China Backpedals

Forget the Fed, it is time to watch China. As the world’s largest developing market, China’s economy matters, and like it or not, the US and Chinese economies are now permanently tethered. A weak China, not a strong China, is a threat to the continuation of the US recovery, and hope for emerging markets. Conversely, China cannot thrive unless the US economy is healthy. This new world means the end of true sovereignty for economic policymakers.

“... if China takes a turn for the worse, all bets are off.” Robin Wigglesworth

A telling sign: ahead of the Fed rate hike on December 16th, the People’s Bank of China announced that China would be pegging to a basket of currencies, not just the US dollar, in order to mitigate expected pressure on the yuan. Another example of crosscurrents: many believe that one reason that the Fed hesitated to raise rates earlier was because of this summer’s extreme turbulence in China’s stock market. 

Buffeted by a global economic slowdown, and over investment in troubled industries such as coal and steel, China is facing tremendous headwinds. Layoffs and pollution alerts are becoming commonplace, and there is a sense that the country’s policymakers have failed to provide a grand vision for China’s future. Premier Li Keqiang in particular, a Peking University economics student whose brief is the economy, is not receiving high marks. Privatization seems to have slowed and reversed, and now large unprofitable SOE’s are being merged instead of eliminated. In this regard Li is straying from the theories of his famed doctoral thesis advisor, Li Yining, the father of the Chinese stock market and an early (and sometimes persecuted) voice for privatization. 

A key internal debate revolves around land sales and hukou for migrant workers. New economic programs appear to favor the sale of rural land by farmers in re-turn for ghost town apartments and subsidies which will solve short term problems, but could perhaps create an unsustainable future when the former farmers run out of money and have nowhere to go. The impetus is not just social engineering-land sales are favored by overextended local governments in order to collateralize their previous borrowings. 

Many have concluded that President Xi Jinping’s long-running anti-corruption campaign has begun the impact the real economy. Policymakers, and young private entrepreneurs (although publically encouraged to start new businesses) are discouraged and confused by a lack of predictability in terms of laws and regulations. It remains a complicated process to begin a business in China, the usual source of new employment in any economy. Actual support in terms of capital and resources is lackluster. 

All of these issues notwithstanding, it is important to keep the slowdown in China’s GDP in perspective. As Danny Quah at Brookings explains, “China in 2015 is a very different economy from even just 10 years ago. It has changed far more than the world at large has in this time…quantifying the changes that have taken place in the global economy, a 7 percent growth rate for China today means something even more positive than did a 12 percent growth rate 10 years ago.” The base is just so much larger. 

This coming March, the National People’s Congress will announce the GDP target, which is likely to be lower.

What’s Next for China in 2016? Here are some questions and answers. 

  1. How do we even know what’s going on in the Chinese economy? 

    Chinese statistics have a notorious reputation, particularly politically sensitive markers such as GDP. Statistics are reported locally and then are aggregated at the national level. Local politicians and bureaucrats are both judged and reward-ed by their economic performance; therefore, these reports are subject to fiddling. In order to truly understand what is going on in China, it is necessary to gauge the political and policy environment first, and then judge whether or not within the larger global context these policies will be successful. A quantitative approach to a top-down, command economy will not yield a usable forecast. 

    The Central Leading Group of Financial and Economic Affairs of the Chinese Communist Party announced key tasks for the 13th Five-Year Plan beginning in 2016, which provides useful signals about the economy. As mentioned, housing inventories will be reduced by issuing urban-residency permits to migrant workers. Goldman Sachs is estimating that this could increase housing demand by as much as 10—20% in 2016. Will this augment China’s middle class, or create a bubble liable to burst in 5-7 years? Employment will play a key role.
  2. What is China’s debt?

    China’s total debt, fueled by a boom in real estate prices that has since slowed except in China’s three largest cities, is reaching new levels, and is a factor in expected continued monetary easing by the PBOC. Official government debt has been on trend for gradual growth since the late 1990’s, but the real problem is the unknown amount of debt incurred by local governments. The report today by by the Central Economic Work Force has put to bed any prospect of monetary tightening in the near future. Struggling local governments and SOE’s simply could not afford a rise in interest rates. Total government debt has continued to rise since 2008. 

As Chen Zhiwu writes in Foreign Affairs: 

Since Chinese law forbids local governments from borrowing directly, most trans-ferred land titles to LGFVs (local government financial vehicles), which could take out loans freely. These bodies have been so successful at circumventing Beijing’s prohibitions against local government borrowing—on paper, they look just like other SOEs—that nobody, not even the Ministry of Finance, knows how much local governments owe. This ambiguity has made it impossible to estimate China’s true government debt, although guesses range anywhere from $5 trillion to $7 trillion.

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