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Wednesday, January 26, 2022

When China slows, the world economy will stutter

There is good reason to believe that the acute financial problems besetting Evergrande, China’s highly indebted property developer, will not constitute a Lehman Brothers moment for the Chinese economy. But this should be no reason for complacency. 

Rather, Evergrande’s problems should be a wakeup call to the strong likelihood that China’s days of very rapid economic growth fueled by its property sector are over. It should also be alerting us to the strong likelihood that the world will no longer be able to rely on China, the world’s second-largest economy, to be its main engine of economic growth and to be the main driver of the international commodity market.  

With more than $300 billion in debt, Evergrande is the world’s most highly indebted property developer. Yet despite its dire straits, it is highly improbable that the Chinese government will allow Evergrande to fail in the way that Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke allowed Lehman Brothers to fail in September 2008.

Rather, being mindful of the likely contagion to the rest of its heavily over-leveraged property sector that an Evergrande failure would entail, the Chinese government is very much more likely to use its large resources and its control of its financial system to secure an orderly debt restructuring of the troubled Evergrande.

The real significance of the Evergrande debacle is that it should be a reminder to us of the unsustainability of China’s present economic model, which has relied on an outsized housing and credit market bubble to keep the country on a high economic growth path. 

That model has allowed the Chinese property sector to increase to more than 25 percent of the overall economy. And it has caused China’s housing prices to increase to a level some 25 times the average citizen’s income. Those ratios are almost double the comparable U.S. ratios. China’s economic model has also allowed China’s private sector credit to increase by a staggering 100 percent of GDP over the past decade. That is a faster pace of credit expansion than that which preceded Japan’s “lost decade” in the 1990s or the United States’ 2006 housing and credit market bust.   

The task of weaning China off its property and credit dependent economic growth model will not be easy, especially considering the worryingly high degree of the country’s present property and credit market excesses. It is also all too likely that this process will be seriously complicated by the fact that it will be occurring while President Xi Jinping is embarked on his “common prosperity program,” which seeks to reduce the country’s income inequality.

Among the challenges that the “common prosperity program” poses for the longer-run Chinese economic outlook is that it involves an assault on the private sector in general and the high-tech sector in particular. By so doing, it seems to be rolling back Deng Xiaoping’s economic reforms of some 40 years ago, which have been the fundamental factor in the Chinese economic miracle that has made China the world’s second-largest economy.

If the Chinese economy were to slow in the same way that Japan’s economy slowed in the two decades following its economic miracle and property bubble in the 1960s and 1970s, it will have a profound long-run impact on the world economy. No longer will China generate around one-third of world economic growth, as it has done over the past decade. No longer too will China provide the enormous support that it has done to date to the international commodity market or to the export markets of its Asian economic partners.

“Let China sleep,” Napoleon purportedly said, “for when she wakes, the world will shudder.” If he were alive today, Napoleon might warn that when the Chinese economy slows, the world economy will stutter.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


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