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Business, Economics and Jobs

China’s economic crisis, explained

GlobalPost

July 10, 2013 · 10:00 AM UTC

By Benjamin Carlson

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Editor’s note: China’s “miracle economy” is faltering. In this multi-part

series, GlobalPost brings you the latest from the struggling Pearl River Delta,
where much of the world’s merchandise is manufactured.

SHENZHEN, China — To understand China’s economy today, a local financial journalist

recently told me, you need to picture a stool with three legs. We were having dinner, and he
took a toothpick and one of the chopsticks from a serving dish to demonstrate.

One leg is investment, he said, propping up the chopstick. One is exports, he said, standing
up the toothpick. And the other is consumption.

But the investment leg is too big, he continued, the export leg is broken, and the
consumption leg is justfor
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“The stool is very imbalanced,”DONATE

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Simple as it is, this illustration gets at the heart of what’s worrying many people about the
future of the world’s second largest economy.

A er 30 years of meteoric, double-digit GDP growth, China’s economy is at a crossroads. The

main drivers — exports and infrastructure investment — have lost their punch. Meanwhile,
low wages and high housing costs have made it impossible for Chinese consumers to fill the
gap.

As a result, China’s growth in 2012 fell to its slowest pace this century, and 2013 looks like it
could be even slower. Last month, the International Monetary Fund lowered its projection to
7.75 percent growth from 8 percent, and UBS, Standard Chartered, and Bank of America
have likewise lowered their predictions for the year.

Michael Pettis, professor of finance at Peking University, sees an even darker scenario, saying
in a recent newsletter that his “expectation for long-term growth is that it shouldn’t average
much above 3-4 percent annually.”

“Not only will China’s real GDP growth drop as China shi s towards a di erent growth
engine, but it will drop even more as China is forced to recognize the hidden losses buried in
its debt levels,” Pettis said.

China’s leaders are well aware of these challenges, and have sought to manage expectations.
In a speech at the end of May, Premier Li Keqiang told senior Communist Party o icials that
economic “complications are increasing,” and that the government will have to step back
and allow the private sector more power in the market.

“Scientific approaches are needed to ensure this year's social and economic goals,” Li said,
reiterating the government’s target growth of 7.5 percent this year.

Yet even with these lowered expectations, the latest data have disappointed. In May of this
year, China’s exports, industrial production, and lending data all fell below analyst
predictions.

In other words, the stool is starting to look shaky, and it’s unclear what Beijing can do to fix
it.

Take exports. With labor

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Add in an aging workforce and an appreciating yuan, and Chinese factories have become
much less competitive. Labor intensive industries have begun to shi to Vietnam, Indonesia,
and Thailand.

Then there’s investment. China has long been the land of big government projects,
especially a er 2008, when Beijing deployed an estimated 4 trillion yuan ($652 billion) in
spending to ward o a slump from the financial crisis. The countryside exploded with new
train stations, airports, and apartment complexes. Analysts say many of these projects were
ill-conceived. And now that they are built, there’s even less the government can do to spur
growth without risking additional waste.

"Across the board you’ve got overcapacity. Overinvestment. What that translates into is bad
debt," says Patrick Chovanec, a longtime China watcher and chief strategist at Silvercrest
Asset Management. "You can pump more money into the economy, but it’s getting less and
less of a result."

Or take consumption. China’s middle class will eventually become the engine of its economy
— as in America. But that transition is happening slowly, and insanely high housing prices in
cities have suppressed people’s ability to spend. At the same time, any fall in the real estate
market could be catastrophic.

China’s economic stool looks even shakier when you consider other factors. Debt is
ballooning, and banks are being squeezed for cash. Last month, the inter-bank lending rate
shot up to a high of 25 percent when the central bank warned that it would not step in to
flood the market with liquidity.  

Across China, city governments have issued dubious, high-interest-rate bonds to fund
projects. The total amount of credit in China may now be more than twice the size of the
economy, according to the China Securities Journal — nearly eight times what it was a
decade ago. As a result, credit-rating agencies Fitch and Moody’s both recently downgraded
China’s sovereign credit rating.

Remarkably, the mood among many Chinese remains very optimistic. Nearly 90 percent of
Chinese people feel that the economy is doing well, according to a new survey of global
attitudes by Pew. But Chinese analysts warn against complacency. Hu Shuli, the editor-in-
chief ofGlobal
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“To many Chinese, the fact that China managed to escape the worst impact of the global
financial crisis is proof that its economic system is perfect,” she wrote in an op-ed.

“This kind of view is harmful, because it blinds us to the deep-seated structural problems of
China's economy, and how truly urgent comprehensive reforms and a transformation of
China's economic model are.”

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