By Raaghav A
The debate between the new holders of economic power has tended to be largely black and white. There is one section’s proclivity for the emerging world and there is its complement’s preference for a return to the developed West’s dominance. The reality tends to be more convoluted. It is embedded in shades of grey. The former, common opinion held true between the years of 2001 and onwards, till about 2008 (interestingly the timeline between the last 2 crises: The dot-com bubble and the great financial recession respectively). However, it proved to be a tipping point to render any further forecasts of economic superpowers useless.
These surrounding shades of grey consist of 4 spheres. One: The non-linear culmination of the economic and migration crisis in Europe. Two: the increasingly optimistic outlook for the US with job growth and healthy insulation from Europe. Three: the sheer confusion regarding under, or arguably overestimated, “middle countries” such as India – with clear potential but doubtful execution. Four: the dangerously increasing influence of China’s economic story which will invariably be a miracle or, increasingly likely, an unmitigated disaster.
Walk into any store, and the odds are that the item you pick up is manufactured in China. Similarly, economists are starting to embrace the fact that the next global crisis, will also be “Made in China”.
The Kiss of Debt
Peter Drucker’s iceberg principle explains that akin to an iceberg, majority of the reality is below the surface. China’s seemingly miraculous growth rates of over 8%, in the aftermath of the Lehman crisis in 2009, was just the shallow exterior with a crumbling inner system. China, in the words of renowned writer and banker Mr Ruchir Sharma, got lured by the “Kiss of Debt”.
In order to propel their economy at all costs with an aggressive strategy for growth, China borrowed such massive amounts of debt, that it became unproductive.
Debt makes sense if the Return on Investment (ROI) is greater than the interest cost (taking into account possibly bankruptcy too). At present, 6$ of debt is needed to generate 1$ of GDP in China. This figure is much worse than the US at its weakest- 3$ of debt for 1$ of GDP. The latter was at the peak of the housing bubble in 2007-08.
China appears to be the underdog who’s gotten so ahead of herself that she’s lost the challenger’s advantage. On the shallow surface in the aftermath of the crisis, China’s investment-drunken portfolio was a key driver of growth, with investment accounting for ~50% of GDP in 2010.
This is an absurd statistic when contrasted with the “traditional success models” of the West, whose investments accounted for ~30% of GDP only. At the peak of its economic miracle, Japan was investing only 30% plus of its GDP.
The immediate impact of the above is invigorating, but it leads to excess supply when the bridges, malls and all that the government has built, face over capacity. For instance, what if toll revenues are too low on account of low propensity to travel – how will the highway/bridge costs recover themselves? Add to this the demand slump we have seen in China in 2016 and we can see signs of impending doom!
Even worse, China’s problems are not just, well, China’s. It’s difficult to be insular when you host 1.8 billion people or 25% of the globe’s human population. Even a minuscule change in aggregate preferences can have repercussions. It could lead to downward consumption and import trends that would render exports of China’s peers worthless. As a result, their welfare will suffer equivalently. All of these will collectively add up to a stagnant global economy.
China really is the joker in the pack of economic cards. It’s almost like the economy in a glass house which has come to embody the world. Throw stones at it and you’ll find the ramifications of broken pieces everywhere.
When is this ideation going to reflect in everyday reality? On average, and there isn’t a science to this, we see a global recession every 8 years. You had it with the Mexican Peso crisis in ’94, the Asian crises in the same decade 90’s, the dot-com bust in 2001 and the great financial crisis of 2008-09. The math says that the year we find ourselves in today; 2016 – should be the period for the next inflexion point.
With July already in season, one wonders whether China’s steroids, in the form of humongous debt and investment, could actually prove the critics wrong. Will China be able to cultivate a new economic model that lies beyond the thresholds of traditional restraints and gravitational pulls?
A Question of Politics?
Fundamental economic strength is arguable but globalised political trends can prove to be a further headwind for China. One key trend that pops up is that of anti-incumbency. Around the world, whether it’s with Brexit, the seemingly absurd American support for a figure like Donald Trump, or India, where a corrupt government was voted out after 10 years, there is a strong rebellion against the traditional establishment status quo.
Why is this relevant to the China story? Because its often touted drawback is its polity. As compared to India and other large democracies, China has a salient totalitarian regime. This puts it at a disadvantage, at least on paper. The world’s wealth, even today, resides in democracies. Democracies, statistically, host a happier and freer population.
China’s stock market crash and resultant volatility, since 2015, continues till today. The signs ahead are most definitely worrisome. China’s manufacturing sector continues to contract. The Caixin China General Manufacturing PMI for June 2016 was 48.6. For the last three months, China’s PMI has come in below 50. Its real estate is in a bubble with home prices rising 50%+ in some locations. A property bubble happened in the U.S. right before a stock market crash and subsequent recession.
Notwithstanding any bias in this argument, cycles repeat themselves. Sand from the hourglass empties out to merely enter a different time warp. Every boom, it seems, leads to the next recession and vice versa.
In 2016, as this article is being written, everyone’s playing Pokémon again, a Clinton is running for President, Blink 182 has a #1 song on the charts and Tarzan is in theatres. We’re apparently back in 2001.
Except, instead of a dot-com bust, we are facing an economic bust. And just like everything else these days, odds are it will be “Made in China”.
Raaghav is currently working as an Analyst at AT Kearney and also has experiences working for The Boston Consulting Group, CNBC, The Godrej Group and The Oberoi Group. He has studied at Vasant Valley School, Delhi and summer schooled at Oxford University, England. He has completed his studies of Economics from the London School of Economics International Programmes in Delhi.