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Perhaps the best reason to worry about China is that its current building bubble is likely to soon pop, leading to massive deleveraging and an ugly balance sheet depression in China. With substantial amounts of USD denominated debt, and other international exposure, this could have more serious knock-on effects than Brad has considered. This from Henry Ergas, of The Australian ( "...however, perhaps the most troubling news is coming out of China, whose economy now accounts for 16 per cent of global GDP. The disturbing aspect is not the slowing of Chinese growth: no economy can indefinitely expand at 8 per cent or more a year, and a growth rate of 5 to 7 per cent would be eminently respectable for an economy of China’s size and income levels. "Rather, it is the perception that the Chinese regime, in responding to that deceleration, is pursuing policies that are both harmful and inconsistent. "That the regime would find slower growth hard to accept was always clear: not only was sustained expansion vital to the solvency of China’s nouveau riche (with the wealthiest 10 per cent of Chinese households receiving 56 per cent of the nation’s personal income, compared to 24 per cent in Australia, and accounting for an even higher share of personal debt); it was also the basis on which the regime built its wider legitimacy. There was consequently always a danger that the regime would fall into the error of trying to keep growth rates far above those its economy could achieve. "It has done precisely that. But to make matters worse, it has, in the process, chosen a policy mix that seems especially toxic. "On the one hand, the regime has reopened the spigot on borrowing. That is partly so as to encourage yet more infrastructure spending by local governments, whose previous borrowing binge, from 2009 to 2013, has left an estimated $US9 trillion in “ineffective investment”; but it is also so as to support a housing bubble that has taken property to nearly 25 per cent of output (compared to a peak of around 5 per cent in the US during the construction boom that led to the GFC). "That renewed flood of borrowing will not just prolong China’s reliance on relatively low productivity investment as the pillar of growth, slowing the transition to an economy driven by consumer demand; it will also increase debt, which has already risen from 130 per cent of GDP in 2000 to 250 per cent of GDP today. With estimates that half of all non-financial debt is property related, that debt’s quality is highly questionable, heightening the economy’s vulnerability to adverse shocks. "Yet the regime, while using the lending spigot to keep borrowers afloat, is at the same time acting in ways that can squeeze liquidity. In particular, the People’s Bank of China — China’s central bank — is supporting the exchange rate of the yuan by selling its dollar reserves for yuan, potentially reducing the money supply. "That the yuan is overvalued has been clear for some time. The Bank for International Settlements calculates real trade-weighted indices for different currencies; as of June, China’s index was 126, up from 111 a year earlier and 105 in September 2012. As its currency strengthened, China’s exports have spluttered, with exports plummeting by 8.3 per cent year-over-year in July. At the same time, capital has been flowing out of China, putting downward pressure on the yuan and forcing the People’s Bank of China to run down its US dollar reserves by a record $US125bn in August as it seeks to protect the exchange rate. "Set against those pressures, the August devaluation, which reduced the value of the yuan by about 3 per cent, was obviously insufficient, leading global investment giant Pimco to estimate that a further 7 per cent fall is required. But with China’s fragile property sector owing over $US1.3 trillion in US dollar denominated debt, the Chinese authorities fear devaluation would unleash a wave of bankruptcies. "China could therefore find itself with the worst of all possible combinations: a slowing economy; a stimulus package that entrenches reliance on debt-fuelled, low quality investment and perpetuates asset price bubbles; and an overvalued exchange rate."
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Oct 3, 2015