Summary:
Edward Chancellor argues that the Chinese economy is facing an Austrian-style “malinvestment” crisis that may become more apparent after the Olympic Games. Outlook for Chinese companies looks bleak. Beijing has allowed an Austrian-style bubble to inflate in China by applying interest rates well below rate of inflation. Interest rates must be in line with rate of growth, if not readjustment will eventually follow. Result was credit growth, leads to misallocation of capital (malinvestment). Today: profits are set to be crushed by a combination of weak export growth and rising input costs at a time when a record amount of new investment comes on stream. China's "malinvestment crisis" will not damage the country's long-term prospect, but is likely to lead to devaluation of the RMB, rather than a revaluation. Will hurt investors as, in April, $50bn of hot money entered China in the belief that a revaluation was a sure bet. (Published: 04/07/08)
Notes:
- Most observers expects China's growth will continue
- may prove correct in the long term, but serious clouds are appearing on the horizon
- Dr. Jim Walker, former chief economist of CLSA, founder of the Hong Kong-based consulting firm Asianomics
- Adherent of Austrian school of economics
- Austrians are obsessed with interest rates, and most particularly about what happens when central banks apply the wrong rates.
- when interest rates are too low credit expands too rapidly
- stimulates investment and fosters asset price bubbles
- eventually, credit "inflation" shows up in rising consumer prices
- by then, it's too late to stop the damage
- end of the boom reveals the misallocation of capital
- Austrians call it "malinvestment"
- after this, there follows a painful process as the economy is forced to adjust back to equilibrium
- believes that Beijing has allowed an Austrian-style bubble to inflate in China
- in equilibrium, he argues, short-term interest rates should be roughly in line with the economy's nominal GDP growth
- but: China has actually enjoyed interest rates well below the rate of inflation at a time when its economy has been expanding rapidly
- result has been strong credit growth
- in turn, has fuelled an extraordinary investment boom
- investment has been growing at 25% a year and constitutes around 40% of GDP
- most of the fruit of this new investment has been exported abroad
- the trade surpluses generated by these exports have meant yet more intervention in the foreign exchange markets and further credit growth
- for a while, this must have seemed like a virtuous cycle
- Chinese export growth is set to fall sharply
- housing bust dented appetite of American consumers for all things "Made in China."
- Europeans initially took up the slack
- but: the credit crunch is wreaking havoc on both sides of the Atlantic.
- Recent data suggest that European export demand is slowing.
- many claim that Chinese domestic consumption will take up the slack
- unrealistic: UK alone consumes more than China and India combined
- another problem: the credit boom has finally erupted in widespread inflation
- costs of commodities and wages of semi-skilled workers have been soaring
- leaves the authorities with little choice but to tighten monetary policy into a slowdown
- real credit growth has already slowed sharply to around 6%
- suggests the economy will be far weaker next year than is generally expected
- Chinese export prices to the US have started to climb
- combination of rising inflation and the revaluation of the RMB against the dollar means that China in some sectors is losing its position as the world's low-cost producer
- little doubt that many ill-conceived projects have been financed during China's investment boom
- Austrian analysis suggests that the outlook for Chinese companies looks bleak
- Profits are set to be crushed by a combination of weak export growth and rising input costs at a time when a record amount of new investment comes on stream
- China's "malinvestment crisis" will not damage the country's long-term prospect
- but makes a revaluation of the RMB less certain
- Andrew Hunt: the Chinese business cycle normally ends in devaluations, not revaluations, of the currency
- Yet: in April some $50bn of hot money entered China in the belief that a revaluation was a sure bet.
- "It's difficult to think of a better way for Beijing to punish noisome speculators than by frustrating such expectations."