In hindsight, anyone who takes the time to study what was going on in the buildup to the Great Financial Crisis wonders why so few economists predicted what was about to happen. One of the few who did was Nouriel Roubini, a professor at New York University’s Stern School of Business.
Roubini is now something of a rock star in economic and business circles and when he speaks, investors listen. In the spring of 2011 while participating in a panel discussion of economic gurus, Roubini predicted a continuation of heated growth rates in China in the near term, but warned of an increasing probability of a “hard landing” towards the end of 2013 once the country faces decreasing opportunities for continuing its policy of relying on fixed investments.
According to Roubini, China’s fixed investments are already 50% of gross domestic product and history tells him that level of over-investment inevitably ends in hard landings. Here are a few general observations he noted:
• ‘I was recently in Shanghai and I took their high-speed train to Hangzhou,- the new Maglev line that has cut traveling time between the two cities to less than an hour from four hours previously.
• ‘The brand new high-speed train is half-empty and the brand new station is three-quarters empty. Parallel to that train line, there is also a new highway that looked three-quarters empty. Next to the train station is also the new local airport of Shanghai and you can fly to Hangzhou.’
• ‘There is no rationale for a country at that level of economic development to have not just duplication but triplication of those infrastructure projects.’
He bases his prediction largely on the belief that their huge overcapacity will lead to a crisis of non-performing loans in the banking system. According to him, China needs to do three things:
1. Get inflation under control.
2. Cut fixed investment.
3. Encourage domestic consumption.
While some would say Roubini has earned his reputation, there are a number of other experts who point out that the demise of the Chinese economic boom has been predicted for the last fifteen years. Some go so far as to say “wake me when it happens!”
Regarding Roubini’s suggested remedies, Australians should be particularly concerned about the possibility of China cutting back on fixed investments in infrastructure, as there rests the demand for our resources.
While no one can predict what the Chinese government will do, it is hard to imagine them turning their backs on the second leg of the economic duet – exports and infrastructure – that brought them to the status of the world’s second largest economy.
Although they are already taking measures to promote domestic consumption, their program of high speed rail expansion would suggest they have no intention of cutting back on infrastructure spending anytime soon.
In early 2011 the Chinese government began a program of reducing import tariffs, cutting the tariff on electronic imports by 50%. Their goal of a national high speed rail network continues unabated, even in the face of quality concerns raised by the tragic crash of two high speed trains in July of 2011.
The government is well aware of the problem they face with inflation. Rising prices fuel domestic unrest, which a centrally planned economy must avoid at all costs. In response, they have raised interest rates three times. In addition, the central bank has raised capital reserve requirements six times. Despite these efforts, inflation in China reached 6.5% in July, the highest level in the past 37 months.
China has been stockpiling commodities for some time, with some experts believing their principal intent was as a hedge against rising commodity prices that would negatively impact their infrastructure buildup.
However, in May of 2009 the Royal Bank of Canada (RBC) suggested an additional reason. They released a report with the following conclusion:
• “China is stockpiling commodities such as copper and iron ore as part of a reallocation of its sovereign wealth amid concern that the value of its dollar assets may decline. It’s part of an overall desire to decrease its exposure to dollar assets.”
If the Chinese were concerned in 2009, they have even more reason to be concerned following the US credit downgrade in 2011. A prominent academic advisor to the Chinese central bank – Xia Bin – recently told reporters China must move more quickly with its diversification away from dollars as a hedge against future declines in the value of the US dollar.
Their problem is there are few places to go. Investing in hard assets, such as buying foreign mining operations and other businesses, sometimes is met with resistance from local governments and there are limited places to invest. Continued stockpiling of commodities leaves them exposed to losses in the event a significant economic downturn in the United States and Europe drives down commodity prices and slows down Chinese exports. In reality, their options for moving substantially away from US debt instruments are limited.
Not surprisingly, officials within China see little reason to fear anything more than a moderate slowdown in their growth.
Zhang Xiaoqiang, vice chairman of the National Development and Reform Commission (NDRC), pointed out the government has already reduced its growth forecast for 2011 to 8% and sees no reason they cannot meet that number. However, he did cite the following concerns:
• As a whole, the global economy will post a low growth rate this year.
• Continued depreciation of the US dollar will increase inflation pressures in China.
• The U.S. policy of continuing a loose monetary policy into 2013 will negatively impact the purchasing power of China’s foreign exchange reserves.
• Chinese exports will suffer due to the impact of the debt crisis in the U.S. and Europe.
• Some developed countries may resort to protectionist measures which will further dampen global growth.
How can he have such optimism considering this list of global concerns?
Amidst the immediate carnage of the Great Financial Crisis, the United States passed a $787 billion dollar stimulus package. As is often the case in democracies, the final package was a potpourri of compromises attempting to please everyone a little that in the end, did not have the intended effect, thus pleasing no one. Observers of US politics may remember the heated and divisive struggle over the legislation.
In contrast, the Chinese government enacted – with little fanfare – a stimulus package of 4 trillion Yuan (586 billion in US dollars) that directly targeted 10 separate industry groups. It worked.
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