Friday, April 15, 2011

The Coming Chinese Collapse

. Friday, April 15, 2011

Nouriel Roubini is pessimistic. Okay, that's not news, but this time the U.S. isn't his subject. Apparently Project Syndicate doesn't allow cutting of their articles, so I won't, but here's the gist:

China is involved in an enormous fixed investment bubble. At this point a very large part of this is malinvestment, and will eventually lead to deflation and a sharp drop in growth. More than likely it will trigger a financial crisis as well. Right now China is investing nearly 50% of its GDP in capital stock, which is an astounding figure. Inevitably, this leads to many bridges to nowhere, ghost cities, unused high speed rail, and empty airports. Roubini notes that all previous recent examples of over-investment, particularly the East Asian economies in 1990s, ended up with financial crises and slow growth.

Why is this going on? Roubini argues that the causes are structural, embedded in the domestic political economy. High savings is a result of a poor safety net. Households only receive 50% of GDP, with the rest going to politically-influential firms, most of which are exporters. Provincial governments are mini-kleptocracies. There is an enormous patronage/rent-seeking industry in China that feeds off itself.

In other words, the ever-wise and politically-liberated Chinese leaders are actually quite constrained, and that's leading to some very poor choices. At some point, Roubini says 2013 or so (but I think perhaps a bit later), a crash or major slowdown is very likely. And then, politically, what happens in anyone's guess. Let's just say that China's leadership isn't feeling especially comfortable right now, and their position won't be helped by a slowdown.

We've written a decent amount here about how China's rise is not likely to be a strictly linear process. Drezner's also covered it a lot, and Michael Pettis has sounded similar notes. China has very real problems, economically and politically, and most of the actions they've recently taken have reiterated just how strong those vulnerabilities really are.

Of course, if China does slow down that raises a potential problem for the U.S.: servicing our debt potentially gets more expensive. Which is one reason why, even if the Invisible Bond Vigilantes haven't appeared yet, closing the medium-run deficit is pretty important.


Adam W said...

China's role in debt service is a function of its current/capital account surpluses. If those close when China's growth slows, it will have to be offset by a narrowing of a deficit somewhere else. If the world was just the US and China, that would mean either U.S. consumption would have to slow and US savings would have to increase, which would result in lower domestic demand and thus lower U.S. interest rates. Of course, China could just shift the surplus to a third country, but that wouldn't have an effect on U.S. interest rates.

In short, China does not finance the US fiscal deficit. It finances the US current account deficit. the funding costs of the US government are only tangentially related.

Kindred Winecoff said...

That assumes our fiscal deficit and current account deficit are unrelated. I see no reason to think that's so.

The Coming Chinese Collapse
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