As the world braces for what looks like a possible second economic downturn, it is increasingly important to understand how China weathered the first one. Today and tomorrow we are going to take a very simplified look at this issue. Please keep in mind that this is meant to give a broad overview and is in no way a complete account.
When the markets started to drop off in 2008, the gov’t took a number of actions to try and prevent a financial collapse in the middle kingdom. They made it easier for companies to get loans, pushed a massive economic stimulus, propped up domestic consumption by offering discounts on things like home appliances and cars, increased college enrollment to delay entrance to the job market (while preparing the next generation of white collar workers), and fixed the RMB to the USD (this one I’ve already discussed).
As the rest of the world has faltered, China seems to have emerge unscathed. But before we start implementing Soviet style 5-year plans in the US, it’s important to consider the long term effects these measures are having on China’s economy three years later, and whether or not they are the success they first appear to be.
Company Loans & Stimulus Spending
Much has been made in the U.S. of China’s stimulus spending and how it helped maintain China’s GDP growth. I think the benefits of this are not yet clear. Instead of the gov’t literally giving money to local gov’ts to spend (something like what happened in the U.S.), the Chinese gov’t required the banks to make these loans. This has had a few important ramifications that have not yet been resolved.
One of the major issues is that this allowed local gov’ts to borrow far beyond their means. It is estimated that these local gov’ts now hold over $2 trillion in debt which financed their infrastructure projects. While many visitors to China have marveled at the Party’s ability to construct high-speed rails and other expensive projects during the recession, few realize they were funded in part because of the need to stimulate the economy and that the resulting debt is held by ministries and local governments instead of the Central gov’t.
Another way of describing this stimulus would be to say that China created a line of “easy credit” (which you may remember as the villain of the US downturn). This has made investments in areas that were traditionally considered too risky or too low yield to be attractive to local gov’ts and state owned enterprises. As Dan from China Law Blog caught, at least 60% of Chinese companies have now invested in property, and many others are engaged in gray market lending. This is a large part of what is fueling China’s real estate boom, which many are calling a bubble, and has helped keep China’s GDP enviously high.
The catch here is that the loans made to local governments were taken out against gov’t land holdings, whose prices have increased dramatically over the past few years due to speculation done by companies who can borrow money at low rates from the banks because of gov’t encouraged loans. This reinforcing loop has allowed local gov’ts to spend far beyond their means and has pushed property prices beyond the reach of many Chinese.
If the property bubble bursts, the source of revenue for many local govt’s will disappear; they will default on their loans and the land they used as a guarantee won’t be worth as much as the banks had bet on. Patrick Chovanec compared China’s economy to Wile E. Coyote, “He’s running and running and goes off the cliff, and as long as he doesn’t look down he’s fine. But when he does – he drops.”
However, there are also many who would argue that China is rapidly urbanizing and only recently removed restrictions on housing prices, so the 400+% increases seen in some cities may actually be moving closer to the actual value of the property, since it was far undervalued before (or the bubble deflates instead of bursts). The gov’t has also been cautiously monitoring the housing market and local gov’t debt issues, and may be able to guide the economy. One of my Chinese friends recently bought a new apartment based on this line of thinking. He argued that as long as enough people believe that the gov’t can control the prices, the market will remain stable and in 10-15 years, his investment will pay off.
China’s loans have helped grow both the GDP and a possible property bubble. They have created a number of jobs through massive infrastructure projects, but those projects have also displaced a huge number of farmers. All in all its still not yet clear whether or not China’s creation of easy credit has created a sturdy foundation for future economic growth.