Saturday, November 19, 2011

Testing China to destruction

A major characteristic of the Great Recession is the way that chronic and long-term problems finally lead to an acute crisis. The public sector profligacy in Greece or the high debt position of Italy are the consequence of decades of policy mismanagement. The US deficit is the result of long term political deadlock, while in the UK and Ireland the roots of the crisis lie in an obsession with property, rather than production, as the key to wealth. Policy mistakes, misallocation of capital, unfunded pensions, poor productivity have been festering for decades. It is only now that the pressure that these put on economies finally leads to crisis.

We have, up until now, mainly seen the crisis hit the Western world. The United States still faces a political struggle to control its deficit as the parties refuse to compromise and, as with much else in the political discourse of the USA enters instead into an arid discussion on matters of the constitution. Yet Business America has coped better than elsewhere, and while the state sector continues to drag the country down, the USA is increasingly well placed to recover.

The European Union and especially the Eurozone faces a far more grim prospect. Without major structural changes, the single currency can not survive, yet those necessary changes are still resisted and the process of reform is very slow. Eventually- for such is the way of the European Union- there will be a compromise that creates a new stability, but until that compromise is achieved, the outlook is dangerous and uncertain.

The conventional wisdom is that Europe and America- and probably Japan- are declining powers in the face of the new powerhouse of Asia, China. That may be so in the longer term, however it is not certain, and the crisis has only just started to lap against the shores of the Middle Kingdom. If the roots of the crisis in the West lie in a property bubble, China has a huge property bubble, which is about to burst. If the roots of the crisis in the West lie in too much state intervention, then nominally Communist China has plenty of misallocation of resources and inefficient capital. If the roots of the crisis in the West lie in policy mistakes of politicians, then how many more mistakes have been made in a system where the power of politicians is untrammeled? 

Now that the overheated Chinese property market is slowing sharply, it is clear that China too is joining the crisis- it is not the safe haven that some were suggesting. Indeed long term China bears, like Hugh Hendry, are dramatically outperforming. In fact, the crisis coming to China will begin to test the major Chinese weak spot: its political system. Ever since 1989, and repression of the Tiananmen Square protest, there have been questions about the long term political stability of the Chinese Peoples Republic. With an upsurge in protest in Chinese society, it may well be that the impact of the bursting of the property bubble could lead to major political instability.

The impact of the repeated policy interventions of the Greenspan years at the Fed did not smooth the cycle: it lengthened it. All the problems of the boom were stored up, until even the shock and awe of the Fed could not stave off the required re-balancing. After the longest boom in history, we seem to be set for a prolonged period of retrenchment and austerity. As that happens, many of the ideas of the boom: that debt and deficits don't matter, that inflation is banished, that you can have too much cash, that governments can not go broke- all are being tested. 

Yet the critical thing that underlined the prosperity of the boom was the huge shift in production to the seemingly limitless labour market of China. Now, we can see that this labour market is not limitless, that inflation in China is reducing their productivity and competitiveness, that there are financial and political risks in China (just as there is a risk to your intellectual property). The result will be that China comes under much greater scrutiny as a place to base manufacturing- and already, several American companies are repatriating production of some high-end goods.

As with so much else in the Millennium Depression, our most basic assumptions about the world order are being challenged- and China will not be immune from that either.    


Newmania said...

while in the UK and Ireland the roots of the crisis lie in an obsession with property, rather than production, as the key to wealth

That's an interesting idea but while the property market is behind many problems ( Secondary education ,welfare , Labour mobility ..)

I think this is a country rather than a problem,only for a brief historical period has manufacturing predominated.
Our problem was overspending in a boom, precisely as Greece did.

Cicero said...

Hi Newmania, well the government certainly did do that, but the private sector (both personal and corporate) also went on a massive debt fueled spend, and that was largely because they began to think of property as a store of wealth, which they freely dipped into, thus increasing their total debt substantially.

When everyone thinks property is a one way bet, they buy property instead of investing in production, so in the corporate world, the property companies were also the stars of boom- but since they borrowed to finance, they were also the first to be hit when the credit crunch hit.

David Walsh said...

Just one samll comment. Have we taken into account China's relatively untapped market for domestic consumption for home produced products ? In a sense, this may be a redeeming feature, and could parallel the way in whih the US used domestic consumption and the profits from this, to bolster its growing defence budget in the 1950's.