China's capitalist crisis threats world economy

January 22, 2016
The abandoned 'eco city' of Jing Jin in Tianjin in north-eastern China.

In 1978, Deng Xiaoping, who Mao Tse Tung called a “capitalist roader”, initiated an economic reform program labelled “market socialism.”

Within two decades, China had managed to transition from a closed communist state to an open centre of dynamic capitalism with the greatest economic growth rates in human history.

After the onset of the Global Financial Crisis (GFC) in 2008, China immediately injected $US586 billion into its economy in classical Keynesian counter-cyclical stimulus spending. The next year, it began the largest fixed investment stimulus program the world has ever seen.

Globally, fixed investment (physical assets) contributed no more than 25% of GDP growth in the 1990s. By 2009, fixed investment was responsible for 90% of GDP growth.


If there is a single statistic that conveys the enormity of this infrastructure program, it is cement production. Between 2011 and 2014, China used more cement than the US did in the entire 20th century — 6.6 billion tonnes in four years compared with 4.5 billion tonnes in 100 years.

One result of this huge program of state-sponsored growth has been a property bubble that predictably burst, leaving roads to nowhere and ghost cities in its wake.

Another result is huge overcapacity in industrial production in the aluminium, cement, glass and steel industries. China produces more than 800 million tonnes of steel a year, half of all global output, yet its domestic needs are no more than 600 million tonnes a year.

In late December, China's Central Economic Work Conference determined that two of the top economic policy priorities for this year were to cut housing stock and lower excess industrial capacity.

Just prior to the conference, China's Premier Li Keqiang announced that companies that did not meet energy efficiency, environmental, product quality, profitability and safety standards would be shut down or restructured. But at the same time, the premier gave companies three years to self-regulate.

State authoritarianism

China's economic model is often referred to as “neoliberalism with Chinese characteristics”. What actually dominates its economy, however, is state authoritarianism as the country attempts a painless transformation to a consumption-led economy.

The stimulus program of the past six years has been financed by forcing state-owned banks to lend money to state-owned enterprises (SOEs).

The SOEs took advantage of this cheap money to turn a tidy profit by lending it on to the private sector at extremely high interest rates. Private sector companies and SOEs then both used their overvalued assets as collateral for further borrowing.

Between 2008 and 2014, available new credit in the economy rose by more than $US20 trillion – an amount that exceeded the size of the whole US commercial banking sector by one-and-a-half times.

With bank deposit accounts yielding zero real return, and property investment no longer a profitable avenue for exploitation, excess capital had nowhere to go except to an already overvalued share market.

The Chinese government's attempts to manage the inevitable share market downturn resulted in embarrassing failure — the Shanghai Composite Index plunged 43% in a two-month period last year. In early January, it collapsed twice in the space of two weeks — followed by a run on the currency.

China's pivotal position in the global economy — it generates about 17% of world GDP but has accounted for a third of world growth for the past 10 years — sent share markets tumbling around the world.

Hedge fund manager George Soros was merely stating the obvious when he warned that the slowdown in China meant that the global economy was back once again to the crisis of 2008 — the GFC has never gone away.

Which is why head of European rates strategy at the Royal Bank of Scotland, Andrew Roberts, has advised investors to “sell everything except high-quality bonds — this is about return of capital, not return on capital.”

The Chinese economy is still expected to grow this year, but it will almost certainly do so at a much reduced rate. Modelling by the investment bank JP Morgan, which examined the effects of the commodity market crash on China's industrial output, suggests that it will shrink to 2%.

Global ramifications

The World Bank now estimates that each 1% decline in China's growth rate will cut growth rates in other Asian economies by about 0.8%.

This is not good news for Japan, the world's third largest economy, which has spent the last quarter of a century hovering between stagnation and official recession. When it again slipped into recession in November, it was the fifth time in seven years.

Russia, Brazil and South Africa are in deep recession, the eurozone grew by a miserable 1.6% last year and the data for the US is expected to show that in the last quarter of 2015 growth dropped to barely 2% — well below the long term average of 3.3% between 1950 and 2014.

And then there is the debt problem. In Japan, the ratio of gross public debt to GDP has gone from 67% in 1990 to 246% last year. In the US, federal debt has risen from 35% of GDP in 2007 to 74% today.

Calculating China's debt to GDP ratio is no easy feat. On one account it has gone from 160% in 2007 to more than 240%. According to global management consulting firm McKinsey & Company, it presently stands at 282%.

This is not the first time that the Chinese economy has tanked, it did so in 1998 in the wake of the Asian financial crisis. The state-imposed solution — shutting down state-owned industries and retrenching 21 million workers over a three year period — seems an unlikely fix this time around.

As political economist David Harvey has pointed out, China must either absorb or violently suppress its massive labour surpluses.

A much more militant and confident working class, self-organising and willing to adopt innovative forms of struggle, has emerged in China since 1998. One of its achievements has been average wage rises in excess of 10% a year over the past decade.

So any attempt by the state to repeat the “creative destruction” of jobs of 18 years ago risks a confrontation of much greater significance than the Cultural Revolution of 50 years ago.

