Roubini's latest on China

[don]

Via Email update, Nouriel Roubini sent out a note regarding China's growth.

I’m writing on the heels of two trips to China during which I met with senior policy makers, bank executives and academics, just as the government launched its 12th Five-Year Plan, intended to rebalance the long-term growth model. My meetings deepened my own impression and RGE’s long-standing house view of a potentially destabilizing contradiction between short- and medium-term economic performance: The economy is overheating here and now, but I’m convinced that in the medium term China’s overinvestment will prove deflationary both domestically and globally.

Once increasing fixed investment becomes impossible—most likely after 2013—China is poised for a sharp slowdown. Continuing down the investment-led growth path will exacerbate the visible glut of capacity in manufacturing, real estate and infrastructure. I think this dichotomy between the high-growth/inflation pressures of the next couple of years and growth hitting a brick wall in the second half of the quinquennium is far more important than the current focus on a “soft landing” amid double-digit growth. A number of local scholars close to policy circles agree that this is the biggest challenge of the next few years, as we’ve been saying for months.

• Despite policy rhetoric about raising the consumption share in GDP, the path of least resistance is the status quo. The details of the new plan reveal continued reliance on investment, including public housing, to support growth, rather than a tax overhaul, substantial fiscal transfers, liberalization of the household registration system or an easing of financial repression.
• No country can be productive enough to take 50% of GDP and reinvest it into new capital stock without eventually facing massive overcapacity and a staggering nonperforming loan problem. Most likely after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP.
• China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in brand-new empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, massive new government buildings, ghost towns and brand new aluminum smelters kept closed to prevent global prices from plunging.
• It will take two decades of reforms to change the incentive to overinvest. Traditional explanations of the high savings rate (lack of a social safety net, limited public services, aging of the population, underdevelopment of consumer finance, etc.) are only part of the puzzle—the rest is the household sector’s sub-50% share of GDP.
• Several Chinese policies have led to a massive transfer of income from politically weak households to the politically powerful corporates: a weak currency makes imports expensive, low interest rates on deposits and low lending rates for corporates and developers amount to a tax on savings and labor repression has caused wages to grow much less than productivity.
• To ease this repression of household income, China would need a more rapid appreciation of the exchange rate, a liberalization of interest rates and a much sharper increase in wage growth. More importantly, China would need to privatize its state-owned enterprises so that their profits become income for households and/or massively tax SOEs’ profits and then transfer those fiscal resources to the household sector.

Medium Term Deflationary

Interestingly, Roubini concludes "China’s overinvestment will prove deflationary both domestically and globally."

http://globaleconomicanalysis.blogspot.com/

[don]

Re: Roubini's latest on China

The over-production crisis, transferred from one state to another.

[Jay]

Re: Roubini's latest on China

It's a grand game of economic chicken between the US and China. Who blinks?

[don]

Re: Roubini's latest on China

It's a grand game of economic chicken between the US and China. Who blinks?

Who's the chicken and who's the rooster

[Kcim67]

Re: Roubini's latest on China

It's a grand game of economic chicken between the US and China. Who blinks?

I don't think China cares two hoots, for Bejing read Seoul, for 5 year plan sub 50 year plan, the fall of the wall allowed the eye of the ball and the Chinese have just blindsided the defense and sacked the quarterback. You're now losing tactically and caught deep in your own defensive area, you need a new game plan and you need it quick! I don't see anyone in FIRE with any new game plans?

[Jay]

Re: Roubini's latest on China

I don't think China cares two hoots, for Bejing read Seoul, for 5 year plan sub 50 year plan, the fall of the wall allowed the eye of the ball and the Chinese have just blindsided the defense and sacked the quarterback. You're now losing tactically and caught deep in your own defensive area, you need a new game plan and you need it quick! I don't see anyone in FIRE with any new game plans?

