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Home > Economy August 18,2009

By Liu Xianfa How shall we look at the Chinese economy from and short-term and mid-term perspective? How can we judge whether asset bubbles will continue to inflate, only to burst? This is a key problem for the current economy.

 

We believe that the Chinese economy has bottomed out but has yet to rebound. In the near future, risks for the economy may come from two directions: deflation, and the collapse of asset bubbles. Inflation or stagflation risks do not loom.

 

Deflation is the greatest risk threatening the Chinese economy at present.

 

The Chinese economy entered a growth period in 2002, reaching its peak in 2007. In 2008, under the influence of the subprime crisis and the global financial shock, economic growth soon slowed, not so much due to the shock but to cycle fluctuation.

　　

If we take October 10, 2007, as the starting point of the economic decline, the adjustment period lasted only 20 months until June 2009. It is too early to say the economy has started to rebound, but an optimistic may say that the economic decline has bottomed out.

 

But now the economy is at risk of deflation. Such risk comes from three aspects.

 

First, while the government’s stimulus program prevented the economy from falling further in the short term, it has also prolonged the necessary production capacity adjustment. For example, current domestic steel production capacity is estimated at 670 million tons, but actual demand is only 400 million to 500 million tons. Working off the resultant inventories will take time.

 

Second, experience from the last round of macro-regulation shows that the effect of the government’s investment will decay with time. With its disappearance, the macro-economy will again decline. One report says that insufficient financial investment has already emerged as government investment has fallen since the second quarter. The government’s financial investment was 104 billion yuan by the end of 2008, and totaled 130 billion yuan, 70 billion yuan in the first and second quarters and is projected at 80 billion yuan in the third quarter of 2009. The growth of central government investment projects dropped to 5.5% in July, 26.1 percentage points lower than the growth in June. 

 

Third, the central bank’s extremely loose monetary policy is leading to new imbalances in the system. Many state-owned enterprises have put the great sums they borrowed into the real estate and stock markets seeking big returns, but also driving prices up to unrealistic levels, prices that will not be sustainable when loose money tightens.  

 

A more complicated problem is that as the Chinese economy has become so increasingly tied in to the world economy, it is no longer entirely in control of its economic destiny. External uncertainties and economic moves made elsewhere now directly affect its stability.

 

The risk for new deflation is increasing gradually, though it is not likely to occur until 2010.

 

Under extremely loose monetary policy, the public’s usual macroeconomic concern comes from possible inflation. Such inflation expectations mainly refer to asset prices. In the first half of the year, stock and housing prices both bounced significantly. The current trend of the asset market is opposite that of the real economy, with excessive liquidity lifting prices. Due to common inflation expectations, people consider the stock and real estate markets as inflation hedging tools, and the bubbles grow.

 

The key problem is the risk for the bubbles bursting, though no such collapse looks imminent. The Chinese stock market is unlikely to collapse soon. A market reversal would hinge on a shift in government policies, and the central bank is unlikely to greatly adjust macro-policies in the near future.

 

The real estate market is more closely related to the real economy, however, and here the government’s macro regulatory policy makers now face a dilemma. If the real estate market is not active, expansionary plans for economy are hard to launch. However, if funds are injected into the real estate market, as they now are, at least indirectly, bubbles are unavoidable, and this threatens the asset security of the banking system. But as the government has made “guaranteeing growth and promoting consumption” its primary task, it is unlikely to intervene in the real estate market in the near future.

 

Besides, the two strongest propellers of the real estate market, commercial banks and local governments, share great interest in seeing market continue to froth. Commercial banks’ most profitable projects are their housing loans, and the real estate market is the source of much of the revenue of local governments. And the state-owned enterprises that entered early have profited greatly, boosting the market.

 

Under such circumstances, real estate market bubbles will continue, growing even larger than those in 2007. Asset bubbles and the stock market will promote each other until they both collapse, and perhaps lead to another round of deflation in China.

 

(The author is director of the Macro Economy Center of the China Development Institute)