On January 19, the International Monetary Fund revised its global growth estimates downwards by 0.4% in 2016 and 2017 to a still optimistic 3.4% and 3.6% respectively.

The widely distrusted official data for China's GDP growth in 2015 was 6.9%, the slowest growth for 25 years. Debt is growing at more than twice this rate, which suggests that a significant amount of new lending is being used to pay off old loans. This leaves no scope for a repeat of the 2009 stimulus program that ignited the global commodity boom.

Investment bank Citigroup says there is a 65% chance China will lead the global economy into recession this year — and this is before the implosion of the US shale industry, groaning under the weight of $200 billion of debt as the oil price continues to fall.

A large part of the industry seems headed for bankruptcy, which will cost the major US banks billions of dollars.

The one thing that can be said with confidence is that all economic indicators point to China going into recession and taking the rest of the world with it.

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"One result of this huge program of state-sponsored growth has been a property bubble that predictably burst, leaving roads to nowhere and ghost cities in its wake". Rubbish. Property values continue to rise. Road connect cities. 'Ghost cities' don't exist: there are cities that are slow to fill and cities that fill up overnight. That's inevitable when you're building 200 cities for the 200 million people who are urbanizing. "Calculating China's debt to GDP ratio is no easy feat". That's why we leave it to agencies whose job it is and who can inspect China's books. The World Bank is one such agency and the CIA accepts its figures for their World Factbook. What does the World Bank say? Japan's debt to GDP is 390%, the USA's is 290% and China's is 209%. Given that China's GDP is growing at 7%, that makes China's debt burden almost negligible compared to non-growing Japan and the US. "This is not the first time that the Chinese economy has tanked, it did so in 1998 in the wake of the Asian financial crisis". 7.8% growth is hardly 'tanking'. If the US economy grew by 7.8% there'd be dancing in the streets and loud self-congratulations. "The one thing that can be said with confidence is that all economic indicators point to China going into recession and taking the rest of the world with it." In real life, things like stock market and currency corrections aren't indicators of anything at all. Here are some links to real indictors: China's debt fragilities are over-stated. They don't threaten the model. [In real life, corporate net debt is near zero, private savings are $3 trillion, foreign reserves $4 trillion]. The proof is in the numbers. Not just headline growth, but stable and low inflation, strong wage growth and rising tax revenue. Debt to GDP Chart . Bad Loans: China’s Banking Regulatory Commission says that the trend of rising bad loans, or non-performing loans, is within expectations, and overall risk is under control. Official data showed non-performing loan ratio at China's commercial banks rose to some 1.6 percent at the end of September, while loan-loss provision coverage ratio, the ratio of provisions held to gross non-performing loans, stood at some 168 percent. The total of NPLs across Europe is about 1 trillion euros ($1.1 trillion), equivalent to the size of Spain’s annual gross domestic product (GDP) and 7.3 percent of the EU’s GDP. Non-performing loans (NPL) across Europe’s major banks averaged 5.6 percent at the end of June, down from 6.1 percent at the start of the year. But that compares with an average of less than 3 percent in the United States. From 2010 to 2014, the growth pace of the public sector's net assets averaged 8.6 percent, according to the finance research institute under the People's Bank of China, the central bank. Total net assets of China's public sector, including government executive departments and state-owned enterprises, was 113.8 trillion yuan (US$17.2 trillion) by the end of 2014. The research also showed that the debt risk of the public sector is under control, with debt growth dropping from 26.6 percent in 2011 to 13.2 percent in 2014. China is flooded with new capital - a huge US$3T a year (and keeps rising): Four reasons the RMB is doing fine: According to the Salary Guide released by global recruiting group Hays Plc on Tuesday, about 44 percent of the 1,200 mainland employers said they would offer salary hikes of 6 percent to 10 percent this year. About 29 percent said they plan to hike wages by 3 percent to 6 percent, while nearly 16 percent intend to give salary increases in excess of 10 percent. China's salary increases are the most generous, finds Asia ... Chinese Are the Most Optimistic People in the World. Current growth slowdown has given rise to a widely shared view that China needs to shift to a more consumption-driven growth model and reduce its dependence on investment. Yet standard growth theory tells us that consumption is not part of the equation. Consumption is the result of growth; it does not drive growth. Personal consumption in China has been growing around 10 percent per year for more than a decade, the highest rate in the world by far, multiple times faster than developed countries and twice the rate of other middle-income economies. Growth in personal consumption rates are likely to decline as economic growth moderates. Regional? Yunnan Province 2015 Report: In the year to November 2015 China imported significantly more, 8.9% more, year on year, to 6.6 million barrels a day to become the world’s largest oil importer. Singapore (Platts)--9 Nov 2015 559 am EST/1059 GMT. China's crude oil imports rose 9.4% on year to 26.35 million mt in October, or 6.23 million b/d, preliminary data released by the General Administration of Customs Sunday showed. China’s smartphone market saw record 2015 sales of 460.5 million units. Apple’s sales in China rose 90% World’s Biggest Public Companies are Chinese SOEs: The share of state-owned enterprises in industrial output continues to drop steadily, from 78% in 1978 to 26% in 2011. Private industry far outstrips the value added in the state sector, and lending to private players is growing rapidly.

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