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Don’t look to China for salvation

Pinchas-LandauIt is generally accepted today, by everyone except the most US-centric of analysts, that the single most important player in ‘saving the world’ when it was falling apart in late 2008, was the government of China. The efforts of the outgoing Bush and incoming Obama administrations notwithstanding, it was the massive stimulus program — estimated at some 4 trillion yuan, or 15% of China’s then GDP — that was critical in stopping and then reversing the ongoing implosion.
Of course, the Chinese did not act in that way from altruistic motives. On the contrary, their goal was entirely selfish — to preserve the extraordinary achievements that the Chinese economy had recorded over the previous 30 years, and to resume the double-digit rates of annual economic growth that had become the norm, in order to ensure the continued rule of the Communist party. Pulling the rest of the world out of its slump was a by-product of that effort, but also a necessary component of the salvation of China itself because, after all, someone had to buy the huge volume of Chinese exports.However, the passage of five years has provided a much better perspective with which to view that phenomenal stimulus program. Its immediate and decisive contribution to preventing a global depression is, as noted, widely recognized. But its longer-term damage to the Chinese economy — and by extension, to many other countries round the world — is coming into steadily clearer focus as time passes and the costs mount.As recently as 2011, when I would present reports compiled by serious, well-informed analysts that predicted a rapid decline in Chinese growth rates, from the 10-11% per annum that still held sway then to as little as 5%, these forecasts were viewed by businessmen and bankers with great suspicion — if not outright contempt. China in particular, and the ‘emerging markets’ in general — led by the ‘BRIC’ countries (Brazil, Russia, India and China) were almost universally regarded as the rising force in the global economy, which were destined to shove aside the old and sclerotic European economies and the rapidly-weakening American one too.

But this view of the world has crumbled over the last 12-18 months. All the BRIC countries, along with most other emerging markets and economies, have suffered sharp falls in their rates of growth, the value of their currencies and — perhaps above all — the level of expectations regarding their prospects. China has not been the worst-hit of this group, but it has been hit hard enough — and the decline in its reported growth rate to around 7-7.5% per annum has caused, or at the least amplified, the weakness that has engulfed the developing countries.

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With regard to China itself, a steady stream of reports — that has now become a veritable torrent — have exposed, described and explained how and why the Chinese growth miracle has ended its most intensive phase and why much more moderate rates of growth should be expected henceforth. What was long suspected by knowledgeable observers of the Chinese economy — that the stimulus, which was channeled via Chinese banks into infrastructure and residential housing projects, was largely a monumental waste of money and one of the greatest-ever examples of mal-investment in modern history, has now been largely confirmed.

Economic theory says that mal-investment represents a misallocation of resources, because the money poured into projects that have no hope of making a profit will eventually have to be written off and the firms that made them declared bankrupt. There is an alternative, however, and that is for the firms that borrowed and/or the banks that lent to them to be bailed out by the government (i.e. the taxpayers). If this happens frequently, borrowers and lenders will assume that they will be saved from the consequences of their own incompetence or idiocy and will act even more recklessly.

Nevertheless, bailouts are commonplace in most countries, whilst allowing state-owned firms to go bankrupt was unthinkable in China. That explains why the tough policy of the new Chinese leadership, which has allowed several large borrowers to go bankrupt and is signaling that there will be no further large-scale stimulus programs, is viewed with such amazement. Indeed, most analysts continue to believe that the Chinese government will soon reach a political ‘pain threshold’ which will oblige it to come to the rescue of the growing number of foundering enterprises, especially in the real-estate sector.

But perhaps they should think again. The richest man in Asia, Li Ka-Shing, a Hong-Kong based ethnic Chinese, has bben investing in China for over 20 years and knows a thing or two about the Chinese economy and how to make money there. It is therefore most instructive to learn that he recently sold his last major asset on mainland China, the Pacific Place shopping center in Beijing, thereby completing a process he began in August last year. After over 20 years of investing in China, Mr Li has sold out in toto. Interestingly, he continues to make investments in Israel, in promising start-ups. Draw your own conclusions.



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