Reality Check: What Does Chinese Economic Growth Really Mean?

China promoters have long touted the admittedly amazing economic growth numbers coming out of China. And even now, in the middle of a global downturn involving both Europe and China, investors' eyes still turn to China when scouting for isolated patches of growth:

China has long been seen as the country with the biggest potential to prevent the world from falling into another 1930s-style depression, helping to offset contraction in North America and Europe. Admittedly, China is highly dependent on markets in both regions for exports, and thus for wages and domestic consumer spending. And admittedly, the economic data coming out of Beijing have been called into question. Yet growth there will still be the most robust of anywhere in the world, according to forecasts from Oxford Economics via Datastream – real GDP should grow 7.5 percent in China this year. But that’s almost anemic compared to the country’s recent track record of annual double-digit GDP advances. _Fiscal Times

But even if one takes the Chinese economic growth figures at face value, there are any number of details which could devil your dreams, should you decide to make big and bullish bets on China.

News of a slowdown in China’s economic growth has been building of late, and many disparate theories have been offered in explanation of the phenomenon. One issue facing the country has been debated particularly heatedly. Commentators cannot seem to reach a conclusion on whether the Chinese economy is a victim of over-investment.

...The story, in simple terms, begins with the restrictions China places on the maximum deposit rates allowed by banks there. These restrictions, though slightly relaxed earlier this month, leave borrowers accepting very low rates on deposits, because of lack of other investment opportunities.

The low rates allow money to flow to borrowers, who pay very low rates on their loans. That means householders are effectively losing money to subsidize the borrowing of investors. The Chinese financial system is being used as a machine, that allows this to happen.

The borrowers in China are the local and central government agencies, real estate developers, corporations, and other infrastructure investors. Because their investments are effectively subsidized, they face lower repercussions than borrowers face in free market conditions.

...China’s low interest rate constraints mean investment that is concentrated in a single area, and therefore provides economic growth in the short term, has its cost spread across the entire country through the household financial system.

The cost of building the infrastructure is much higher than the benefits that come from it. This is over-investment. The scourge is exacerbated by the structure of the country’s financial system. The subsidized lending leads to worse decisions being made because market realities are not in force.

China’s per capita income and worker productivity mean that the level of capital stock in the country should land at a much lower equilibrium level. Advanced infrastructure is not saving labour as much as it does in Germany or the United States. China is over-investing.

...Politics in China is undergoing its most egregious challenges in decades this year. The succession plans for the replacement of the country’s leaders have already been rocked by scandal. Something special will be needed to avoid the worst effects of the over-investment problems that have been created in recent years.

That is unlikely to come from these appointments. China is still conservative when it comes to reform, even when faced with economic slowdown. The recent tremors in the party’s system of choosing successors, could bring to the fore a more open method of investing leaders but it is not likely to do so.

China’s government has allowed over-investment to become rampant in the east Asian giant. It is not a sustainable situation. If something is not done at the highest levels in the country there will be a market readjustment that will shake China and the rest of the world.

Pettis also makes a startling statement on China:

” A mainland think tank, Unirule, estimated in 2011 that monopoly pricing and direct subsidies may have accounted for as much as 150 percent or more of total profitability in the state owned sector over the past decade. I calculate that repressed interest rates may have accounted for another 400 to 500 percent of total profitability over this period.?Monopoly pricing, direct subsidies, and repressed interest rates all represent transfers from the household sector.”

_Value Walk

China Financial Markets _ Michael Pettis' blog

Another look at threats to economic stability in China from Patrick Chovanec

Inbred Chinese State Owned Enterprises Hope to Monopolise Coming Shale Gas Boom in China

Meanwhile, belated news of coal and other commodities stockpiles growing to record levels, and reports of faked electricity utilisation data being leaked to financial media, suggest that someone in China may be trying to project a false impression.

The political class in China benefits from the massive economic inequality fueled by corrupt state owned enterprises. As long as Chinese wage earners cannot invest outside of China, corrupt insiders have the means of re-distributing hard-earned funds from the pockets of wage earners, into the pockets of political insiders and the well-connected.

How is that different from the situation existing in western countries? In western countries, citizens can invest overseas, can move to other countries relatively easily, and are generally not being held as captive blood donours to the same extent as their counterparts inside China.

How long can this China scam of massive malinvestment continue? Time will tell.