The global economy is facing difficulties, with Europe experiencing a slowdown and Japan’s economy shrinking at an alarming rate of 7.1 percent annually. However, our focus today will be on China, whose once-thriving growth engine now shows signs of deceleration.
When an economy begins to falter, many hidden issues emerge, often exacerbated by years of growth fueled by borrowed funds. In China’s case, the consequences of excessive borrowing have become glaringly apparent, with a significant overcapacity in the property market.
Recent Chinese data reveals a stark reality: cities have constructed enough infrastructure for 97 million new urban residents, yet only 35 million have relocated over the past five years. This results in a staggering gap of 62 million potential ghost residents.
Ghost cities typically emerge after prolonged periods of economic growth. Over time, the factors that supported this prosperity can shift dramatically, resulting in phenomena like population decline, as evidenced by Detroit’s population drop from 1.8 million in 1950 to approximately 688,000 today.
As economic conditions worsen, the sustainability of services and entitlements established during thriving times erodes. Anticipated returns on investments may not materialize, leading to a cascade of bankruptcies.
Deceptive Optimism
In China’s situation, the development of these cities was never rooted in true prosperity. Government initiatives provided low-cost financing for projects that would not have been feasible under normal circumstances. For the central planners in Beijing, development was a policy priority, irrespective of whether it aligned with economic fundamentals.
Yet, reassuringly, The Economist claims that while China has a significant debt issue, it is unlikely to lead to a sudden crisis or jeopardize the global economy. This perspective seems overly optimistic.
“China is facing a substantial debt problem. However, due to its control over its banks and ability to provide bailouts, a crisis akin to those seen in other countries is unlikely. The real danger lies in complacency—officials may neglect the urgent need to rectify the financial system, perpetuating a cycle of stagnation with non-performing loans and ‘zombie’ firms,” the article states.
It’s noted that half of China’s debt is from corporate entities, predominantly state-owned enterprises and property developers. As the economy cools and housing prices decline, many of these loans risk becoming unpayable. While banks report bad loans at just 1 percent of their assets, investors are skeptical, believing the true figure is closer to 10 percent.
The article maintains that even in the event of significant loan defaults, a catastrophic financial collapse is improbable. This is largely attributed to the government’s tight grip on the financial sector. State-controlled banks fund much of the lending, and in times of crisis, the government could instruct banks to continue lending. Chinese authorities have substantial foreign-exchange reserves, insulating them from sudden capital outflows, a common trigger of crises in other emerging economies.
Impending Hard Landing for China
Despite The Economist’s analysis, it lacks an essential element: critical thought. The suggestion that government interventions and enforced bailouts can magically erase bad debts is utterly misguided.
The reality is that debts must be settled. Each month, 62 million ghost payments are required to manage the implications of China’s overcapacity. Just because the government can shore up failing loans doesn’t imply it is beneficial.
This practice further misallocates capital, diverting it from productive avenues, which detracts from actual economic growth. Moreover, it elongates the period of underperformance, delaying the inevitable reckoning.
Chinese officials may believe they can maintain this level of growth and industrialization, perhaps even positioning China as the largest economy globally, surpassing the United States. Nevertheless, this does not shield China from a harsh economic landing, even if Premier Li Keqiang insists it won’t happen. History tells us that when leaders declare that adverse circumstances will be avoided, they often occur. This skepticism is precisely why a hard landing looms for China.
In summary, while China has achieved remarkable growth, the economic landscape reveals underlying vulnerabilities that cannot be overlooked. As the world watches, it remains to be seen how effectively China can navigate the challenges ahead.
Sincerely,
MN Gordon
for Economic Prism
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