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Asia Economy Last Updated: Jan 30, 2014 - 7:01 AM


China should welcome a recession
By Michael Hennigan, Finfacts founder and editor
Jan 28, 2014 - 8:13 AM

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See IMF link below

A former official of China's central bank says China should welcome a recession to work through distortions that have built up over three decades of rapid growth.

Joe Zhang, chairman of a microcredit company in Guangzhou, China, a former official at the People's Bank of China and author of “Inside China’s Shadow Banking: The Next Subprime Crisis?” says China’s bank credit has expanded at a compound annual rate of 18%, and money supply at 21% over the last 27 years. and has left "a large array of ills to sprout up alongside - - environmental degradation, resource depletion, income inequality and runaway government debt. All these ills are interlinked, and they are becoming unbearable."

In The Financial Times today, Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management, writes:

Recent studies have isolated the most reliable signal of a looming financial crisis and it is the 'credit gap,' or the increase in private sector credit as a proportion of economic output over the most recent five-year period. In China, that gap has risen since 2008 by a stunning 71 percentage points, taking total debt to about 230% of gross domestic product.

A credit boom of this scale is not likely to end well. Looking back over the past 50 years and focusing on the most extreme credit booms - - the top 0.5% - turns up 33 cases, with a minimum credit gap of 42 percentage points.'

The International Monetary Fund uses the term 'augmented government debt' for Chinese public debt that includes local government debt.

IMF staff estimate the augmented government debt has risen to around 45% of GDP in 2012, having increased sharply through the global crisis. "Nonetheless, that level still falls within sustainability thresholds. For 2012, staff estimate that the augmented net borrowing was around 8% of GDP and the augmented fiscal deficit was on the order of 10% of GDP."

However, the authors of an IMF paper [pdf] this month  acknowledge that others have higher estimates.

Joe Zhang wrote in an op-ed piece published by The South China Morning Post of Hong Kong last Friday

  • "I want to see tariffs on water, gas and electricity rise substantially - - by as much as two to three times immediately, if possible - - In the past decade, or two or three, the prices of utilities have lagged far behind inflation, and this has led to huge amounts of waste, pollution and depletion of resources;
  • Second, in most of the past 35 years, China’s interest rates on bank deposits have not reflected the sacrifice of the savers who are delaying consumption. And, indeed, interest on those deposits has been below the inflation rate. That rip-off has led to huge and persistent subsidies to business. They get low interest rates on loans and consequently low hurdle rates for returns on investments. That has artificially boosted economic activity for too long;
  • Finally, whatever your school of thought, the clearest test of a currency’s fair exchange rate has to be its trade balances in the medium and long term. The fact that China has run a trade surplus of large magnitude in the past two decades proves the point that its currency is undervalued."

Zhang goes on to make his case for a recession by citing America's most famous investor: Warren Buffett split the 34 years between 1964 and 1998 into two equal periods to give a lesson on investing.

Zhang says China’s rapid growth, fuelled by fiscal and monetary stimulus, will stop. The only questions are when and how? "Given the dominance of the state sector, which has a high tolerance for low returns, and the existence of millions of low-wage workers, China Inc’s business model can continue for a long while to come.

But that does not mean that allowing it to do so is in the best interests of China’s citizenry."

Finfacts: Economic convergence is a myth in Europe and in emerging economies

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