China’s fizz goes flat

Price swings mask the fact that money is no longer energising economic muscles, writes James Kynge

A worker cuts steel billets at an iron and steel enterprise on June 9, 2014 in Ganyu County, China. China's consumer price index (CPI), a main gauge of inflation, rose 2.5 percent year on year in May, official data revealed on June 10. (Photo by ChinaFotoPress/ChinaFotoPress via Getty Images)©Getty

Steel prices and volumes in China have fallen flat in the past few days

China’s sugar highs do not last as long as they used to. The saccharine stimulus of 2009-10, which relied on heaped spoonfuls of debt-fuelled investment, kept the economy fizzing at least until the end of 2011. But the impact of far larger credit infusions this year is much more feeble.

An economic equivalent of insulin resistance appears to be setting in. So large is the credit injection that much of it cannot be productively absorbed. This has led to liquidity spillovers that have spurred a speculative frenzy on commodity exchanges.

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A tide of money has flowed into China’s commodity exchanges, bidding up iron ore and steel prices this year by about 50 per cent. So fevered did trading become that in April one steel futures contract alone recorded a turnover of 1.4bn tonnes. But in the last few days, prices and volumes have slumped.

The wild swings distract attention from a basic truth: money is losing the power to energise important economic muscles. Asset prices in the all-important property market — which drove China’s recovery from the 2008 financial crisis — are now so high relative to household incomes that it is hard to envisage another sustained rally.

On average, it would take 25 years, 33 years, 36 years and 19 years of household income in Beijing, Shanghai, Shenzhen and Guangzhou respectively for a family to buy a 90 sq m apartment, according to calculations by Mizuho Securities in Hong Kong. By contrast, London house prices are 9.2 times average earnings for first-time buyers, according to Nationwide data.

Dynamism among companies also appears hobbled. Chronic overcapacity in the traditional industries of steel, coal, aluminium and cement has depressed earnings and profits, exacerbating debt strains. The International Monetary Fund estimates that $ 1.3tn in corporate debt — or almost one in six of the business loans on Chinese banks’ books — was owed by companies that brought in less in revenues than they owned in interest payments.

More broadly, China still appears uncertain on where it stands between Marx and the market

So unleashing a new tide of credit to ease debt problems is “like smoking opium to look healthy”, said Professor Li Weisen of Fudan University, according to the South China Morning Post.

Indeed, the fading buzz gained from artificial stimulus is clear from macro numbers. China expanded total domestic credit by Rmb12tn, or 34 per cent of gross domestic product, in the year to November 2009 — significantly less than the Rmb27.9tn, or 40 per cent of GDP, in the year to February this year, according to Bernstein Research.

But while the 2009 stimulus reinvigorated growth from 6.1 per cent in the first quarter to a full-year GDP growth rate of 9.2 per cent, the flood of credit seen in the year to February has been accompanied by a gentle decline in GDP headline numbers.

All this has important implications for the wider world. In 2009-10, China was praised as a dependable locomotive that helped haul the global economy on to a path of recovery from the financial crisis, partly through its growing demand for emerging markets’ commodities.

Now the risk is that it becomes the opposite: a source of instability and unreliable price signals to developing economies.

So riven is Beijing by conflicting policy objectives that regular economic trend reversals seem assured. Local authorities have announced attempts to tame a rise in property prices that is only a few months old.

More broadly, though, China still appears uncertain on where it stands between Marx and the market. At the 18th Party Congress in 2012, Beijing announced that the market would take a “decisive” role in allocating resources.

Since then, however, its actions have told a different story. Gao Xiqing, a Tsinghua University professor and former head of the China Investment Corporation, a sovereign wealth fund, told a US audience last month of his doubts about the reform process. “Are we allowing [the market] to be the decisive force? It doesn’t look like it,” Mr Gao said, according to a transcript.

This basic contradiction underlies others. Beijing says it wants to strip out industrial overcapacity and shut down “zombie” companies but is also flooding the economy with cheap credit. It is committed to opening the capital account but has stepped up curbs on capital outflows. It was content to see stock prices rally last year but intervened heavily when prices slumped.

Chairman Mao Zedong used to warn revolutionary cadres to remain obdurate against the flattery of capitalists — or, as he put it, the “sugar-coated bullets of the bourgeoisie”. Beijing’s challenge now is how to descend from its sugar high without crashing the economy.

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