Bloomberg: Challenges China’s New Leadership Faces
On Friday, I was on Bloomberg TV talking about China’s latest economic data for October (at the time of my interview, only the inflation figures had been announced), and some of the key challenges facing China’s ruling party as it begins its once-in-a-decade leadership transition. I took a distinctly contrarian view on the latest inflation numbers, arguing they do not create room for monetary loosening to give the economy a quick and easy boost, because the issue isn’t just how much money is sloshing around China’s economy, but where that money is going. To the extent that prices in certain key sectors like steel and coal — and I would add real estate, despite the official statistics saying otherwise — are falling, it reflects real overcapacity compared to real demand, and the absence of real value being created. The PBOC is right to resist pumping in more money and reflating bloated investment sectors, which would only reinforce the imbalances in China’s economy and prevent the kind of adjustment China needs towards more meaningful growth. You can watch my interview here.
I also discussed aspects of President Hu Jintao’s big address to the 18th Party Congress. Let me just highlight four key points of the speech that caught my attention:
1) Hu promised to double China’s 2010 GDP by 2020. That sounds really impressive, but it actually equates to just 7% growth going forward — and I’m assuming here that he meant double real, not just nominal GDP, because otherwise the real growth rate would be even lower. So really, he’s lowering the bar in a pretty significant way. Hu also set the goal of doubling per capita income by 2020. The problem is, if GDP and per capita income both double, China won’t see any meaningful rebalancing towards consumption, because household income won’t grow as a portion of GDP — and again, that’s assuming he’s talking about real income growth, because if income only doubles in nominal terms, it will decline relative to real GDP. To rebalance its economy China needs to grow income faster than GDP — which could either mean faster growth in income, or slower growth in GDP.
2) Hu spoke forcefully about how corruption seriously threatens to undermine the Party’s rule. I agree, and talked in my Bloomberg interview about why it’s so hard to deal with this problem. I should also add that inflation — driving investment growth by pumping more and more money into the economy — is one of the major factors contributing to corruption, because it drives a widening gap between those who have pricing power and those who don’t, and those who have access to credit and those who don’t. Inflation (from a big lending boom), and inflation-driven corruption, were two of the main grievances that fueled the Tiananmen protests in 1989.
3) Hu also spoke of the need to “resolutely safeguard China’s maritime rights and interests” and called on China to become a “maritime power.” Given recent confrontations in the South China Sea (with the Philippines and Vietnam) and the East China Sea (with Japan and South Korea), as well as the launch of China’s first aircraft carrier, these lines surely caught the attention of China’s neighbors (as this FT article suggests).
4) Hu also appeared to push back against reformers’ calls to reduce the role of the state sector in China’s economy. Instead, he insisted China would “unswervingly” adhere to “the basic economic system in which public ownership is the mainstay and economic entities of diverse ownership develop together,” and said the party and government “should steadily enhance the vitality of the state-owned sector of the economy and its capacity to leverage and influence the economy.” His stance appeared to run contrary to the prescriptions in the World Bank report issued earlier this year in conjunction with top Chinese policy makers, which appeared to have the support of Hu’s protegé, Premier-in-waiting Li Keqiang, and had raised hopes that positive reforms might take place after the leadership transition. We’ll have to wait to see what, if anything, the new rhetoric means for actual policy.
Patrick Chovanec 
Good thing you’re staying quiet nowadays. Someone mean-spirited is bound to throw those hard-landing predictions in your face if you start posting more predictions. Maybe you can switch focus and remake yourself as political analyst, at least there are no hard numbers and statistics gathering to make you look a fool.
Ahhh, I should count myself lucky that you’re not mean-spirited then.
I have been quiet recently because I’ve been busy with news that I cannot announce yet, but will soon.
If, however, you have been following me on Twitter (@prchovanec), I think you will find plenty of reasons why I remain quite concerned about a hard landing for China:
First, I’m very much of the mind that China’s actual GDP has grown about 4-5% this year, mainly because I don’t believe private sector investment has grown 24% y/y, as the official statistics indicate, but has basically been flat. I think there is plenty of evidence, both data and anecdotal, to support this.
Second, there are very good reasons to conclude that the “rebound” that we are seeing is driven solely by renewed credit expansion (mainly shadow banking, the conventional banks are quite reluctant to lend) going into renewed over-investment. China can, at great cost, engineer a new “bump” in the economy. But this is not sustainable, and does represent any fundamental change to the story I have been telling.
Third, we are seeing very signs of financial stress in China. An increasing amount of credit and fiscal resources are being channeled to prop up existing levels of economic activity rather than fund growth (good or bad). The amount of credit growth needed to finance a unit of GDP growth has been steadily rising.
I don’t have a crystal ball, nor do I pretend to. I know everyone likes “predictions,” but I have always seen my role as provoking people to think about things they might otherwise take for granted. You may not come to the same conclusions I do, and events may play out differently than either of us imagine, but I believe the various points I’ve raised throughout the years — many of which have proven quite accurate — are ones that anyone thinking about the Chinese or global economy should at least be wrestling with.