OVER the past several months it has become quite obvious that the Chinese economy is “cooling.” The Chinese themselves refer to it as “the new normal,” an environment in which the economy is supposed to be more domestically focused, growing at a rate closer to 7 percent per year than the 9 or 10 percent pace of the past several years.
Because China is so unpredictable, it was difficult at first for outside observers to reach a consensus about whether Chinese policymakers were describing a legitimate, sensible policy direction or trying to put lipstick on a pig. The general feeling was that it would be the latter if it were the leadership of any other country prattling about “the new normal,” but because China’s performance has defied conventional wisdom so often, no one could be really confident in predictions of the Friendly Red Giant’s imminent demise.
The crash—although “crash” may actually be an overstatement—of the Chinese stock market last week seemed to be the confirmation of everyone’s worst fears that everyone was waiting for, because the reaction to it whipsawed through the rest of the world’s markets almost instantly. Investors rushed to dump everything whether it made any logical sense to do so or not; about the only people who were not rattled were those whose investments were in gold or cash stuffed under the mattress. And why not? When even the eternally optimistic Chinese press starts referring to a market collapse as “Black Monday,” one naturally assumes that a major disaster is unfolding.
A Saturday (Aug. 29) editorial in The Economist made a couple of points that should remind us to be a little discerning about getting swept up in a panic over a collapse in China. Right now, there are three basic fears gripping the world, according to the respected journal: One, that China’s economy is in deep trouble, more than the Chinese leadership is letting on or than is evident in recent declining indicators (GDP growth, manufacturing output, imports and exports); two, that emerging market economies, particularly in Asia (the world’s current bright spot), are extremely vulnerable to a Chinese downturn; and three, that the “recovery” in developed-markets economies is over (which means that they, too, are vulnerable to any decline in China).
The Economist points out that China has recently made some frankly stupid decisions, namely, excessively manipulating the value of the yuan and making what was ultimately a futile attempt to prop up equity prices through various stock-buying schemes and other market interventions. However, there is the matter of scale. China’s consumer market still vastly outweighs its overseas market, and probably always will; consumer spending has tailed off in recent months, but not nearly to a degree (yet) that would cause real contagion. Chinese equity markets, spectacularly volatile though they may be, are a relatively small part of the economy; the property sector—which supports the banking sector—is several orders of magnitude greater in value and importance, and in defiance of all outside expectations, has seen prices and transactions improve over the past couple of months. Chinese per capita income has been relatively stable, even improving a bit through most of this year, and if things start to really stagnate, the People’s Bank of China even after a rate cut last week still has ample room to adjust policy.
The bottom line, The Economist seems to be implying, is that pure inertia will at least for the near future keep China from causing serious harm to the rest of the world economy, provided the rest of the world doesn’t let itself be overwhelmed by its own malaise. “The economy is slowing,” The Economist says, “but even five percent growth this year, the low end of reasonable estimates, would add more to world output than the 14 percent expansion China posted in 2007.”
Even so, that is not enough to say that a serious crisis will not happen, or cannot happen. A scenario such as, for example, a collapse of one or two of China’s big four state-run banks is plausible, however unlikely it may seem now, because there are definite structural handicaps Chinese planners have to confront. For one thing, China is not very productive; its incremental capital-output ratio (ICOR), a measure of how much capital is required to create one new unit of capital, has climbed from about 3.0 in 2007 to just over 6.0 now. That is an indication of excess capacity, or put another way, over-investment relative to returns. For the Chinese economy to ‘stabilize,’ so to speak, it needs to shift its focus in a comprehensive way.
Doing that will most likely cause some turmoil, and that could lead to serious, albeit relatively short-term, trouble for some parts of the world. But it seems now that it will take something far bigger than we can even conceptualize—and therefore, bigger than can possibly exist in our three-dimensional universe—to cause the calamity everyone wants to be afraid of. The “China problem” is not so much a “problem” as it is an “issue,” or “area of moderate concern,” and the rest of the world would probably do itself a favor by dialing back the hysteria by a couple of notches.