Thursday, July 30, 2009

If the Chinese Pop a Bubble, Does It Make a Sound?

. Thursday, July 30, 2009

James Fallows ruminates on China's options:

Obviously the Chinese government had to do something to offset the tens of millions of layoffs happening all at once. Its predicament was in a way like America's at the start of the Great Depression: having had an abnormally large share of the world's manufacturing jobs and export earnings when times were good, it had more of them to lose when demand crashed. But China's situation was worse, because it is so much poorer than America was, and because exports represented a bigger share of its employment base.

So China had to do something. The danger, as with the US recovery measures now, came from the long-term implications of the necessary short-term damage-staunching measures. And here the main fears were: (a) that the government would try to maintain its huge trade surplus (through subsidies, Smoot-Hawleyesque trade barriers, "buy Chinese" rules, etc) even as foreigners were forced to cut back on their buying, thereby triggering understandable resentment and retaliation; (b) that its stimulus efforts would aggravate trade-imbalance problems in the future, since so much was devoted to new productive capacity which could further glut world markets; and (c) that the stimulus would lead to a big destabilizing bubble, since a lot of it was propelled by China's version of sub-prime loans. (Ie, shaky, under-collateralized, dubiously repayable loans to sweetheart or shady companies).

Meanwhile, John Makin considers the possibility that China is bubbling (I'm trademarking "bubbling" by the way):

The worst outcome for China would be one that includes ever-rising inflation pressures, as money and credit flows augmented by "hot money" capital inflows push the inflation rate up to a level that threatens China's stability. Since that would be most likely under a scenario in which industrial economies are not recovering in the second half of the year, we could see a situation in which disappointment over the recovery in the big three economies coincides with disappointment about the sustainability of China's planned 8 percent growth path. That outcome would coincide with a likely bursting of the stock and property market bubbles that are inflating in China now on the hopes that a second-half recovery will validate China's goal of sustained 8 percent growth in 2009.

Yesterday I briefly discussed whether it would be possible for regulators to effectively deflate bubbles before they crash, but I didn't discuss whether governments would take such actions even if they could. Surely this is just as great of a concern. The Chinese Communist Party is not responsible to its citizens in the same way that, say, President Obama and Democrats in Congress are, but that doesn't mean that Hu Jintao doesn't face domestic political pressures. Since 1973, the Chinese Communist Party has staked its political future on continued economic progress, and has been willing to make many compromises to that end. So if faced with a choice between putting the brakes on the domestic economy -- and facing the political backlash that will surely come -- and continuing to gamble greater and greater sums on a growth model that may not be sustainable, the Chinese may have little choice but to take the bet. If they pop the bubble they risk their political survival.

This political calculus is not unique to the Chinese leadership of course. In fact, their institutional advantages make them more insulated from domestic pressures than the governments of most other large economies. Still, even Chinese policy is (likely) influenced by these pressures. The lesson is that in many instances the political incentives will point towards bubble-inflating policies rather than away from them, so gearing a regulatory structure towards bubbling-popping is self-defeating.


If the Chinese Pop a Bubble, Does It Make a Sound?
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