Reality check: economy of China


First thing first: no countries can grow at a double-digit pace forever.

China, the world’s second largest economic power, seemed to (probably) have learned hard lessons from the recent stock crash that is taking place in the last two months: there are no expected circumstances. No matter how many trillions of dollars the government has been pumping in to support the ailing stock market indices, the money is still lost. And now, more than 5 trillion US$ (pretty much the annual output of Japan’s economy) have all but evaporated from the country’s stock markets in Shanghai and Shenzhen.

The recent crash sparked numerous discussions worldwide about the real situation happening in China’s economy. Google ‘China economy’, and most likely the keywords are overwhelmingly negative; many users even question if the economy is none other than a ‘gigantic Ponzi scheme’. And what makes economic risks in 2015 particularly very distinct – and also unprecedented – from the previous crises in 1998 and 2008 are that the problems are three-fold:

  1. There is uncertainty among US Federal Reserve whether to increase interest rates or not – the first time since 2006. Given that the central bank has pumped more than 4 trillion US$ from 2008 up to the end of 2013 into global financial markets, US economic recovery gradually reverses the quantitative-easing policy, posing countries with massive short-term capital inflows at significant risks.
  2. China’s economic slowing-down ‘exacerbates’ the matter. As the world and China increasingly co-depend on each other – especially in international trade, any economic problems inside the country will translate as bigger problems for global economy as well. If, in case, US Federal Reserve decides to increase the interest rates, this will impose increasing burdens for, plainly speaking, a whole lot of people worldwide – especially companies with bonds and debts denominated in US dollars.
  3. The slowing global economy also pushes commodity prices to unprecedentedly low levels; oil prices continue to linger between 38 and 40 US$ per barrel, the lowest since 2009. Dozens of currencies depending on oil incomes have seen their values significantly decline (Nigerian naira, Saudi Arabian riyal, Malaysian ringgit, Zambian kwacha being the biggest casualties), and in fact, most of the currencies whose commodity exports depend on China’s economy are actually plummeting in values.

Given the tendencies for mass media to make any stories overblown, let us do some reality checks on what is actually happening with Chinese economy in brief points below. Some are indeed alarming, but others may be more soothing, so a delicate balance of views has to be considered. These are the things we need to know:

Soothing: China is different from Greece, and its manufacturing output remains huge

With the country expected to have domestic output at over 11 trillion US$ this year, industry-related sectors account for approximately 45% of the GDP composition, slightly larger than those provided by services-related economies. Even though labor costs are increasing very rapidly in recent years (hint: GDP per capita was already 7,500 US$ last year), China’s manufacturing output remains huge, particularly in coastal regions. Initially, there were worries that Greece’s rejection of financial bailouts would result in a blow on Euro values, and therefore spell a trouble in global economy, until China’s stock market crash took its turn as another headline.

Alarming: China has a bad-debt problem

On paper, and on most statistics offered by CIA World Databook, IMF, and World Bank, China’s external debt and public level debts stand at approximately 25-35% of total GDP. But there is one huge caution: debts generated through ‘shadow banking’ (financial institutions that are not listed in the government records) are not counted in the process, and that is an alarming sign. In fact, much of this debt, whether clean or not, is mostly used to fund projects that turn out to resemble more like ‘white elephants’, say, ghost cities. While estimates provide that the actual debt-to-GDP level for China is more than 280% (which may be true), we truly have no idea how much debt the country has accumulated since the beginning of economic reforms in the last almost four decades.

Alarming-soothing: Some portions of these ‘bad-debt’ amount are actually overwritten

Accounting, no matter how tedious it is, sometimes can have its own magicians. This is particularly the case for Chinese state-owned enterprises that build numerous projects overseas – and end up losing money. The question is, do they actually lose the money, or does the money go ‘somewhere else’? Another controversy is overstating debt amount in order to reduce taxes paid, or even to avoid paying taxes at all. While there has been little research about this area, more works need to be done in the future to understand further about such accounting magic tricks.

Still, we don’t actually know how much China owes the world, and most importantly, its own people.

Soothing: Even at an annualized growth rate of 7% this year, China already ‘grows pretty fast’

Even both President Xi Jinping and Prime Minister Li Keqiang acknowledge that fact. The premier, in particular, emphasized that the economy has entered a new normal, and the world has to accept the reality that China, indeed, can not grow at an astronomical pace forever. With increasing labor costs, China will have to move its factories, one by one, to other emerging markets, and upgrade its economic composition to be based more on services and domestic consumption. China’s appetite for natural resources is also gradually declining, and indeed, the slowing economic growth should be a positive thing to celebrate for environmentalists: they are doing really hard to reduce emissions of carbon dioxide, one side effect resulting from the country’s rapid-fire growth in the last 30 years.