Just to be clear, I don't personally see this as a "me" vs. "them" jingoistic kerfuffle. I am most interested in which ever path ends up offering relative long term growth and stability and a sustainable restrengthening of the middle class. In reality, with the pie shrinking as energy costs continue to rise, sovereigns will be fighting over a smaller pie or at least one not experiencing the growth of the past; at least until the liquid hydrocarbon situation is sorted out (I'm not worried about fixed energy sources at all). I hold out strong hope that implementable economic solutions will be found, yet realize how large the hurdles of replacing liquid hydrocarbons are. Selfishly, this likely means a lower standard of living for me in the near future, so in that sense, I want the US "to win;" whatever the hell that means in the era of FIRE in which even the idea of the US winning becomes muddy and somewhat silly. The winners are the global plutocracy. It is clear that the Anglo-American economy has become rigid and quite ill, yet Western Civilization has developed a sclerotic bureaucratic economy multiple times in the past, yet those problems were always overcome. The most recent example occurred during the industrial revolution; the solution was coal and steel among other things. Whether this was due to luck, or some innate strength of Western society is arguable of course. I think it was both. The key is we, as a world, need growth to continue on the current economic model. You can have opinions either way whether growth is "good" or "bad" but its presupposition for our society to remain "as is" is probably necessary. This is one of the reasons I think we are seeing multiple small wars break out but I'll leave that and its implications alone for now.

I do feel that Chinese citizens will have an increase in their standard of living over time, if uneven. The spread of nonrival economic goods through the internet practically guarantees it. The mean standard of living in developed nations will likely fall in the meantime. I think most of the central bankers know this, and their mandate is to try and keep their respective essential domestic power structures intact through the transition. China will have a bumpy time as they attempt to transition into a more consumer driven middle class as oil prices rise. I expect oil prices to rise in real terms for the Chinese over the medium term horizon even considering a yuan revaluation, and even if there is some short term demand destruction and a price decrease in the near future.

There is certainly some give and take between the US and China when it comes to how the new world economy will look and who will hold what powers. And that is quite an understatement. Each wants as much power as possible, but they also each want stability and consensus if possible. The last reshuffling after WWII was easier because winners and losers could be clearly delineated. Now without a large war consensus will be much harder.

When thinking of the US as a strategic entity determined to "win" I usually come back to four or five things, the reserve status of the dollar, a history of entrepreneurship, and America's military, financial and agricultural might. These are all in various states of disarray, but I'm not convinced at all that the quarterback has been sacked.

[c1ue]

Re: Roubini's latest on China

These are all in various states of disarray, but I'm not convinced at all that the quarterback has been sacked.

The quarterback hasn't been sacked; he's part of the point shaving scandal.

[GRG55]

Re: Roubini's latest on China

It's a grand game of economic chicken between the US and China. Who blinks?

It's not a matter of who blinks. I think Bernanke is going to "win" this contest.

I was in Hong Kong last fall and was a bit surprised to learn from our business associates there that virtually every business they had in mainland China could not generate profits. Our associates are involved in everything from manufacturing, construction, building materials supply, technical services, food services equipment and retail [in one case auto dealerships]. Not one deviated from the same story when I queried them hard. In every instance they told me they were unable to justify making additional investments in the mainland China branches of their businesses, nor could they justify investing in any new business opportunities in mainland China.



Those discussions led me to conclude that:

1. The amount of "free" money flooding the mainland Chinese economy to overbuild damn near everything in every economic sector must be truly staggering by any measure;
2. The corruption is now so bad in mainland China that even the Hong Kong Chinese can't always deal with it;
3. If the Chinese can't make any money in China, nobody else is making money there either;
4. It's a bubble, and if nobody is making any profits now and some are already curtailing investment as a result, I wonder if Roubini's "after 2013" estimate before it bursts is optimistic [EJ has written that it could start before the end of this year].

[Jay]

Re: Roubini's latest on China

I was in Hong Kong last fall and was a bit surprised to learn from our business associates there that virtually every business they had in mainland China could not generate profits.

Just tell them to invest in Chinese real estate!

[touchring]

Re: Roubini's latest on China

Just tell them to invest in Chinese real estate!

They are already doing it, aren't they? lol

[don]

Re: Roubini's latest on China

Solid on-the-ground post. Thanks, GRG55!

[cbr]

Re: Roubini's latest on China

I used to be very bearish on china, but they keep surprising me... I have done a fair amount of business in shanghai and HK, and dealt with some bright people (some more than others).

My impression is, they already have an upper class and lower middle class equalling the US in size and total money... their middle class is slightly better educated. The upper middle class is still smaller and less sophisticated. The government class is much more competent and pragmatic than ours. These classes are all jammed in the big coastal cities.

