China's feeling the economic storm too

I've written a great deal about the economic problems facing the USA and Europe. I've mentioned China in passing, but not in any detail. That needs to change, because China's the world's fastest-growing economy - and the economy most vulnerable to a catastrophic slowdown, which would have far greater social effects there than in other nations. The process appears to be already under way.

The good people at STRATFOR recently produced a short video report titled 'Eurozone Debt Crisis Reveals China's Economic Weakness'. Here's a transcript, printed here with their permission.

The Chinese continue to watch the way in which the Europeans are trying to deal with their financial and political crisis right now. For China this is particularly important. Number one, Europe has become China’s largest export market and that has a major impact, of course, on the way in which the Chinese operate their economy. Number two is that a continued or an even deeper crisis in Europe could pull the entire global economy into recession.

Chinese exports to Europe and to much of the rest of the world saw a particularly sharp drop in 2009. This was something that the Chinese government had to rush to stabilize — they counteracted that dip in exports with a huge increase in domestic investment. The Chinese had hoped, during that time, that the Europeans would simply build themselves back up, pull themselves out of this particular crisis and that China would be able to continue with its fairly rapid expansion of exports to Europe to keep its economy chugging along as China headed towards its 2012 leadership transition.

Although Chinese exports to Europe picked up a little bit in 2010, the rate of growth that the Chinese had been seeing in the previous four or five years slowed down quite a bit. The problem for China is that as the pace of export growth slows, the pace of import growth doesn’t. The Chinese still need a very large amount of commodities. They’re importing these commodities, not only to feed their export market, but to feed all of this new domestic investment. And that means that while the Chinese may not be making as much selling, they are having to buy still a very high market prices to be able to develop internally.

The European crisis, and really the slowdown in the United States as well, has brought home to the Chinese something that they already knew but they had hoped to be postponing — and that is the need to fundamentally restructure their economy. The Chinese base their economy very similar on what we’ve seen in other Asian economies; it was an economy that needed continuous growth. Continuous growth in exports, more money, more money every year and that would allow the Chinese simply to borrow, to supply employment, to not have to worry about things like profits, but rather find some ways to funnel money down into the population.

If we look at the Chinese then we see that there’s maybe 300 million people who are part of the really economically active part of China. However, that leaves out more than a billion people from being part of this Chinese economic growth, this Chinese economic activity. Historically, it’s not from the coastal areas, it’s not from the wealthy areas that trouble comes in China. It’s from the rural areas, it’s from the people who are poor, it’s from the people who aren’t connected to this economic system.

One of the solutions the Chinese have tried to follow is urbanization: the idea that if they build it, people will come and if people move to the cities they will suddenly have jobs and in having jobs in the cities and living in a city, they’re going to become consumers. And certainly this is not for the entire billion of the population that’s not active, but maybe another hundred million, 200 million, 300 million. And that would help to better distribute wealth throughout China; it would also ease China off from their heavy dependence upon exports.

This boom in urbanization coincided with this government need to spend a lot more on domestic investment. It also fell right inside of what was already building as a speculative bubble in real estate investment. And that investment was coming not only from the coastal populations in China — the ones who are trying to find ways to save for the future and therefore invest in real estate — but also from businesses, from SOEs, who are buying real estate watching prices go up and then betting against that real estate, or investing or taking out loans against that real estate, to be able to continue to operate their businesses.

So we have a China that’s facing a real estate bubble in an attempt to build a new urbanized society, but the individuals who would be moving into that urbanized society can’t afford to move in because of the price rise in housing. The government is trying to find ways to slow down that rise in price, but if they move too quickly it can undermine the collateral for the loans from state-owned enterprises, it can pull away the nest egg from their middle class and that can cause a very rapid backlash against the central government.

For China then, what this European crisis has done is it has brought something that they’ve known for a long time right up into the front. They no longer have the ability, it seems, to simply keep pushing back economic change and perhaps even not the ability push back political change in the country because the European crisis has ended their ability to count on this continuous rise in exports.

Thanks to STRATFOR for allowing republication of their report. Let's take a closer look at some of the factors identified in it.

• Urbanization and the real estate bubble: We've studied this before in these pages. Now it appears that Chinese real estate prices are dropping, and falling property sales are severely hurting local governments.
• Continuous economic growth and investment in infrastructure: This is slowing noticeably, and in some sectors (for example, the country's ambitious rail network) has even been reversed.
• Finding a way to support the poor: This is a huge problem for China. Well over half its population has missed out on the economic boom. The 'have-nots' fiercely resent those who've been flaunting their new-found prosperity. However, China has no 'welfare state' to support the hundreds of millions of people affected in this way - indeed, one authority there has claimed that such systems in the West 'induce sloth and indolence'. Further, although China's economy will soon surpass that of the USA in overall size, its 'wealth' must be spread over more than four times as many people, meaning that even if distributed evenly (which it won't be), every Chinese would still be only about 25% as well off as the 'average' American.
• The demographic problem: China's 'one-child policy' has resulted in an enormous age imbalance in its society. This will result in a 'demographic time bomb'; a huge increase in the numbers of elderly people over the next few decades, coupled with a rapidly shrinking working population, whose taxes might be expected to support those older than they are. China's present plentiful, cheap labor supply will soon be a thing of the past.
  

China controls the news coming out of that country pretty well, so it's hard to understand its current economic situation on the basis of official reports. However, more and more unofficial reports, such as the one from Stratfor cited above, indicate that its economy is slowing dramatically, and that its exports to the rest of the world - essential to support its internal economy - are dropping drastically as other nations cut back. It's a certainty that any economic turmoil in the USA and Europe must eventually affect China too.

That will, of course, have a profound impact on the USA, as China has invested hundreds of billions of dollars in US government bonds. Without that flow of capital, the US will have to look elsewhere to borrow the billions of dollars it needs to fund day-to-day government expenditure. One might hope that would cause our government to reduce expenditure, but so far there's no sign our politicians are willing to do so. They'd rather drive our economy into the ground rather than do something that they know will be politically unpopular.

*Sigh*

Peter