Pettis: China to keep slowing

Good stuff from Michael Pettis at Bloomie (a few weeks old but worth revisiting):

What’s less-understood even now is that if China begins a serious deleveraging, reported GDP growth rates will fall by a lot more than expected – by more than the amount of non-productive activity that had formerly been capitalised. This is clear from the historical precedents. In every modern case where countries enjoyed similar investment-driven growth “miracles” and then suffered painful adjustments, medium- and long-term GDP growth rates slowed much more than even the most pessimistic projections.

…After many years of overstatement, then, reported GDP growth rates will begin to understate real growth in the underlying economy. This can happen quickly in the form of a crisis or, as is more likely in China’s case, it can take place over many years as seems to have happened in Japan.

The second way in which balance-sheet dynamics will push down growth is by forcing a heavily indebted economy to absorb what finance specialists refer to as “indirect” financial distress costs…We can already see this process at work in China in the form of capital flight, private-sector disinvestment, regulatory maneuvering and elevated levels of financial fraud.

In short, Japanifaction cometh. Do not mistake any short term cyclical rebound with a resolution to these structural issues. More and more, the faulty structure of growth is dragging on cyclical recoveries, such that we’re passing through the point now where the former overwhelms the latter and no matter how much new stimulus is injected it is greeted with little more than a dull grunt in the real economy.

This is Australia’s real challenge ahead. Much lower commodity prices and its own structural adjustment to two decades Chinese distortions via lower asset prices, lower wages and a much lower currency. In short, a much lower real exchange rate.

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