IMO, most of this new Chinese 'wealth' was not so much EARNED as it was STOLEN from the west by anti competetive practices and wanton theft of intellectual property, so when I read about all the US 'debt' held by the PRC, I don't feel real obligated to them in any way other than to deal purely in our self interest. I'd prefer to ensure rather that such never becomes a real obligation, and that such theft is offset (problem being we are rapidly losing our ability to 'punish' them for such theft).

the lower classes are MUCH larger than the US of course.

througout the infrastructure, there is a lot of veneer, and not nearly as much substance there, but the steady results their command economy has maintained has been shockingly consistent for a shockingly long time. I have seen no evidence that they can't continue that surprising success.

In my experience, the corruption was rampant, but not easy to ferret out, at least in the trucking/logistics business it was not readily apparent.

[unlucky]

Re: Roubini's latest on China

For what it's worth, I recently attended a seminar at which a senior executive in a multinational pharmaceutical presented bullish views for this sector in China. Chinese pharma sales have grown substantially and will continue to grow (annual revenues at 15%) because of 1. general economic growth, 2. aging population, 3. steadily increasing state/social subsidization of health care costs (starting from a base near zero).

However, after the presentation there was a reception providing a chance to speak semi-privately with executives from several pharma multinationals.Their view: multinationals are spending money to buy revenue growth in China, and profit growth is lagging far behind. Costs are increasing and the state demands an ever increasing share of profits in the form of both taxes and "investments" designed to provide jobs. That's good in a sense because it means that revenues flow back to the Chinese population. But for those thinking of investing in pharma multinationals active in China: caveat emptor.

Just an impression.

[touchring]

Re: Roubini's latest on China

For what it's worth, I recently attended a seminar at which a senior executive in a multinational pharmaceutical presented bullish views for this sector in China. Chinese pharma sales have grown substantially and will continue to grow (annual revenues at 15%) because of 1. general economic growth, 2. aging population, 3. steadily increasing state/social subsidization of health care costs (starting from a base near zero).

However, after the presentation there was a reception providing a chance to speak semi-privately with executives from several pharma multinationals.Their view: multinationals are spending money to buy revenue growth in China, and profit growth is lagging far behind. Costs are increasing and the state demands an ever increasing share of profits in the form of both taxes and "investments" designed to provide jobs. That's good in a sense because it means that revenues flow back to the Chinese population. But for those thinking of investing in pharma multinationals active in China: caveat emptor.

Just an impression.

anyone who thinks it is easy to make money in China should ask Mr google.

[Chris Coles]

Re: Roubini's latest on China

[*]No country can be productive enough to take 50% of GDP and reinvest it into new capital stock without eventually facing massive overcapacity and a staggering nonperforming loan problem. Most likely after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP.

While not wishing to quibble about the percentage; the truth is almost every nation on the planet is having to face changing direction to a new economic model. In my view, trying to continue with the existing model will continue to fail and for that reason alone, they have to open their minds to new thinking.

The major problem is a lack of prosperity at the grass roots. Plenty of money to spend on fixed assets which only make the upper echelons wealthier. What they need is a major push towards using equity capital to create millions of minute; people owned small businesses which address their own, local community marketplace, manufacturing and selling all the things they need for their own homes and welfare.

What they have at the moment is simply major manufacturing developments, originally driven by external "inward" investment; targeting high profit for the inward investors, local home market. Electronics is a very good example. So, on the back of all that inward investment, their own local people got wind that they could drive any associated investment, at no cost to themselves personally. I do not call that corruption; but taking the chance. Let us be totally honest, any of us, presented with such a possibility; would take that chance.

Some of their investments, such as major infrastructure, will turn out to be the same as the dark fibre laid down during the dot.com bubble; well placed to take advantage of the next phase of the economic development of what has been, up to relatively recently, a depressed agricultural economy not unlike Europe pre the industrial revolution.

As fast as some will fall by the wayside, others will step forward to fill the voids they have left behind. Remember they have billions of peasants that can see their own chance to make a better life for themselves.... exactly what they have done so far.

What they need is prosperity right down at those grass roots. The only mechanism to do that is equity capital invested into very tiny, up to five employees, businesses. Each addressing their own local product marketplace.