An edited version of this piece was published in the August 12, 2013 edition of the Shenzhen Daily.
I am not a Harvard trained economist, like the geniuses who are running the world’s economies, but I am an interested observer. There are many economic trends going on in China and the rest of the world that are troubling.
There is an ongoing property bubble in China. Official government figures show a 113% increase in property prices in the past eight years. This is contradicted by research by Tsinghua University and the National University of Singapore which found prices actually rose by 250% between 2004 and 2009. These figures represent a faster increase in values than was experienced during the US housing bubble. This confusion and contradiction about values and trends comes about because of the lack of transparency in the Chinese economic system. It’s difficult if not impossible know exactly what is going on.
There is trouble brewing in the Chinese banking system. The trouble comes from three areas: bad loans to local governments, bad loans to property developers, and the shadow banking system.
Because there is so little transparency in the Chinese banking system, it often seems that one hand doesn’t know what the other is up to, and no one is in control. Some experts say many or most loans to local governments are now non-preforming. In 1999, the Chinese government created four massive asset management companies that would eventually take on toxic loans valued at some USD $480 billion. According to Moody’s these bad loans are still on the books.
The shadow banking system is fraught with abuse, though no one seems able to get a handle on exactly what is going on in it. The government and the The People’s Bank of China have joined forces in efforts to tighten the screws on the banks participating in the shadow system, which has fuelled the explosive credit growth that has helped to drive China’s economic success, but also raised doubts over the ability of borrowers to repay loans.
One of the greatest problems created by the increased reliance on shadow banking is the maturity mismatch. While most infrastructure and property investments are financed over three to five years, products sold by the shadow banks generally have a maturity of 3-12 months, This has effectively created what some have described as a national Ponzi scheme system, whereby existing investors’ returns are paid for from the influx of money gathered from new depositors.
The average Chinese keeps some 70% of the family assets in cash or bank deposits. These deposits earn about 3.5% interest, sometimes a little more. The banks use these deposits to make risky loans at high rates of interest in the shadow banking system.
China’s central bank has sent a warning signal to the country’s overextended lenders when it refused to increase money supply. This pushed short term borrowing costs to a six-year high, and caused the banks to have to scramble to increase liquidity. Largely because of the problems in the banking system, Moody’s cut China’s credit rating from AA- to A-.
The Chinese government has signaled a willingness to bail out the big banks, instead of letting them go under. As we discovered in America and Europe, when there isn’t a penalty for failure, you get more failure.
Hopefully the Chinese authorities are well aware of the dangers in the banking and property industries. They have been taking steps to try to end the crisis without precipitating another crises. Most of what they’ve tried has been weak and ineffective. They jiggle a little something here, adjust something there, pass a new rule elsewhere else. So far they efforts have been largely unsuccessful.
But it’s not only China where economic storm clouds are gathering. The U.S., Europe, Japan and other countries have discovered the joys of quantitative easing. That is printing money from thin air to finance the government debt and borrowing at absurdly low interest rates. In the U.S. the government borrows from itself at close to 0% interest with money it prints from nothing.
This can not go on forever and the central bankers have indicated they will consider slowing the amount of money they print in the future. This will send interest rates up and could increase the cost of borrowing dramatically, creating even more problems for the cash strapped governments.
There is a moral aspect of government printing and spending money made from nothing. Money is supposed to be a store of value. In the old days a U.S. quarter had 25 cents worth of silver in it. A British penny was made from a penny’s worth of copper. Paper money could be redeemed for gold or silver bullion at Federal Reserve banks.
In 1971 President Nixon ended the dollar’s convertibility into gold. Soon most other nations followed suit. This led to torrents of money being printed and borrowed by both governments and individuals. The amount of debt in the world doubled, redoubled, then redoubled again as the printing presses ran 24/7.
This led to 16-18% inflation and world-wide economic stagnation. Inflation is the cruelest tax of them all. It penalizes everyone, especially those who worked hard and tried to plan for the future by saving money. It seems likely what is going on today will end up the same way. We are witnessing the beginning of the destruction of fiat currency.
One consequence of the money printing is that much of it is flowing into the world’s stock markets. Most markets are behaving well, some are hitting new highs, despite the underlying poor business conditions. This is another bubble that will inevitably burst.
The bureaucratic strangulation of economic activity is another big problem. China’s bureaucracy and red tape are legendary, but can it usually be overcome with a few well placed Yuan. In the west a bribe is not always possible.
In the U.S. there were 71,000 pages of new rules, regulations, and unlegislated laws imposed in 2012. In 2011 the number was 82,000 pages. Each of these rules limits or imposes requirements on something, often economic activity. Slowly the unelected and unaccountable bureaucracies of the world are strangling the golden goose.
A final worrying thing in today’s economy is the slowing of worldwide economic growth. The Chinese economy looks like it will grow about 7.5% this year, after 13 straight quarters of slowing growth. That’s down from a high of well over 10%.
The U.S. will be lucky to see 2% growth this year, down from an average 4% in better economic times. With a handful of exceptions, most world economies will see virtually no growth, and some will experience contractions. Brazil grew at 7.5% in 2010. It has slowed to 0.9% today. South Korea went from 6.3% growth in 2010 to 2% now.
A healthy economy helps everyone, from the richest to the poorest. Economic growth is vital. If overall economic output is declining or merely holding steady, most companies will not be able to increase their sales, profits, and employment which are the primary drivers of economic expansion. New labor entering the job market will discover finding employment difficult.
The world way may muddle its way through these problems, but then what?