The global economy is full of intriguing developments, and China is a prime example. According to the International Monetary Fund, based on purchasing power parity, China ranks as the largest economy in the world.
However, the country has started the year on shaky ground. For instance, China’s exports dipped by 3.3 percent in January compared to the same time last year. But the more alarming statistic is the staggering 19.9 percent drop in imports.
“The decline in imports is the most significant since May 2009,” Reuters reported. “At that time, Chinese factories were still reducing inventories as a response to the global financial crisis. This poor trade performance raises concerns that the anticipated shift in China’s economy—from a heavy reliance on investment and exports toward greater domestic consumption—might be faltering.”
At Economic Prism, we were surprised to learn that China’s economy might still be in jeopardy. Hasn’t it already derailed? Any economy that has consumed 6.6 gigatons of cement from 2011 to 2014 is in serious trouble. In contrast, the U.S. used just 4.5 gigatons over the past century.
Clearly, these grim trade figures indicate underlying issues. Perhaps the answer isn’t to pour more concrete after all. This could explain why Chinese policy-makers are now in a state of panic…
Increased Chinese Stimulus Ahead
Recently, the People’s Bank of China made headlines by reducing bank reserve requirements by half a percent. This move will effectively boost the money supply in the economy, theoretically leading to increased demand and consumption.
When compared to the economic conditions in the United States and Europe, China appears to be thriving. The country’s GDP grew by 7.4 percent in 2014, although that marks the slowest growth rate seen in 24 years.
In today’s volatile economies, where financial systems rely heavily on ongoing debt accumulation, even a slight dip in growth rates can lead to significant repercussions. Many decisions have been predicated on flawed assumptions. If growth doesn’t align with expectations, servicing debt may become unmanageable.
Of course, lowering the cost of borrowing is a standard approach for central banks aiming to stimulate economic activity. Cheaper loans enable businesses and consumers to take on higher debt loads, borrowing more and spending at lower interest rates. This is among the strategies that China’s central bank is expected to pursue.
“Economists generally anticipate further cuts to reserve requirements and interest rates this year, alongside additional funding injections as the central bank attempts to reduce persistently high borrowing costs that are further straining heavily indebted Chinese companies.”
China’s Concrete Conundrum
While it is likely that the People’s Bank of China will continue to stimulate the economy, the outcomes may be quite different from expectations.
The common belief is that more credit will bolster the economy. But what happens when an economy is already burdened by excessive debt?
“The Chinese economy is indeed reliant on construction, and its leaders seem unable to detach from this dependence—even as they recognize that they are heading for a major crash,” stated David Stockman, a former Congressman and budget director under President Reagan.
“Currently, nearly 50 percent of the GDP is derived from fixed asset investments—such as housing, commercial real estate, and public infrastructure. This figure is unprecedented compared to historical standards. Even during the peak growth periods in Japan and South Korea, this ratio never surpassed 30 percent and was not sustained for long.”
“Thus, China finds itself trapped in a monumental debt cycle. Its leaders fear social unrest if they don’t continue to boost GDP and the associated job growth and asset values through more credit and construction. Yet, they understand the risks, leading to erratic shifts between credit expansion and contraction on an almost daily basis.”
It’s evident that China is facing a significant dilemma, with no turning back. Their only course of action is to continue pouring concrete, believing it to be their only path forward.
Sincerely,
MN Gordon
for Economic Prism
