Bullish China economists, like Morgan Stanley Strategist Stephen Roach, have long argued that western economists do not understand the resilience of the state-driven Chinese economy and the scale of economic forces, particularly urbanization, that will drive future growth.
But Peking University Economics professor Michael Pettis has recently pushed back against bullish economists who argue that “China has a different set of economic rules under which it operates,” The Globe and Mail reported recently. Mr. Pettis said that “there’s no such thing as a different kind of economics” and argues persuasively that the credit bubble in China is no different than the credit-driven housing bubble that imploded in Spain, although much larger in scale. And by the way, the ripple effect of China’s landing could be phenomenal. It was just recently that the Chinese government was scrambling to settle a credit crisis that threatened banks and financial institutions after 62 companies, from furniture makers to import-export traders, were affected by the collapse late last year of one single property developer called Tianyu Construction Co. Ltd.
Here is an excerpt from the article:
“The comparisons between China and Spain are alarming in light of a European financial crisis that has left the financial viability of Spanish banks and the sovereign government hanging by a thread, dependent on vast euro zone government support. Before 2007, Mr. Pettis says that demographic factors – the European elderly retiring en masse to a limited amount of beachfront – were expected to drive Spanish housing prices higher indefinitely. He sees a similar type of misguided faith in the China growth story.
Financial and economic leverage plays a central role in Mr. Pettis’ projections. He believes that China’s growing stockpile of commodities magnifies the economy’s leverage to the infrastructure-driven economic experiment.
Mr. Pettis expects that Chinese infrastructure and real estate spending will slow as the financial viability of new projects is questioned and non-performing loans continue to accumulate. Commodity prices, which had been driven higher by mass investments in these sectors, will decline sharply. The end result, in Mr. Pettis’ estimation, will be a negative feedback loop where declining investment causes lower growth, which causes lower commodity prices that threaten the financial sustainability of commodity-based investments, resulting in still lower levels of aggregate investment.”