China came to the rescue of the world economy in 2008, when the global financial crisis vaporized a good part of the banking system and plunged the Western world into deep recession. Then growing at low double-digit rates, China kept on importing, spending and consuming. German factories shipped scads of machine tools and cars to China, and China imported vast amounts of high-priced commodities – coal, oil, iron ore – to feed its voracious, belching industrial beast.
But even China's insatiable appetite for pretty much everything went only so far. The West's economic recovery was still painfully slow and some countries – France, Italy and Greece, among them – are still in recession or barely out of it. If China hadn't done the heavy lifting, those countries and many others might still be stewing at the bottom of the recessionary pot.
The question now is whether the country that probably prevented the Great Recession from turning into the Great Depression will now do the reverse and plunge the fragile global economy into crisis. It could, not so much because of waning economic growth, but because of chronic economic mismanagement that seems to be doing an able job of exporting deflation to countries that don't want it.
In spite of the tentative recovery in the European Union, and the stronger, though still underwhelming recovery in the United States – Canada seems a lost cause because of its oil state status – a Chinese crisis could ensure global stagnation. British finance Chancellor of the Exchequer George Osborne got it right this week when he named China an ingredient in the "dangerous cocktail of new threats" to the global recovery.
Partly because of China's slowdown, the World Bank on Jan. 6 dropped its forecast for global growth in 2016 to 2.9 per cent from 3.3 per cent (the economy expanded by 2.4 per cent last year, well below the World Bank's previous forecast of 2.8 per cent). China's growth this year should land at 6.7 per cent, down from the forecast of 7 per cent made last June, the bank said.
China's waning growth is not welcome, of course. Just look at the depressed share prices of any resources company – Glencore, Noble Group, Anglo American, BHP Billiton, Teck Resources – who bought into the "stronger for longer" theory. It was based on the assumption that Chinese growth, driven by urbanization and the world's desire to buy unlimited supplies of cheap Chinese plastic junk, would be the gift that would keep on giving to the end of time.
The theory promoted by the resources bosses now looks like "stupider for longer," because China's double-digit growth rate was plainly unsustainable under any circumstances. China's economy had a gross domestic product of about $2.3-trillion (U.S.) in 2005. Today, the GDP is about $11-trillion. An 11-per-cent growth rate (the rate during much of the last decade), based on the current GDP figure, would see the Chinese economy double in a little more than six years, probably burying the planet in soot in the process. Even the weaker current GDP rate is probably unsustainable as the Chinese economy gets ever larger.
The slowing Chinese growth rates won't help the global recovery, but they alone won't kill it either. Instead, considerable damage could be done by the Chinese economic model, which props up loser industries, manipulates markets (as it did on Friday, when government funds were evidently deployed to prop up the sagging stock markets) and devotes far too much money to capital expenditures (capex). The result is vast overcapacity in heavy industries, breakneck expansion in others, excessive debt everywhere and a highly leveraged property sector. While it sounds like a recipe for economic implosion, China has the financial reserves to keep the game of musical chairs going for many years. The more immediate problem, for the rest of the world, especially the West, is exporting deflation.
Marshall Auerback, columnist and research fellow at the Levy Economics Institute, notes that China's capex, which is typically funnelled into state-owned enterprises, is absurdly high, at about 45 per cent of GDP. The U.S. capex is about 15 per cent of GDP. During the bubble years, Japan's capex never got higher than 24 per cent.
When China's throws capex at an industry, watch out. The solar sector is one example, Mr. Auerback says. A few years ago, China funnelled billions of dollars into photovoltaic cells, sending capacity soaring and the price in the opposite direction. Many solar companies in Europe and North America, including Canada's Arise Technologies, were obliterated by cheapo Chinese exports – deflation in action.
The Chinese economic model seems allergic to debt deflation, apparently for fear that restructuring debt-soaked, uncompetitive industries will kill jobs and wreck growth. Instead, the state-owned companies are mobilized, even if the result is economically unproductive. The result is more white elephants, more capacity than demand, less profits and more pain to the West. Some countries might opt for competitive currency devaluations to help fight the overcapacity threat. Note that the European Central Bank's €1.4-trillion ($2.1-trillion) quantitative easing program is indirectly aimed at weakening the euro – and has worked brilliantly – in an effort to boost European exports.
The West will be watching nervously as China plots its next moves. China must shift its economy from one reliant on heavy industry to one driven instead by consumption. It must get rid of loser industries and companies, clean up its banking system and stabilize its currency. And it must do all this without triggering a financial crisis or quickly lopping another couple of points off its growth rates. If it fails, not only will China be in big trouble, so will the West. China is now a global player and its mistakes have global repercussions.
Eric Reguly