Thursday, February 4, 2016

China: Hard or Soft Landing?

  Pick up any article on China since mid-2015 and it either begins or ends with , "We don't expect a hard landing in China." Same goes for statements of globally feted wise man and prominent China analysts on TV.  One also often hears statements that, "We don't expect China's economy to collapse." As no one asked (whether China's economy would collapse) nor has anyone publicly  said that it would, one wonders about the motivation for this unsolicited remark?  Could be that the speakers business interests in China demand such a statement to remain on the right side of the CCP?

  As none of the writers or speakers define "hard landing", it is a flexible term whose definition has changed over the last year and can continue to be changed without embarrassment to the reputation of this prominent personalities and experts.  With the exception of a few analysts who have been predicting (for 15 years) a growth slowdown during the current decade and a handful who started predicting it after the Global Financial Crisis (GFC) of 2008, most predicted a "soft landing".  "Soft landing" meant a gradual slowdown of China's growth trend from the 10%% that prevailed for about 30 years to a trend growth of about 8% (a decline of 20%).  However, since 2009 a handful of analysts realised that China's credit expansion was fuelling a debt bubble that was a substituting for essential policy/structural reform and disguising the underlying decline in the growth trend.  The longer this process continued, the greater would be the probability of growth falling further and more sharply below 8%. Since then the winding down of US QE, the sharp decline in commodity and oil prices and the China's policy actions in August 2015 have reduced China's trend growth to around 6%.

  A "hard landing" is now underway. Government is politically unable and/or unwilling to make the fundamental structural reforms to reduce controls that may reduce or eliminate the CCPs monopoly of politico-economic power. It appears poised to use debt financed expansion in government expenditure and government guaranteed expansion of debt financed infrastructure investment, to disguise this fall in growth trend from 8% to 6%. As with the previous experiment from 2010 to 2014, this cannot work for more than three years, particularly given the additional problem of capital outflows and the consequent difficulty of managing the trilemma.  The longer macro controls and fiscal-monetary policy are used to suppress the negative effects of unchanged growth model/growth policy, the larger the likely growth deceleration. Thus we predict another sharp drop in China's trend growth rate in about 3 years to below 4.5%.

   What about the global effects of China's growth decline. In my judgment most of the real effects of the growth decline from 10% to 6% are already absorbed into the World economy. What is creating greater turmoil and uncertainly  in the World economy is the unwillingness and/or inability of China analysts and China buffs to understand and accept China's political and economic reality(as outlined above).  New uncertainty will however be created by China's efforts to keep the trend growth rate from falling from 6% to 4%, as it will continue to create excess capacity in tradable undifferentiated manufactures and other tradable goods, export deflation to the World and put pressure on non-Chinese producers of these goods as well as on banks and financial institutions that have lent to them.

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