China's Runaway Chariot (January 21, 2011)
China's authorities may have lost the ability to control the increasingly complex and opaque Chinese economy.
China's economy appears to have reached a critical threshold of complexity and obscurity that renders it uncontrollable. Recent reports of surging bank loans, real estate speculation, industrial growth and inflation triggered a sharp decline in the Shanghai stock index yesterday.
A recent comparison of food prices in Boston and Beijing found that China is now more expensive than the US.
Though the first link states that the average urban wage in China is about $3,000 a year, my sources in China report that a college-educated worker makes about $6,000 a year--about one-eighth the average U.S. income of $49,777. A mid-level manager might make $12,000 a year--an excellent salary in China.
Food eats up (sorry) about 40% of the average household budget in China, roughly in line with the percentage U.S. households devote to housing/mortgages. As I have noted here before, it's not the absolute percentage rise in essentials such as food and energy that matters, it's the relative impact on lower-income households that matters.
A 10% rise in food prices in a household that spends 10% on food (a typical upper-middle class U.S. household) results in a "statistical noise" 1% increase in the family budget. In a family budget with 40% devoted to food, a 10% increase in food meaningfully crimps household spending. A doubling of food prices would be catastrophic.
The roots of China's inflation are visible to all: huge increases in bank credit and lending, and massive speculative flows into real estate:
Industrial-output growth accelerated to 13.3 percent last month from a year earlier, exceeding economists’ median estimate of 13 percent.
We recently spoke at length with a young Chinese friend who travels extensively in China in his engineering/design job. He reported that prices for some food items have doubled and tripled practically overnight. That suggests the official estimates of food inflation are lower than the reality facing consumers.
He bought two designer-label business suits here in the U.S. because he said they were half the price he would have paid in China. And yes, the suits were made in either China or another low-cost Eastern Asia nation.
How can workers making $6,000 a year afford food and other consumer prices that are higher than prices paid by Americans making 8 times as much? Even our Chinese friends are mystified how the average (low-wage) household manages.
One answer is that housing is often dirt-cheap in China. As part of the privatization/opening of the economy process in the early 1980s, Chinese families were able to buy a 99-year lease on their residences for very modest sums. There is no property tax in China, though authorities there are trying to impose them for the first time to dampen speculation.
So families who still live in their old 1980s-era housing pay virtually nothing in housing costs.
Everyone who can work does work in Chinese households, and so the household income often includes three or even four incomes (Grandmother or Grandfather might be receiving a government pension, or might generate income in the informal economy).
Most Chinese workers pay no income tax, so whatever they make, they mostly keep.
Despite these pluses, inflation is now so high that it has overtaken these built-in advantages.
The central illusion in the Chinese economy is that the Central State can effectively control it. When China's economy was smaller and simpler, that was possible. Now there are far more nodes of power and control, and the Central Government's control over regional and local government borrowing and spending is more nominal than absolute.
There are powerful, conflicting mixed signals throughout the Chinese economy. The Central government is certainly aware of the economy overheating, and it is making modest efforts to dampen lending and speculation by increasing bank reserves and raising interest rates.
But at the same time, its targets for local government growth--growth at any cost-- remain high, meaning the incentives and directives are still in place to build, build, build as a way of generating all-important growth and revenues.
Local governments remain dependent on land and development fees for fully 40% of their income, so slowing down real estate speculation would spell fiscal doom for local governments.
Add these factors up and it's easy to see why empty malls and towns continue to get built, regardless of final demand. The truth is that the Chinese economy is heavily dependent on massive credit and lending expansion, fixed-investment (in factories, power plants, etc.) and real estate.
In other words, it is the acme of a speculative economy. Though certain aspects of the economy are resilient, others are increasingly fragile and extended.
Rampant growth has led to increasing complexity and obscurity. The policy modifications imposed by the central government authorities have had effectively zero effect on runaway lending and speculation. That is painfully clear evidence that the authorities have lost control of the economy.
Many observers seem to see China and the U.S. as players in a zero-sum game: if one gains, the other loses. I think that is an inaccurate model; the two gain together from each other's stability, and lose together if either one is destabilized.
That's why we should hope that China's leaders manage to eliminate the mixed signals that are exacerbating the credit/inflation/speculation bubble that is threatening to destabilize their nation.
We have our own destabilizing problems, and a loss of U.S. stability is certainly not China's gain, either.
"one could describe the global economy as a race between the U.S. and China,
to see who goes down first."
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