China warnings

In the past few days there have been three new interesting media outputs that warn of growing risks of a Chinese hard landing. The first is by, of all institutions, the Australian Treasury. In a new Working Paper full text below), Treasury offers a respectable assessment of Chinese macroeconomic navigation through the GFC, and the growing imbalances that have resulted.

The paper includes a measured but nonetheless thumping critique of the notion of “decoupling” that took hold of the weak minded in 2008:

Arguments about decoupling were based on the growing trade integration in Asia, centred on China, and the large potential within the Chinese economy for domestically‐driven demand. According to this argument, China and its regional trading partners increasingly represented an independent engine of growth for the world economy, less dependent on demand from the USA and the major economies of Europe. Moreover, notwithstanding the People’s Bank of China’s (PBoC) substantial holdings of US treasuries, China’s financial sector had limited exposure to that of the USA. The counter argument was that China’s growth continued to be highly dependent on final demand for exports in the advanced economies, suggesting a severe downturn in the USA and other advanced economies would have to impact the Chinese economy.
While China’s relatively closed capital markets protected it from the financial fallout from the crisis, trade proved to be a key channel for transmitting the financial crisis to the Chinese economy. The growth rate of exports and imports declined in November 2008 and continued to be negative until November 2009 (see Chart 2). The USA, the EU, and Japan account for about half of China’s exports. China’s exports to these regions fell substantially as demand in these economies contracted.

It continues with some detail of the stimulus package before turning to risks that are now gathering, firstly of excess liquidity, the housing bubble and general inflation:

While pumping liquidity into the economy supported China through the crisis, there are increasing signs of excess liquidity. Property prices have reached levels well beyond the reach of average income earners in some of China’s major cities, such as Beijing and Shanghai, leading to concerns of a property price bubble. Speculative investment has appeared in areas asobscure as tea and garlic as investors seek returns through capital gains across the economy.

Next, the threat of a too low currency:

The cost of a gradual nominal exchange rate adjustment is that China will continue to accumulate foreign reserves, making it even more difficult to control liquidity, fuelling inflation pressures. It also makes China susceptible to speculative capital flows attracted by expected appreciation of the RMB. To help combat inflation, the Central Government may need to reassess the speed at which it allows the nominal exchange rate to adjust.

And the threat of rising defaults:

Excessive reliance on debt leads to concerns about the possibility of non‐performing loans (NPLs). The CBRC has indicated that RMB 1.76 trillion out of RMB 7.66 trillion of the local government financing vehicles loans in June 2010 were at risk of default (, 2010).

NPLs are likely to increase, with most outstanding debts ultimately falling upon the Central Government. This is because the NPLs will largely belong to government banks offering loans to LGFVs. With the Chinese Government working under a single hierarchy, any debts in the government‐owned banks and local governments will ultimately be passed to the Central Government.

And finally, the difficulty in raising consumption share:

There are three broad drivers of growth in the Chinese economy: consumption, investment, and net exports. The Central Government is committed to raising the consumption share of the economy. However, consumption is a relatively stable contributor to economic growth, and it will take many years for policy to raise the consumption share substantially. It will require reforms to raise household incomes, including social security and health reforms, and policies aimed at raising the wage and capital incomes of households. It will also require a reduction in the savings rate at a time when the aging of the population will raise the dependency ratio and increase incentives for households to save.

Ultimately, the study is optimistic but it’s not bad for a government department whose bosses have hung the nation’s hat on this one single peg.

Of course, none of this is remotely new. And some perspective on how conservative this one release is is offered by a recent CCTV discussion in which a spectacularly paternalistic anchor led a lively debate with the excellent Patrick Chovanec and the head of the Financial Times Chinese wesbite. I mean, if the Chinese government’s media mouthpiece can discuss a hard landing and the need to sustain growth for political control, then the Australian Treasury’s single research paper looks a bit paltry:

Finally, last week, BusinessWeek published a story on the likely fallout from a Chinese hard landing. It included a nice assessment of the recent ratings agency concerns about the NPL problem:

Moody’s Investors Service (MCO), the credit ratings agency, says China has underestimated by half a trillion dollars the exposure of state-owned banks’ loan portfolios to local governments. Despite five interest rate hikes since last October, inflation is now running at 6.4 percent, the fastest since 2008. Second-quarter gross domestic product grew at 9.5 percent, its slowest pace in almost two years.

