Beijing winning the right to host the Olympics is symptomatic of an unsubstantiated China fever. Those who chose to believe the promises made by the communist authorities to allow free and open reporting and to clean up the environment did so by suspending their sense of reality.
And so it is that many people choose to believe that China's economy will continue it heated pace of growth despite the economic doldrums afflicting much of the rest of the globe. Even so, China is widely expected to continue growing at around 7.5 percent this year. A pause is in order here since exports constitute one-quarter of China's GDP.
According to the official Xinhua news service, China's exports fell by 0.6 percent year on year to US$22.08 billion for June; compared with a 3.5 per cent increase in May and an 11.1 per cent increase in April. Consequently, export growth for the first half of the year was only 8.8 percent, after growing at nearly 28 percent last year. If such high rates of export growth were needed last year, how can high growth be sustained after such a sharp decline.
Attitudes about China's economy bring to mind the giddy notion that high growth in Japan Inc came from the discovery of a new economic paradigm. Whoops! Then, Japan's "bubble" economy unceremoniously blew up in the late 1980s. With so many people blowing hot air into China's balloon economy, those wishing to avoid injury when it crashes to earth should consider the following.
As it is, belief that Chinese growth rates can defy gravity by ignoring economic laws is based upon several mistaken beliefs. These are related and are based upon a faulty theoretical construct that prescribes manipulation of the demand side of the economy. In particular, a mistaken belief has it that increased consumption drives an economy, and similarly, that government spending can generate real and sustainable growth.
On the one hand, China's continued growth is being heralded as the result of strong consumer demand and domestic investment. Improvements in consumer confidence since early 1999 has contributed to rising domestic retail sales that grew by over 10 percent in the first five months of this year, reaching 1.5 trillion renminbi (US$181 billion).
On the other hand, a World Bank report estimates that public-investment will boost growth by between 1.5 and two percentage points to growth this year. Such spending is justified on the basis of a slowdown in export demand.
Let's check the logic. It turns out that sustained increases consumption are a consequence instead of a source of growth. Whereas loose credit can unleash a false sense of prosperity that promotes temporary boosts in buying, new rounds of sustainable consumption only come from increased employment and rising real wages that result from investments into productive activities.
Likewise, government spending only rearranges real assets. For net economic gains to occur, public spending must be more efficient than if used by the private sector. History offers few examples of this phenomenon, especially when corruption is as rampant as in China.
So what about the ability of China's economy to continue growing? It is said that a robust domestic sector of the economy will keep up growth, but that idea is based upon the two canards of economic logic cited above.
And what about the many structural defects in the economy? Perhaps the most pernicious of these problems has been deflation. Although it seems to have disappeared from official data, it is likely that it is masked by inflows of foreign capital that have allowed money supply figures to increase and to create more funds to be squandered by state-owned enterprises (SOEs).
Logically, deflation is a continuing threat as long as there is a large hangover of bad debt, as is the case in China. With real interest rates reaching as high as around 10 percent recently and with the high degree of inefficiency of many SOEs, it is not surprising that the proportion of non-performing loans became so large. Beijing's recently revised its own data on bad debts held by state banks that was set at nearly 12 percent of GDP. Estimates of outside observers put non-performing loans closer to 25 percent of GDP or more.
As it is, investments in China are beginning to take on the air of a Ponzi scheme. Having reached the plausible limits of wasting the savings of the citizenry through the banking system, now the government has a new scheme for commandeering wealth by undertaking "reforms" of domestic capital markets that opens them more widely.
Unfortunately, without accompanying changes in the operations and efficiency of enterprises with state connections, punters in these markets will face steep losses. Ironically, Beijing will almost certainly blame the faulty operation of markets for future losses in shareholder values, even though these are predictable and have been essentially orchestrated as a matter of policy.
With a range of a few rotten options, it is understandable why Chinese citizens can be suckered into going along with Beijing's evil plan. However, it remains a mystery why so many outsiders buy into this wobbly situation.
Portraying both portfolio and direct investments as a "pyramid scheme" is an apt analogy for China. Should be a significant slowdown in the inflow of foreign capital, China would almost certainly face the specter of a banking crisis and possible industrial collapse.
It is unlikely that China's economy can defy the drag of gravity from the slowdown in the global economy. One has to question why so many people stubbornly cling to such a fairy tale.
Christopher Lingle is global strategist for eConoLytics.com and author of The Rise and Decline of the Asian Century.
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