Some things are sure to happen even if we do not know when. California eventually will have a major earthquake, and China will have an economic crisis and severe recession.
Right now, a major Chinese recession in the next couple of years seems much more likely than “the big one.”
Why is China destined for crisis? It has had a quarter century of remarkable growth since Deng Xiaoping turned away from central planning. While many Chinese remain extremely poor, the movement from Leninist heavy industry to the nimble entrepreneurship prevalent in today’s coastal provinces is a true economic miracle.
In 2004, China has the most dynamic economy of any large nation. Output is growing so fast that Chinese demand is driving up world prices for steel, nonferrous metals, oil, chemicals and ocean shipping — to name just a few. Construction is hot. Urban consumers with incomes well above subsistence levels are spending freely.
Such growth cannot continue indefinitely for two reasons. The first is the same reason the U.S. boom in the 1990s had to end. Irrational exuberance overcomes good judgment. Money pours into new factories and companies that have no chance of profitability in the long run. Banks make loans that later will turn out to be folly.
Economic momentum keeps things going for some time, but eventually the accumulating weight of bad decisions drags growth to a halt. The ensuing recession involves pain; people lose jobs, lenders write off bad loans and entrepreneurs’ dreams are crushed.
Recessions are, however, an economy’s way of wringing out the results of accumulated bad decisions so that growth can resume. The United States experienced repeated busts and panics between the Civil War and World War I, yet growth always returned and overall economic growth was stupendous.
China is overdue for a normal business-cycle recession. Warning signs are all around, the money supply is growing far too rapidly and there are physical signs of overinvestment in plants and equipment.
The second, more serious problem is that China still has a huge and increasingly unproductive state sector. Moreover, hundreds of millions of thrifty Chinese households have saved trillions of yuan in state-run banks that made dud loans to state-owned and private enterprises.
Some estimate that bad loans by Chinese banks may total 30 percent of gross domestic product. Our 1980s savings and loan bailout cost about 4 percent of U.S. GDP. Politically, the Chinese government cannot let banks go bust when they contain the savings of poor and rich households alike. Writing off mountains of bad debt will be even more difficult in China than it has been in Japan.
The next few years for China will be interesting. The country may well weather recession and structural adjustments eventually and return to long-run growth. But economic problems on the horizon are daunting, to say the least.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.