China market crash could be a blessing in disguise
The gyrations of the Chinese stock market, which has lost more than 20% of its value since late May, have refocused attention on the state of the Chinese economy. Since recording its last double-digit growth in 2010, the Chinese economy has been losing steam over the last five years. In 2010, China grew an annual 10.4% but this year, the country would be lucky to hit its target of 7%.
Of course, the Chinese government has maintained a brave face and insisted that there is nothing to worry about in the slowdown -- that Chinese growth is merely entering a "new normal" phase. Such soothing rhetoric, unfortunately, cannot conceal the harsh reality. What is happening with the Chinese economy is anything but normal. To put it plainly, this is an economy that has been kept buoyant only by multiple and simultaneous bubbles. Without the temporary growth-boosting effects of these bubbles, the Chinese economy would have been in a "new horrible" state by now.
It is worth recalling that in the last two decades, the Chinese economy has been sustained by a series of one-time positive shocks and bubbles. For example, the most powerful positive shock was China's accession to the World Trade Organization in 2001, which helped spur its exports. In 2001, the value of total Chinese exports was $266 billion. By 2010, exports had risen to $1,577 trillion, increasing at an astounding annual growth rate of 50% on average. Since 2010, Chinese export growth has slowed to an average of 10% a year.
In addition, the Chinese economy has experienced a prolonged boom period of investment, fueled by a massive credit bubble that has raised the total debt-to-gross domestic product ratio from 121% to 282% between 2000 and 2014, according to consultancy McKinsey & Co. Among other things, apparently limitless access to bank loans has enabled China to fund its investments in infrastructure, real estate and manufacturing with little regard to profitability. The investment rate in China rose from an average of 35.8% of GDP in the 1980s to 42.8% in the 2000s and 47.2% since 2010. While the credit boom powered the Chinese economy to new heights, it also created the country's real estate and manufacturing bubbles.
Based on Chinese official data, from 1999 to 2004, the value of completed real estate projects, both commercial and residential, averaged 1.17 trillion yuan ($188.51 billion) per annum. Between 2005 to 2009, this figure shot to 2.51 trillion yuan, more than double the previous six-year average. During 2010-2013, the number was 4.6 trillion yuan. These figures, if anything, suggest massive overbuilding in the Chinese real estate sector in recent years.
A similar story unfolded in the manufacturing sector, particularly in the steel industry. In 2000, crude steel output in China was 128 million tons; in 2014, it reached 822 million tons (nearly 10 times that of the U.S., which produced 88 million tons).
REAP WHAT YOU SOW
Unfortunately, the overinvestment binge in real estate and factories has resulted in a glut of unsold apartments and goods that have now begun to generate deflationary pressures and weigh down economic growth.
Amidst all the froth, China's latest stock market bubble has also steadily inflated. Since last summer, Chinese stock prices have risen more than 150%. The Shanghai Stock Exchange Composite Index rocketed from under 2,100 to over 5,000 before falling back to reach 3,900 on July 2 after the recent sell-off. Amidst a gloomy economic landscape, China's stock market bubble has been, indeed, a bright spot.
But the recent sell-off warns us that China's stock market bubble is on the verge of a spectacular pop.
The question, then, is how the bursting of this bubble will affect the Chinese economy. Opinions are clearly divided. Optimists argue that no real damage will be done. They point to the collapse of an even bigger stock market bubble in 2007-2008. In October 2007, the Shanghai benchmark index reached its all-time high of 5,954, but by November 2008, it had fallen to 1,900, having lost two-thirds of its value in 13 months. Yet, the Chinese economy did not seem to have suffered any direct adverse consequences from the collapse of the bubble.
Pessimists believe, however, that the circumstances today are vastly different from those eight years ago. Immediately after the bursting of the stock market bubble in 2007-2008, the Chinese government implemented a massive stimulus program in response to the global financial crisis, thus probably offsetting the impact of the stock market collapse.
As we now know, the credit-funded stimulus program merely created another bubble -- the real estate and investment bubble that has sharply increased China's overall indebtedness. Another crucial difference is the use of margin loans in equity investments. In the previous bubble, such loans were banned. But this time, speculative margin loans, funded by brokerage firms and the shadow banking system, are estimated to total 3.8 trillion yuan. In the event of a market crash, a significant portion of these loans will go sour and generate secondary financial shocks.
A third crucial difference between the two years 2007-2008 and today is that the current stock market bubble is inflating while the other three interconnected bubbles -- credit, real estate and manufacturing overcapacity -- have yet to pop. The presence of multiple bubbles has certainly made the job of Chinese policymakers much tougher. For one thing, they no longer have the luxury of generating a new bubble to cushion the impact of the collapse of an old one. For another, contagion -- the popping of the stock market bubble -- may undermine confidence so much that it could trigger financial defaults -- and push the overall Chinese economy over the edge into a recession, just like the popping of the Japanese bubble in 1991 triggered the decline that followed.
China's external environment, pessimists would remind us, is not as benign as it used to be, either. Exports are no longer contributing to GDP growth. With rising labor costs and tightening environmental standards, China is losing its cost competitiveness as a manufacturing powerhouse. The ongoing turmoil triggered by the Greece's debt default and continuing economic woes could indirectly hurt China by denting economic recovery in the eurozone, China's largest trading partner.
The compelling case made by pessimists may be right, but the consequences of a severe economic downturn in China may not be all that bad. Most veteran observers of China would agree that crisis is a pre-requisite for genuine reform. Indeed, the most successful reforms in the post-Mao era were all precipitated by crises and shocks. In the last two and half years since Xi Jinping became Communist Party chief, the new leadership has vowed to undertake painful economic reform to reinvigorate growth, but the sad truth is that there has been only modest progress. So an economic downturn triggered by a stock market crash may force Chinese leaders to embrace painful reforms because there is no other alternative.
The second hidden benefit of a potential hard landing is the return to moderation in Chinese foreign policy. Bubble-fueled economic prosperity has made Chinese leaders less restrained in recent years in the use of power, as we can see from examples such as China's behavior in the South China Sea and the territorial disputes with Japan. The bursting of China's stock market bubble may help deflate Beijing's geopolitical ego and force its leaders to flex their muscles less often.
So let us cheer the bears even though the carnage on China's stock exchanges might be unimaginably ugly.
Minxin Pei is a professor of government at Claremont McKenna College in California and a non-resident senior fellow of the German Marshall Fund of the United States.
Minxin Pei: China market crash could be a blessing in disguise- Nikkei Asian Review
Just stating the facts,
