China’s super-heated growth and the the likelihood of monetary tightening
China’s Roaring Twenties haven’t been a decade, like the US a century ago. Rather, the entire last twenty years have witnessed amazing growth. What metaphors are apt for this unprecedented performance in human history? An out of control freight train? A moon shot? The news from China continues to stupefy, via WSJ:
China revised upward the value of the country’s economic output and its economic growth for 2005, adding weight to Beijing’s recent warnings about economic imbalances. Gross domestic product grew 10.2% last year from a year earlier, higher than the originally estimated rate of 9.9%, the National Bureau of Statistics said.
The value of GDP in 2005 was revised to 18.3085 trillion yuan ($2.3 trillion) from a preliminary figure of 18.2321 trillion yuan issued by the bureau in January. The revision to 2005 GDP growth makes it the fastest annual gain since the 10.9% expansion recorded for 1995, based on bureau data….[M]any economists think China’s economy is expanding faster than official figures suggest. In May, the statistics bureau revised the first quarter’s annual growth rate to 10.3% from an originally reported 10.2%. China’s GDP surged 10.9% in the first half of this year from a year earlier.
Despite the latest tweaks, the trend and troubles for China’s economy remain the same: persistent imbalances like excessive fixed-asset investment, runaway credit, a ballooning trade surplus and overcapacity problems in certain sectors. Those problems were highlighted by an official from the statistics bureau in an interview widely published in state media yesterday. Overly rapid investment expansion will lead to higher prices of production materials as demand rises, and “will ultimately lead the consumer-price index higher,” the official said.
China’s national fixed-asset investment as a proportion of GDP has also risen in recent years. National fixed-asset investment accounted for 36.1% of GDP in 2002, 40.9% in 2003, 44.1% in 2004 and 48.6% in 2005, according to the official.
This year, both fixed-asset investment and money-supply growth in China have been rising at rates above official targets, with the level of new yuan loans for the first seven months reaching 94% of the central bank’s full-year target. China needs to prevent investment growth from accelerating further and to foster factors that lead to “reasonable” and “active” growth in investment, the official said.
China’s massive over-expansion in fixed capital investment is going to be a likely source of its eventual and possibly significant economic correction, in our opinion. The idea that fixed asset investment was 48.6% of GDP in 2005 simply boggles the mind. Meanwhile, in the Peoples Daily, the superheated investment climate is also seen as a problem, one created by the necessity to monetize into Chinese currency the vast foreign exchange reserves the country’s businesses have accumulated:
China’s macro-economy presents “obvious overheating of investment” in the first half of this year, Wang Xiaoguang, a macroeconomics professor at the economic research institute of the National Development and Reform Commission, told Xinhua. Total investment in roads, factory equipment and other fixed assets soared 29.8 percent, an increase of 4.4 percentage points from the same period of last year. “The overheating is all-round, in nearly all industries and all regions of the country,” Wang said, urging the government to move to control the trend. Tao Dong, an economist with Credit Suisse in Hong Kong, echoed his remarks, acknowledging the rebound in investment in fixed assets is a “problem” in China’s economy.
Frank Gong, an economist with JP Morgan in Hong Kong, blamed the overheated investment on excessive money supply brought by soaring foreign exchange reserves. Under China’s currency controls, the central bank has to buy a big part of foreign currency earnings by enterprises, which has already helped China build up the world’s biggest foreign exchange reserves, reaching an equivalent of 941.1 billion U.S. dollars at the end of June, while ballooning money supply. Gong said he believes the fundamental solution (to overheated money supply and investment) is to accelerate the appreciation of the renminbi, which, theoretically, will reduce the money unleashed by the central bank in buying foreign exchanges.
Frank Gong is correct. China needs to accelerate the appreciation of its currency to scale back the massive increase in money supply and bank credit that is clearly feeding an overcapacity situation at this point. Can the Chinese authorities take some of the bloom off the rose without killing it — that’s the question. Overleverage and overcpacity, taken together, are a very bad formula indeed for business conditions anywhere in the world when monetary policy shifts in the direction of tightening. It is obvious that China needs to tighten monetary policy at once, and is already doing so in a variety of ways. For the good of the world, we hope that the Chinese can engineer a soft landing. It won’t be easy.