… If a crash or slowdown occurs—which most analysts define as growth below 7 percent—it will be brought about either by inflation or a reversal in real estate. The Chinese Communist Party is loath to allow high inflation, says Chovanec. In the 1940s, hyperinflation turned ordinary Chinese into Communists. Inflation of around 20 percent was one reason protesters took to Tiananmen Square in 1989. Should inflation exceed 10 percent for long, “they pull a Volcker,” says Chovanec. Paul Volcker, the former U.S. Federal Reserve chairman, defeated high inflation in the U.S. with rates so steep they plunged the country into severe recession.

In real estate, the party has gone on too long. As Nicholas Lardy of the Peterson Institute for International Economics points out, inflation in China is outstripping the one-year savings deposit rate of 3.5 percent. That prompted many Chinese to pour parts of their savings into apartments. Already, 9 percent of economic output comes from residential housing investment. It was 3.4 percent in 2003. With the building boom well under way, supply is finally outstripping demand. The unsold inventory of apartments has gone from zero last summer to about three months’ worth now, according to Standard Chartered Bank.

If apartment prices fall steeply, ordinary Chinese could lose their savings, and local governments will be unable to pay off the loans they took out to invest in residential and commercial projects. Local governments also rely on land sales for over 60 percent of their revenues in some cases, says City University of Hong Kong political scientist Joseph Cheng. In a property bust, few will be buying land. A real estate reversal would drag down local makers of steel, cement, and household furnishings.

Victor Shih, a political scientist at Northwestern University who studies the local debt problem, says the banks are reacting to poor returns on their investments in everything from real estate to subway lines. “Banks’ focus now is to use existing credit to ensure loans don’t go into default,” says Shih. “That makes credit to new projects more difficult—one reason we are seeing a slowdown.”

Moody’s estimates that 8 percent to 12 percent of China’s total loan portfolio could be nonperforming: The official figure is 1.2 percent. Earlier this year, Fitch Ratings warned that nonperforming loans could reach as high as 30 percent. Especially vulnerable are small businesses. They account for 80 percent of employment, according to China’s Ministry of Industry and Information Technology, yet struggle to get credit. “They don’t have adequate liquidity at all,” says Dong Tao, Hong Kong-based chief regional economist at Credit Suisse.

The piece goes on to offer the following assessment of the effects:

Fitch, which in June published an essay on what slow growth in China would do to the world, says China’s key trading partners in the Asia-Pacific region would be most affected. If China grew only 4 percent in 2012, says the Fitch report, a sharp drop in commodity exports to China would hurt the Australian dollar, which in turn would force interest rates up, which would finally hurt the overheated housing market.

That last bit is a pile (in fact, the whole piece could be better). If China grew at 4%, commodities would be routed, Australian inflation would collapse along with the dollar. There’d be no reason to raise rates. That’s not to say that housing would benefit. The Australian banks would come under major hedge fund assault. The outcome would depend entirely on what kind of support was given to the bank/housing complex. I suspect it would be everything and the kitchen sink.


  1. Deep in concentrated reading, and ‘that’ came on, and shocked the daylights out of me!

    • Torchwood1979

      Yeah, is there an Autoplay=False (or similar) option in the embed code?

      Anyway I was listening to The Deftones so it was odd hearing this female voice behind some angry man voice.

  2. These recent musings on a China slowdown drove me back to the early 70s to reread the forecasts of what would happen if the Viet Cong ‘won’. They were, as much of the recent material is, based on Western perceptions of Asian behaviour. Unfortunately they all neglected the very pragmatic and patient outlook common to Asian policy makers and hence were wrong.

