We look at china with envy. Its economy grew at 10 percent a year for a decade without skipping a beat. Even during the financial crisis, while the global economy was contracting, China’s grew at more than 6 percent. It seems that China’s “Confucian capitalism” — a concoction of an authoritarian regime and a free-market economy, supersized by the nation’s 1.3 billion population — is superior to our touchy-feely, garden-variety democracy and capitalism. But the U.S. shouldn’t hurry to trade in our political and economic system.
To understand the Chinese economy, we need to begin our analysis in the late 1990s. At that time, the Chinese government chose a policy of growth at any cost. To achieve it, China for the next decade kept its currency, the renminbi, at artificially low levels against the dollar; this helped already-cheap Chinese-made goods become even cheaper than global competitors’. If free-market economic forces had been at work, the renminbi would have appreciated and the dollar would have declined. However, if China had let its currency appreciate, its exports would have become more expensive and demand for its products would have fallen.
Remember the movie Speed? If Keanu Reeves didn’t keep the bus moving at more than 50 miles per hour, it would explode. Well, China is like a bus packed with more than a billion aspiring capitalists. If the Communist Party can’t keep the economy growing at a fast clip, the result will be catastrophic — rising unemployment, which will lead to political unrest and rioting.
In China political pressure for full employment has led to what I call late-stage growth obesity. China built the largest shopping mall in the world, the New South China Mall: Today it’s 99 percent vacant. China also built a lavish city for a million people, called Ordos: Today it’s a ghost town.
All good things come to an end, and great things come to an end with a bang. In the midst of the crisis, exports from China were down more than 25 percent, tonnage of goods shipped via its railroads was down by double digits, and its electricity consumption plummeted. According to the Chinese government, however, the nation magically sustained 6 to 8 percent GDP growth.
Let’s fast-forward a year. Today the global economy is stabilizing. But the consumers of Chinese-made goods are overleveraged and now deleveraging, unemployment is high, the banks have gotten religion and stopped lending, and there’s not much demand for loans anyway (except from the U.S. government). You might think the Chinese economy would be growing at a slower rate. But China’s growth rate is again approaching 10 percent.
Though this growth appears to be real — electricity consumption is back up — it is not sustainable, because it is based on an unprecedented stimulus package and extraordinary government involvement in the economy. Unlike Western democracies, whose central banks can pump a lot of money into the financial system but can’t force banks to lend or consumers and corporations to spend, China can achieve both at lightning speed.
The Chinese consumer will not pick up the demand slack for the U.S. and European consumers who are focused on keeping their jobs and paying down their debts. It will take decades for this to happen. U.S. and European consumers each represent two thirds of much larger economies. Chinese consumers make up only one third of their economy, and their purchasing power is significantly undermined by the undervalued renminbi.
The ascent of China over the past decade has lowered the degree of separation between it and the global economy. In fact, today Chinese economic growth is the force pushing the global economy. However, this growth is predicated on massive forced lending, and as it slows, China will transform from a wind in the economic sails of the world to an anchor.
The impact will be felt in many places. It will tank the commodities markets, commodity producers and commodity-exporting nations. Demand for industrial goods will disappear. Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates.
It may seem, at least for a short time, that the laws of economics work differently in China. This, however, is only a temporary mirage, which must be followed by huge pain and drastic consequences. Everyone wants a shortcut to greatness, but there isn’t one.
Vitaliy Katsenelson is the director of research and a portfolio manager at Investment Management Associates in Denver, and the author of Active Value Investing.
