Contradictions in the red hot Chinese economy

October 27th, 2007

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The China growth story is a fascinating story. The swelling Chinese economy is the envy of much of the developed nations, who are struggling with either economic stagnation or lackluster economic growth (for example, Japan is now faced with the danger of falling back into recession). Indeed, there has been talk that China will soon supplant the United States to become the engine of global economic growth. That argument says that the world should not fear the United States falling into severe economic recession because China (along with India) is there to save the global economy.Again, we would like to express our skepticism with this argument.No doubt, in the very long run (when we say ?long run?, we do really mean a very long time measured in terms of decades), this is true. But that does not preclude harrowing setbacks in the short term. As you may recall in our metaphor (see Crisis and the China growth story), China is like the fit young bloke falling into serious injuries because he is running too fast for his own good. The United States is like the weak and elderly grandfather who is also running too fast for his own good and fell into serious injury too as a result. But in the long run, which of the two is better able to cope with such a crisis?As we look at China, we find many contradictions. These contradictions are warnings to us that the outcome may turn out ugly at least in the interim:

  1. As we mentioned before in Why is China printing so much money?, the supply of money is expanding very rapidly in China, resulting in price inflation. Inevitably, mal-investments are building up in the Chinese economy, which will eventually result in a bust (see What causes economic booms and busts?). Already, as this article in the Sydney Morning Herald (SMH) says,
  2. …many experts believe China has entered a new inflationary era because its pool of surplus labour, which once seemed limitless, is drying up in large tracts of the country.

    Hence, if this trend continues and everything else remains equal, we can expect to see many projects in the Chinese economy to fail due to labour shortages. Such labour shortage will manifest itself in the form of surging wages, price inflation, which will force the liquidations of many unprofitable and unfinished projects. When the Chinese economy enters such a liquidation phase, it will be recognised as an economic bust.

  3. As this article in the SMH says,
  4. Central bankers are also watching whether China can drive the world economy through a US downturn. Whether China succeeds depends on how its politicians view and manage the three contradictory objectives of slowing growth to reduce inflation, keeping growth sufficiently strong to soak up redundant state enterprise workers in depressed areas like A’cheng, and holding food prices high enough to improve peasant incomes.

    What are the chances of the Chinese authorities being able to achieve these contradictory objectives simultaneously? It looks that they have hardly any wriggle room to do so.

  5. Despite bringing economic prosperity to vast segments of the Chinese populace, the gap between the rich and poor in China had actually widen over the years. The root cause of this is uncontrollable monetary inflation (see How to secretly rob the people with monetary inflation?), which resulted in the transfer of wealth from the asset rich to the asset poor. This is a potential social crisis waiting to happen.
  6. With rampaging asset price bubbles in the property and stock market, what will happen when those bubbles burst? As history shows, all price bubbles eventually burst? We are hearing stories that many Chinese people are transferring their savings (some doing so recklessly with complete disregard to their financial safety) into the stock market.
  7. Rampant economic growth had resulted in severe degradation of the environment. As history has shown, no nations can destroy their environment and remain viable in the long run. In China’s case, there is a need to sacrifice short term economic growth for long term sustainability of the environment. The question is whether there will be political will to do so (see China to pull the plug?).

So, is China at turning point? If so, what are the consequences? Stay tuned!