    So, I think that the Chinese government does make mistakes and often reacts slowly to change things but it always takes a very long view which our election driven governments cannot bear to bring themselves to do.

    As to inflation of house prices, don’t restrict it to the major cities, it is all across the country, it just differs in degree and ‘price’. But despite the extraordinary rate of home ownership there is a demand for new (or at least larger and more modern) units which still has to be met. And there is an aversion to moving into a greenfield site so it is often not until all construction is complete that anybody actually moves in. That is however not to downplay the housing bubble but it’s characteristics are not those of Western nations, just uniquely Chinese.

    • “As to inflation of house prices, don’t restrict it to the major cities, it is all across the country, it just differs in degree and ‘price’. But despite the extraordinary rate of home ownership there is a demand for new (or at least larger and more modern) units which still has to be met. And there is an aversion to moving into a greenfield site so it is often not until all construction is complete that anybody actually moves in. That is however not to downplay the housing bubble but it’s characteristics are not those of Western nations, just uniquely Chinese.”

      That doesn’t sound uniquely Chinese to me…

      • Bubbles have one thing in common…everyone claims this time will be different.

        As HnH said, not wanting to move to the sticks (greenfield sites) and wanting bigger and nicer homes…that is your Aussie Housing Battler right there. The yanks and poms were the same.

        There is not much to seperate the housing bubbles of the world. They have a lot more in common with each other than their apparent differences

      • Have a look onsite and see what really happens! For example, in a small city (about 4 million) a development of about 400 houses with some 300 completed to the state they are sold in (not ours, no fixtures and fittings there) but only 1 occupied. And that by a ‘gatekeeper’.

        But once it is finished then most will be fitted out and people will move in.

        Here there will be the odd unoccupied house in a development but certainly I’ve not seen 299 unoccupied places.

        • I dont get your point Jim…what makes China’s real estate boom not a bubble? They are using debt, they are driving the price higher and higher, the average worker cannot afford to buy a house…

          Explain to me why China is different, if that is indeed what you are explaining

          • I worked in a centre of economic orthodoxy in Canberra for many years and we thought we understood Asian countries. But every prediction came to naught.

            Then came the light and I moved North. Then I worked in ‘small’ cities in China. If you can imagine an economist teaching English to incredibly eager pupils do so. It is fun by the way.

            But China is just not in tune with the West nor with our thinking on policy or economics. They have incredible patience and will try things out and keep on trying. To add to it their data is not just poor, it is out of this world. Provinces do what they want but report what they think needs to be heard. Business has even more dramatic problems with adherence to instructions and policy (‘If 20% do what we tell them we are lucky.’) but it percolates on.

            However, the general effect is odd. Somehow it works, not as the central authorities think it should and not as we think it possibly can. I hope to go back next year even though the market there for 70 year olds is drying up. I may end up in a city I’d rather not be in.

            Thinking about it I’d put it this way, try to imagine Alice in wonderland crossed with the Wizard of Oz. It’s fun and, until you’ve lived there and got to know the people at the working level, it seems to make sense of a sort. And then it changes.

            Marvellous people but they do not think like us and our ‘iron clad laws of economics’ (thanks Burgess Cameron for that one so long ago) just do not work there.

            Or that is my take on the situation.

          • Wonderful insights Jim – I enjoy the ‘on the ground’ stuff – and would love to hear more.


    • Thanks, Jim. I’ve been seeing “China’s Hard Landing” stories for 25 years now and I guess they’ll keep coming for another 25.

      Like you, I’ve tried to analyze their deeper origins, and here’s what I’ve come up with: The Chinese must be not only hopelessly corrupt (unlike ourselves, of course) but also more ideologically rigid (as Communists) so it stands to reason that they’ll make decisions that are at least as stupid as ours. QED.

      But the top Chinese leadership is NOT as corrupt as ours (both Hu and his designated successor, Xi, are notoriously honest). They are also engineers, which means that they’re trained to solve problems efficiently and flexibly. These two qualities (prerequisites for CCP membership) give China an almost unimaginably vast advantage over our crowd of quibbling lawyers.

