The reality is that a significant part of China's growth since 2007-08 has been an illusion. Its headline growth of 8-10 per cent since then has been driven by new lending averaging 30-40 per cent of GDP. Up to 20-25 per cent of these loans may prove to be non-performing, amounting to losses of 6-10 per cent of GDP. If these losses are deducted, Chinese growth is much lower.
Unfortunately, China now faces significant problems in maintaining its high-growth strategy. In 2009, the Premier, Wen Jiabao, admitted that the "stabilisation and recovery of the Chinese economy are not yet steady, solid and balanced".
The case for a soft landing assumes that the investment and property bubbles are less serious than thought. Beijing has sufficient financial capacity to boost growth by loosening monetary policy and bank lending, while adjusting specific policies, such as lifting restrictions on housing sales to prop up prices. China is able to boost domestic consumption, replacing investment as the key driver of its economy. Excess capacity is gradually absorbed as the world economy recovers. Growth comes down gradually, without causing social and political disruptions.
The case for a hard landing assumes the rapid and destructive unwinding of asset price bubbles and problems within the Chinese banking system. A poor external environment and losses on foreign investment exacerbate the problem. Growth collapses, triggering massive social unrest and political tensions.
But the end of a cycle of debt- and investment-driven growth is typically disruptive. Japan's experience, which China has drawn on in shaping its economic model, is salutary. Japan grew by 10 per cent in the 1960s, 5 per cent in the 1970s, 4 per cent in the 1980s, and has remained stagnant since, adjusting to the deflation of its debt-fuelled bubble.
China analysts such as Michael Pettis believe growth will decelerate sharply as the identified problems emerge, falling below 5 per cent by the middle to end of the decade. While growth of this level is high by the standards of developed nations, it is below that required in China to meet the needs of its population and their aspirations.
The global economy increasingly looks to China to drive the world's growth. These febrile expectations are ill-founded. China's GDP is only around 20 per cent of the combined GDP of the US, Europe and Japan, which make up around 60 per cent of global output. The view that China, because of its large population, can compensate for a decrease in consumption in the developed countries is fanciful. China's consumption is only a little more than France's, a little less than Germany's and around one eighth of US consumption.
China's median household income is around $6,000, less than 20 per cent of that in the US where it is $45,000. There is a growing number of consumers, around 100-150 million, which is expected to double in the next five years. But a large portion of China consists of "survivors" (a term coined by the research firm Dragonomics) whose income levels allow the purchase only of basic foods and other necessities, making them less interesting for foreign firms.
As China slows and the identified problems emerge, growth in consumption is likely to slow, limiting opportunities and returns.
China's problems are likely to affect global growth. There will be significant effects on commodity prices and volumes, affecting resource producers and commodity-exporting nations such as Canada, Australia, Brazil, Russia and South Africa.
It will also affect demand for industrial goods, especially advanced machinery. China consumes more than $500bn of these products, mainly imported from Europe, US and Japan.
Chinese demand for US dollars, euros and yen will diminish. This will force borrowers, primarily governments, to find alternative buyers for their bonds. This may drive down the value of these currencies and increase the interest cost.
A hard landing will be especially traumatic for the global economy, which has not dealt with its core problems – excessive debt levels, weak non-debt fuelled demand and global imbalances. The crisis and its effects have been masked in developed economies by artificial demand from government spending, which is proving increasingly difficult to sustain. In China, it was masked by debt fuelled investment. Now, that feast too is coming to an end.
Satyajit Das is author of 'Extreme Money: The Masters of the Universe and the Cult of Risk (2011)'
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