China’s $8.5 trillion economy grew 7.8% in the third quarter, compared to last year, barely above the government-decreed minimum of 7.5%, assuming we can trust these figures by the National Bureau of Statistics. On a quarterly basis, the economy grew 2.2%, for an annualized rate of growth of 9.1%. That would be hot beyond imagination for mature economies, like the US.
But it’s a plodding growth rate for the Chinese economy that, over the last three decades, has become addicted to double-digit growth. Deep frustrations are simmering beneath the surface and can explode into riots at a moment’s notice. To maintain social stability, the government has long ago decided to douse the people with money and growth, regardless of what the other consequences may be (can’t breathe the air?).
That minimum to guarantee social stability appears to be somewhere not far below the 7.5% fiat growth rate. So, for the first nine months of the year, the economy grew 7.7%, and everybody breathed a sigh of relief.
The oomph behind this growth?
Investments in fixed assets. The government had unleashed “stealth” stimulus programs earlier this year, a series of mega-projects funded by state-owned megabanks with unlimited resources, such as railroad projects, local ghost cities, high-rises of sold-out but empty apartments that have become a huge asset class instead of a place to live. Then there is the Shanghai Free Trade Zone, approved by the State Council in early August. It will cost 12.5% of Shanghai’s annual GDP.
Construction and property investments are the primary tools governments at the national and local levels have to boost economic growth. They sit at the spigot and can turn it on with the flick a few trillion yuan, issued by state-owned megabanks. Overall investment is up 20.2% so far this year. Investment in infrastructure facilities jumped 25.1%. Investment in the primary industry soared 31.1%, in the secondary industry 17.1%, in the tertiary industry 22.3%. Investment in commercial and residential real-estate development grew 19.7%. Housing construction – whether anyone will ever live in these homes or not – contributed 16% of all economic activity so far this year. Investment in these construction and property bubbles contributed 56% to GDP growth – a delirious number, because even China can’t keep building things at this rate forever. And then what? Would the country erupt?
But consumption did not take off.
Though consumption is still growing at what is a hot rate for mature economies, it’s just not sizzling by Chinese standards. So far this year, total retail sales, adjusted for price changes, grew 11.3%; and in September, 11.2%. The government’s decision to restructure the economy away from the construction and property bubbles, in favor of more consumption hasn’t born fruit yet. Consumption contributed only 46% to growth in the first nine months.
Apparently, the 1.33 billion Chinese consumers have a will of their own. Raising salaries would give them more income so they can spend more and drive up consumption – and salaries are rising. But that drives up the costs of labor and sends manufacturers scrambling for other options. Ah yes, see below.
And exports languished.
Exports dropped 0.3% in September (with the caveat that Chinese export numbers are particularly subject to uncertainty), after uninspiring global demand and a drop-off in the emerging markets. For the nine months, exports still grew 8%, but that was down from a growth of 10.5% last year, and that had been down from prior years. Exports were weak enough in the third quarter to subtract 1.7% from GDP growth. Even if global demand were to pick up, years of double-digit wage increases in China’s main manufacturing areas have sent manufacturers searching for the greener grass – dirt-cheap labor – in other countries. Thus was launched a wave of offshoring that is picking up momentum.
Leaves a conundrum – and a mess.
Local and national government entities have been sitting by the spigot out of which poured credit, and instead of turning it off, they’ve opened it wider and wider. The state-owned megabanks and the People’s Bank of China have made sure the money would flow. Supported by immense local and national subsidies, entire industries have been built up in no time. But these industries have turned out to be inefficient and overbuilt. Overcapacity is ravaging the companies. Hulking industrial structures have turned into waste. Many of the underlying loans are decomposing on bank and non-bank balance sheets. Entire sectors are collapsing.
Cleaning up this mess of over-investment, mal-investment, bankruptcies, bail-outs, and now bad loans has become a government priority. It mandated consolidation and has instructed state-owned megabanks to fund it. It’s an admission that the relentless drive to goose GDP by building structures and capacity, regardless of needs or costs, has created a mountain of waste, a gargantuan risk for lenders, and a drag on GDP.
This kind of hangover is awaiting the property sector as well. Asset price inflation has been soaring. And now consumer price inflation raised its ugly head again, at 3.1% in September, a seven-month high. Jumpy consumer prices can trigger riots. So the PBOC warned about the expansion of credit that is feeding all this, and whose residue is forming a thick toxic layer of sediment in the financial sector.
“The economy is facing a complex and uncertain domestic and international environment,” is how Sheng Laiyun, a spokesman for the National Bureau of Statistics, described the phenomenon.
How long can China inflate GDP by getting banks and the shadow-banking system to pump out loans that may never get paid back for projects that may not be needed, may never be profitable, or if profitable for the developer, may sink the ultimate investors?
The government is worried. But when they tried to slow down the rate at which these bubbles inflate, it caused panic among developers, riots in front of real-estate offices where housewives who’d bought apartments a few months earlier like others buy stocks saw new units going on sale at 30% off. And everybody got scared.
No, this spigot can’t be turned off. Not now. It can only be turned off in the future, but that future gets pushed out further and further. A truth that the Fed has discovered too. You can only turn off the spigot if you accept that these majestic bubbles that all this easy moolah has created will implode. A moment of truth Chinese officials and Fed heads alike are afraid to face.