Many have been looking for China to be the engine that pulls the world economy out of its doldrums. And, economic data of late seems to be pointing in that direction. We have had China pulling ahead of the US as the world's largest market for new cars, the Shanghai stock market is up over 75% this year and most remarkably China has shown economic growth of 8% despite reports of 30 million left unemployed by the drop in foreign orders to local factories.
So what is wrong with this picture? Plenty.
I have found the most interesting source of information on China to be the blog of Michael Pettis. He works in China, and seems to have very good connections there (and in China connections are a BIG thing).
So it was with interest that I read his latest post, especially the part I will reproduce below which comes from a friend of his that has just visited the city of Guiyang (a city of 1.65 million, with close to another 2 million in the surrounding countryside). It is one of the scariest economic observations that I have read for some time.(In the excerpt below, NPL stands for non-performing loans).
I don’t know how much you travel around China. Tom and I do a fair bit, and most recently we were in Guiyang. I thought I’d seen insane excess in the past – 200 thousand square meter malls completely empty next to apartment complexes with 40 thousand units and 30% occupancy rates, etc. etc. But what we saw over there is rather hard to fathom. It seems the Guiyang city mayor had the same idea as the Shenzhen mayor – to move the old downtown to a piece of undeveloped land.
Of course Guiyang has a quarter the population and probably a quarter the per capita income of Shenzhen. They built sprawling new government buildings about a 20-minute drive north of town. And then the residential high rise projects started going up. From driving around the area, Tom and I figured well over 100 20+ storey buildings.
What was most distressing was that the development has been totally uncoordinated – a project with 15 buildings here, in another field two miles away a project with one building, another mile in another direction three buildings, sprawled over what was easily over 30 square kms. of farmland well north of town. Every building we got close enough to see was either incomplete/under construction, or empty. Our tone gradually went from "Haha, another one!" to "Oh my God, another one." We conservatively guesstimated that we saw US$10bn of NPLs in one afternoon. The only buildings that were occupied were six-storey towers built to accommodate the peasants who had been displaced by the construction.
So you have, in just one city, well over 100, 20 story buildings, unoccupied! Yikes.
Why does this matter? Because understanding this helps answer the China growth riddle.
Here is a brief recap of what looks to have happened in China. Faced with a sharp drop in factory demand (and lots of unemployed) the government started a massive stimulus program that consisted of public works and a flood of new loans at low interest rates. With no need for loans to build more factories the newly loaned money had to go somewhere. It looks to have gone into the stock market, real estate, and likely new cars as well.
Chinese consumers, traditionally big savers, have been hit with very low deposit rates, and so have looked for alternative places to put their money. A major destination has been real estate (something solid that they can own).
So you have developers receiving a flood of new loans (from government banks), consumers looking to make money on their savings, and a government hell bent on generating economic growth. Result - PROPERTY BOOM.
Of course having 1000's of unoccupied poorly built apartment blocks is not the greatest outcome, it has produced economic growth and kept the legions of migrant construction workers busy and employed., Unfortunately it has also set up a real estate and banking disaster in the making. It is quite likely that Chinese banks are sitting on substantial current or future non-performing loans (loans that the borrower is not paying interest on). This is like the US S&L crisis or the current real estate mess.
Of course the comparison with the US is missing one key point. In China the banks are often government run and can therefore in theory "put up with" non-performing loans for a lot longer than private banks. But that does not solve the problem as Pettis points out.
This is a long way of saying what I have often argued – that what we should expect in China is not a financial collapse but rather a long period – maybe even a decade – of much slower growth rates than we have become used to. There are many reasons to expect a short, brutal collapse followed eventually by a healthy rebound, but government control of the banking system eliminates a lot of the inversion that in another country would force a rapid adjustment. This is not a note of optimism, by the way. As the case of Japan might suggest, the long, slow adjustment may be socially and politically more acceptable but it may also be economically more costly.
So will China be the economic engine that pulls the world out of its funk? I sure looks like it has a few obstacles in its way. The point is also made that as long as China is diverting savings into real estate, it is unable to build a more balanced economy.
China needs to increase domestic consumption for stable internally driven growth. You can’t increase domestic consumption if you’re buying real estate. So this is yet one other way that this whole liquidity injection is preventing a transition to a consumption-based economy. You really do wonder how long the Chinese will keep up this level of "pump priming".
Finally, to bring this back to US terms, an interesting article on Bloomberg yesterday noted that a chunk of the so called "increase" in the US savings rate has actually come from foreclosures (as mortgages get wiped out, debt gets reduced, making it look like savings increased)
The rise in savings so far is largely a product of mortgages being extinguished by home foreclosures, government tax cuts and transfer payments under the stimulus package, he said.
The moral of the story ... just because the headline data says one thing, don't assume that that is the whole story. The devil IS in the details.