans will prove unpayable.  Banks report that bad loans are just 1 percent of their assets and their auditors insist that the banks are not lying, but investors price banks’ shares as if the true level is closer to 10 percent.

“Even if a huge swathe of loans go bad, the consequence is unlikely to be a Lehman-style financial collapse.  For that, thank the Chinese regime’s vice-like grip on its financial system.  Most lending is by state-controlled banks, much of it to state-owned companies.  If it faced an economy-wide credit crunch, the government would (as it has in the past) simply order banks to lend more.  At the same time the country’s vast foreign-exchange reserves mean China need not worry about a sudden drying up of foreign capital, the main cause of many other emerging-economy crises.”

Why China Will Suffer a Hard Landing

No doubt, the above analysis from The Economist is short on a very important ingredient.  What we mean is it is short on thought.  In particular, it is short on clear thought.

For whatever reason the author is eager to point out that government intervention and forced bailouts are the solution to China’s problems.  That, somehow, papering over the bad debts makes them disappear.  This, of course, is nonsense.

Certainly the bills must come due.  There are 62 million ghost payments that are needed each month to cover the costs of China’s overcapacity.  Just because the government can prop up these failed loans doesn’t make it a good thing.

In fact, it further diverts capital away from productive uses into unproductive uses.  This has the effect of subtracting economic growth.  What’s more, it stretches out the inevitable day of reckoning into a long drawn out era of underperformance.

Chinese officials may have another rabbit up their sleeve.  Somehow they’ve encouraged a level of growth and industrialization at a scope and scale the world has never seen.  Perhaps China is already the world’s largest economy, even larger than the United States.

But that doesn’t mean China doesn’t have a hard landing coming their way…even if Chinese Premier Li Keqiang says they won’t.  From experience we know that when a country’s leading man says something won’t happen it most assuredly does.  This, in a nutshell, is why China will suffer a hard landing.


MN Gordon
for Economic Prism

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