Red Alert! China's economy heads for a hard landing

Firstpost talks to economists who felt the pulse of China's economy - and found it failing.

Vembu May 09, 2011 06:05:29 IST

As the Air China flight enters Beijing's skies and prepares for landing, the cockpit radio in the passenger cabin crackles to life. The message is grim. "This is your Captain speaking," the voice says, not caring enough to mask the tension in it. "Three of our engines have failed, and we're in for a real rough landing. Passengers, please assume the brace position."

For a world of investors who have long been used to the cocooned comfort of a high-flying Chinese economy, the message from the cockpit today is nerve-wracking. China's high-octane export-driven economic growth model, which was the envy of the world for some 30 years, is coming to an end. And efforts by the crew to change the flight path to a domestic consumption-led economy aren't working to plan. Worse, the structural flaws in the economy, which had been neglected for too long, and a string of human errors by those in command, have compounded the crisis. A hard landing, the shock of which will reverberate around the world, seems inevitable.

That's the disquieting message from economists, market analysts and China-watchers who have a sharp eye out for macroeconomic trends in China - and an ear to the ground to catch anecdotal evidence that validates their theories.

'A dangerous point'

"This is a pretty dangerous point in the development of the Chinese economy," says celebrated economist Dr Jim Walker, who famously prophesied the 1997 Asian financial crisis and the apocalyptic global financial meltdown of 2008. "We're going to start hitting in China a tremendously dangerous period of potential stagflation, where output is falling (or not rising very fast) and inflation has risen. The danger signs are definitely there."

In an interview to Firstpost in Hong Kong last week (see video below), Walker, who heads Asianomics, an independent economic research consultancy, outlined the reasons for his uber-bearish outlook on China.

Nor is Walker alone in his Cassandra-esque prognostications. Nouriel Roubini, the rock star of economists, who travelled recently to China, warns that China "is poised for a sharp slowdown" - most likely after 2013. "Instead of focussing on securing a soft landing today, Chinese policymakers should be worrying about the brick wall that economic growth may hit."

And Jim Chanos, the legendary hedge fund investor who famously short-sold Enron (and made billions on that trade), has for over a year now been banging away about China's "unsustainable economic growth path" - and been putting his money where his mouth is.

There's an 'earthquake' coming

Red Alert Chinas economy heads for a hard landing

Gordon Chang, author of 'The Coming Collapse of China'. Photo by Venky Vembu.

To noted China-watcher Gordon Chang, author of The Coming Collapse of China, all this seems to suggest that the central argument and prediction of his 2001 book may finally be playing out.

"China cannot escape the laws of economics," Chang told Firstpost. "It can delay them, but at some point they've got to catch up."

Chang, in fact, sees China's economic problems feeding social and political discontent as well, with calamitous consequences for one-party rule in China. "You have a society that is dynamically moving forward, and you have a political system that is pushing back. That's two big tectonic plates moving in opposite directions - in other words, an earthquake."

How did this happen?

But how did the Chinese economy, which grew at an average of 10% a year for 30 years, suddenly run into a brick wall?

Walker points to short-term policy failings, and longer-term structural problems in China's economy.

In the short term, Walker reasons that flawed monetary policy, which set off an avalanche of money supply to prop up the economy in 2008 when exports collapsed in response to the financial crisis, is feeding stubbornly high inflation today. And although Chinese policymakers are trying to dial that back, he says, they are "miles behind" the inflation curve.

"Meanwhile, the problems keep mounting in China: the economy is getting more and more skewed towards investment and property, and inflation is a major problem. They have to tackle that, and when they do, the economy is going to slow down - and sharply."

A difficult course correction

Chinese policymakers, right from Premier Wen Jiabao, have acknowledged the serious imbalance in China's economy, and are evidently engineering a shift from an investment-led economy to one that is driven by domestic consumption, as envisaged in the country's 12th Five Year Plan.

But Walker believes that such a transition "is an easy thing to talk about, but a very difficult thing to do." And such a transition "also implies bad news for the stock market, much slower growth - and a period where, quite possibly, the expansion of China is finished for a few years."

Longer-term demographic trends also don't favour China's growth model. The recent Census findings showed that China's population is ageing rapidly, which trend is compounded by China's coercive one-child policy. This too has implications for economic growth, points out Walker. Growth in China's labour force - the millions of peasants who were leaving their farms to work in factories in the cities - once contributed 1 or 2 percentage points to GDP growth. "That is now finished, because the labour force isn't expanding anymore." And looking ahead to the next 20-30 years, that demographic trend is about to get a lot worse.

This has led economists and academics to predict that China will "grow old before it gets rich" and fall into a middle-income trap - an economic eventuality where growth tends to slow when per-capita GPP reaches a certain threshold. A recent research study establishes that in China's case it could happen as early as 2014.

Is the 'China miracle' over?

So, what do all these trends and data points mean for China? Is the 'China economic miracle story', which had the world so engrossed for 30 years, well and truly over?

"The China story can still be there," says Walker. "I only think we need to be a bit more feet-on-the-ground rather than heads-in-the cloud about China." That means that China's economy could still grow at perhaps on average 5-6% a year over the next decade or two. "That's still pretty good going, even if it it's lower than the nonsensical 8-10%" that investors have come to expect from China's record of the past three decades.

But even within that 5-6% growth trendline, there will, says Walker, be years of adjustment where the economy grows by just 1% or so. "And that's just something that most investors at the moment don't have on their radar."

It could just be that they haven't heard the Captain's orders to brace themselves for a hard landing.

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