  3. “if the Chinese government’s media mouthpiece can discuss a hard landing and the need to sustain growth for political control, then the Australian Treasury’s single research paper looks a bit paltry”
    +1 Something that has boggled my mind for some time now.
    It seems our treasury , central bank and media commentators (with the sole exception of John Garnaut) don’t have a plan B to push their FutureBoom! story.

  4. I’d agree that exchange traded commodities would be routed if growth dropped to 4% — e.g. base metals prices since the GFC have been decoupled from supply/demand balances so 4% growth would probably see a collapse in sentiment and some big shorting.

    It is not immediately obvious to me that 4% growth would result in a drop in demand for iron ore and coal or whether it would result in a drop in the growth of demand.

    • I’m not sure I agree with this. If we assume 9% growth rate made up of 6% fixed investment and 3% consumption, becomes 5% growth rate made up of 3% consumption and 2% fixed investment (hypothetical numbers) then both current resource demand and the future rate of resource demand growth more than halve. And this from the economy that accounts for (from memory) between half and three quarters (or more) of marginal demand for most base metals/commodities. If those numbers constitute a ‘soft landing’ (and they may be indicative of what the Chinese authorities are ultimately trying to achieve) then this could still see a rout in commodities. Augmented by the speculative money in the asset class. Just MO.

      • That was actually my point. I can see how the growth in demand would drop but it isn’t clear why the absolute demand would drop. In other words if you shipped 100 units to China now and expected to ship 107 units next year but instead shipped 103 units it doesn’t follow IMO, that these means bad things for suppliers of those units (iron ore and coal). At the moment supply is working overtime to keep up with demand and will supposedly be the case for at least another couple of years. If absolute declines were forecast then that would be another thing entirely but that doesn’t appear to be what is being forecast.

        • I’m with you then. Last time I looked, Materials sector valuations looked relatively cheap on current earnings, suggesting the market is skeptical about sustainability of growth rates, which is probably a good thing. I expect there’s still plenty of scope for volatility though, if spot commodity prices were to correct sharply.

  5. H&H thanks for the post. It’s hard to get the real deal on China, but there are points in your blog that I’ve seen.

    We were going to invest in a Chinese enterprise in April, but after DD we pulled out. One of the reasons was mainstream Chinese credit availability. We did find out later that shadow banking in Shanghai had plenty of credit, but at a price.

    I saw yesterday that Roubini now thinks there will be no hard landing, but during May and June from what I saw he was betting on a hard landing.

  6. Anyone else think the quality of the questions and interjections by the host was way above what is normal in the Aussie press? I had forgotten that there is a middle ground between being hostile and sycophantic.

  7. Yes Steve, I thought it was delightful. The host seemed very knowledgeable and although I get H&H’s reference to ‘paternalism’ she didn’t brow-beat her guests and seemed quite playful at times.

    I must admit I was surprised at the candid assessments of the econmy and government policy and will have to revisit my assumption that the State media would only allow rose tinted propaganda to be broadcast.

  8. Glad you posted this today. Will make all doubters understand just why we (Australia) must hope that China has a soft landing.

    FFS, the Bank/Housing complex under hedge fund assault, the government to throw everything at it, including the kitchen sink, in support…and if they did not?

    There seems to be some serious lack of understanding as to the role the current resources boom is playing as our ‘hedge’ against such a HF play directed to the bank/housing complex and that this is what is preventing us going into an Irish slide.

    In preparing the report, Treasury has undertaken similar analysis to the majors by looking at all possible scenarios, China soft (most likely?) and China hard landing…and of course Futureboom! At some point, when formulating policy, a direction must be decided upon and Treasury has taken the view of the majors that in the short-medium term strong continuing growth, medium term lower but consistent growth and beyond that, really a bit of a bet. Appropriate to a land of gamblers.