Furthermore, with growth rate at 7% this year, China actually still increases 700-800 billion US$ to its annual output, and that quadruples the amount of real GDP produced by India in 2015, for the first time ever the fastest-growing economy in Asia (with an annualized growth rate at 7.5%).

Alarming: Nobody really knows how the government measures economic growth rate

On theory, economic growth is measured through increase in inflation-adjusted market value of the goods and services produced within a certain time period (usually one year). The real problem here, nonetheless, is not about the definition, but WHAT classifies (or constitutes) as the components of growth by the government. Building buildings is one thing, but do they house people? That’s another thing worth concerning about.

Alarming-number two: China’s gross fixed capital formation is actually increasing, not declining

To get you acquainted with this economic term, gross fixed capital formation is, in simple terms, ‘investment’. Something that requires us to spend money in building fixed assets, such as factories, houses, equipment, infrastructure, or anything that can’t be moved (but destructible). While it is necessary to increase the percentage of gross fixed investment at times of rapid economic growth, no economies can incrementally add up the figures forever. There is always laws of diminishing returns: if you invest too much, you end up losing money. And that is what China is actually experiencing.

In 2008, during the height of global financial crisis, China’s GFCI was already approximately 40% of the country’s GDP, among the world’s highest. The almost 600-billion-dollar stimulus package introduced in 2009, intended to boost domestic consumption to support economic growth, was ironically channeled to numerous investment projects instead, many of which are simply unprofitable. That’s why one sees empty cities, little-used highways, and losses-generating projects overseas, when in fact many people in China are still struggling to gain access to basic infrastructure, particularly in hinterland areas. By 2012, the gross fixed investment was already 46%, and it is estimated that by this year, the rate is approaching 50%, an increasingly unhealthy level.

Soothing: ‘stock market crash’ may be an overblown title

Even until mid-2014, the average indices for Shanghai Stock Exchange remained below 2,000. It was only after Chinese government decided to allow financial liberalization that tens of millions of investors, many of whom used financial loans, placed them on companies’ stock prices. In less than one year, the scores shot up to more than 5,500, an astronomical pace so markedly Chinese form of ‘rapid-fire growth’, that when it dropped starting from June, it dropped catastrophically.

Yes, the stock indices are now below 3,000, but honestly speaking, that is still significantly more than the indices were last year. While government intervention was, admittedly, very heavy, including ‘persuading’ (or forcing?) managers of companies and state-owned enterprises to buy up stocks to withhold the drop in stock prices, that couldn’t do much to reduce the impact. After all, stock index is one unpredictable thing by its own. If the government is committed to financial liberalization, the government should regulate investors so as not to excessively use loans to buy stocks, but not to withhold the drop in stock prices.

Alarming: China’s currency depreciation is not going to help its exports

Shortly after the ‘stock market crash’ and the resulting free-fall of currencies worldwide, China’s central bank took an unexpected turn it has barely done since early 2010s: devaluating the yuan at over 3%. It sends even further shrills to currencies worldwide, delivering a dramatic drop for currencies whose exports increasingly rely on China’s economic strength, such as Taiwanese dollar, South Korean won, Indonesian rupiah, and South African rand.

Even the bank’s recipe-as-usual policy to reduce currency values to boost export is already an outdated move given the changing face of global economy today: China has had more trade agreements in 2015 than it was back in 2008, when their trade policies back then were largely protectionist. While it will increase its export volume, it will not be significant. The most important thing, instead, is to focus on its own 1.4 billion people as potential consumers, and that is where Chinese government needs to pay attention to.

Furthermore, China also ‘suffers another blow’ after surrendering the ‘fastest-growing economy in Asia’ title to India: it now relinquishes the ‘world’s largest trade-surplus’ title to Germany; while China records the volume a little above 200 billion US$ in 2014, Germany put in more than 270 billion US$ in the same year. German model of capitalism, which focuses on ‘hidden champions’ and mittelstand, is slowly winning.


BONUS: Oliver Wyman, a respected consultancy firm, has previously forecast that a ‘2015 financial disaster’ will occur back in 2011, and now, what currently happens largely echoes what the analysts had predicted 4 years earlier. Read the full report, and understand things better, by clicking on the link here.


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