Global Agenda: The China dilemma

The government response to this inflationary surge has been to try and close the spigots it had previously opened wide.

“China economy grows more-than-forecast 9.7%”
“China: Growth on track; higher-than-expected inflation warrants firm tightening in second quarter”
“China’s biggest [investment] bank warns against [Chinese] bourse”
“China economic growth faces risks from property shocks, World Bank says”
These quotes are all headlines, all dating from the last two weeks, all from mainstream media. Taken together, they must create considerable confusion.
After all, while the combination of rapid growth and high inflation makes economic sense, why is there a problem with the stock exchange if growth is racing ahead? And why is the World Bank so concerned about the Chinese property market, while the China International Capital Corp. is more worried about the stock market? Are they perhaps both right? Let’s stay with that last point for a moment. If a major financial institution is warning investors about the local stock market, that market must have been very hot for months, if not years. The same implication is true for the property market. But the facts are quite different.

Although property prices have indeed been soaring, especially in the large cities, stock prices have not been soaring at all. Indeed, in the last six months the Shanghai Composite Index has traded up and down within a roughly 10 percent range, while by comparison, the same period has seen the S&P 500 index rise remorselessly, by almost 20%, and other markets have posted even greater gains.
Yet these warnings seem very relevant. Since that headline about the stock exchange two weeks ago, prices in Shanghai have fallen by more than 5% – although they are still within the trading range mentioned. As for property prices, the World Bank is not in the forecasting game, but recent press reports from China speak of a dramatic slump in residential property prices in Beijing and other cities during March, supposedly of tens of percent in one month.
Like every other piece of data out of China, this needs to be taken with more than a pinch of salt. But the World Bank analysis confirms what many independent and private- sector analysts have been writing for months: that a massive bust in the Chinese property market is virtually inevitable. This will cause severe problems to the banking system, probably necessitating another bailout, as well as inflicting hefty losses on many of the country’s nouveaux riches and even the merely affluent.
How much has the property and allied construction boom contributed, directly and indirectly, to the high growth China has experienced in recent years? How much of the surge in global industrial commodity prices – iron, copper, etc. – is due to it? What will happen to Chinese growth, and to global commodity prices, if and when the boom busts? These are questions analysts have been wrestling with for months, in the near-certainty that the bust is coming – because the Chinese government itself is creating it. The authorities have repeatedly raised interest rates, hiked reserve requirements and capital requirements for banks to crimp their ability to lend, and taken other administrative measures to cool the housing boom – and it seems certain that there are more such measures still to come.
Why should the Chinese government be so determined to pop the housing balloon, even though it will cause so much damage? Good question, especially when you add that it was the same Chinese government and its agencies that facilitated the boom in the first place, by pouring huge amounts of money into the Chinese economy via the banking system, in its response to the global crisis of 2008.
By way of answer let’s try and see a wider picture. The Chinese economic miracle saw the country achieve very rapid rates of growth for many years, driven by exports to the developed world and the investments needed to produce them. The global crisis of 2008-09 saw foreign demand collapse and forced the Chinese government to pull out all the stops to prevent an economic crash there, too.
The rescue operation revived the stock market, but the money flowed primarily to real assets, notably housing and commodities. These domestic problems were exacerbated by global factors such as bad harvests and political upheavals in the Arab world, all of which resulted in rising prices that, in turn, have driven hefty wage increases.
The government response to this inflationary surge has been to try and close the spigots it had previously opened wide. This proved sufficient to douse stock-market speculation, but it has taken much longer to impact the housing market. Maybe it is now, if not the effort will continue until it does.
Why? Because inflation is potentially a greater source of social destabilization than recession, and in a one-party authoritarian state, the primary goal of economic policy is to ensure the continued dominance of the party .