    Anyway, at this point as Chovanec says “What landing?”, forecasts of 9.4% GDP remains strong growth, inflation remains an issue. A correction of some kind will occur, but when. Fitch’s 4% would be difficult in the short-medium term for many resource companies, resources demand not growing at pace and potential for considerable supply likely to have some effect on prices but honestly, growth at 4% – I just can’t see that, I’d go as low as 6-7%.

    It ain’t over, until its over.

    • The Fitch 4% growth is an outlier in my view. That would take the HARDEST of landings. Seems to me that if they are serious about rebalancing, sustained growth in 6% to 7% range is more likely. But that would make life quite hard for us…

    • Even if growth did slow to 4%, the impact on our resource exports depends a lot on what sectors of the economy slow and how long the slowdown lasts. A short, sharp slowdown may not have that great an impact.

    • Will make all doubters understand just why we (Australia) must hope that China has a soft landing.

      Because that’s all we’ve got now: Hope.

      Fanboy, why do you think cheerleading the China boom onwards and upwards will make any difference? Its clearly unsustainable, and will crash and burn at some point.

      Australia should be preparing, not cheering. Cheerleading won’t prepare us for the inevitable crash.

      • It may indeed crash and burn at some point.

        But I’m not going to waste my time wringing my hands and wailing waiting for it to happen.

        Hope. Humanity is built on hope of one kind or another. It’s a good thing. So I hope China continues on for years – enables a stable(ish) deleveraging here, perhaps a government to return to surplus and buys time for our businesses to recalibrate in an economic environment minus a credit bubble. The new normal. Hope is better than no hope.

        And Lorax, just how would you prepare – for an event that may or may not happen, at an undetermined time for an unknown period?

        Better hope it doesn’t!

        • “… buys time for our businesses to recalibrate in an economic environment minus a credit bubble. The new normal.”


          • buys time for our businesses to recalibrate in an economic environment minus a credit bubble

            It does nothing of the sort. While the China boom continues many (most?) businesses will struggle. The only trade-exposed businesses that can survive a dollar at $1.07 are mining companies.

            The boom may well help the government return to surplus, but government debt is not our big problem, private debt is.

            I fail to see how a weak domestic economy is going to help households reduce debt.

            And Lorax, just how would you prepare

            Tax the bejesus out of the mining companies and save the proceeds for one of two eventualities:

            a) China crashes and burns and we need revive our non-mining export sectors

            b) China continues booming for decades, and we need to pay the massive welfare bill for all the people who used to work in non-mining sectors.

            Either way we need to be saving a lot more of the one-off mining bonanza. Hope does not pay the bills.

  9. On other comment … I like to see the US rating agencies put as much vigour into looking at the US as they do into China.

    It’s the old point to spotlight at someone else. Today China, and tomorrow EU again etc., but we get a feeble analysis of the US every time.

    I know why, but who do they think they are kidding.

      • That’s interesting as well since the jobs going to lower labour countries is the Chicago’s schools prime directive and likewise in most western countries we follow that. Even in China they moved industries from the east coast to the centre to get cheaper labour, and now they are moving industries to Vietnam and other countries.

        As an engineer I see the IP world as well, and China is getting to a leading position in a lot of fields with it’s IP. One other point is the about 75% (2009) of US patents were originated by non US citizens. It’s a damning indication of their ability to get local students into industry. Go to a US university and see home many are local students … not many.If you look at Apple they brought all the Nortel patents as they know it’s money for old rope. I could go on about just this issue, and in many fields the money flow is massive. As an Australia example (CSIRO’s WiFi patent generated about a billion…maybe more over time).

        There are lots of issues like this that are structural that just are not addressed, and the problem is caused, by some other country as far as the US is concerned.

        This is a huge topic IMO.

        • US undergraduate standards are so, so, but their graduate schools are very good, far better on average than what you find here, so understandably they attract the best and brightest from around the globe.

          • That’s very true, but locals are not achieving. The ratio of students completing college and being able to get the GPA is very low is my point.

        • Excellent!

          I once tried to find the Save the Rainforest clip for something someone here once said – now I know where to look.