The New Normal of China's Economy
By Cheng Xiaonong
Last year the Chinese government coined the phrase “New Normal,” but didn’t explain what it meant. In fact, the “New Normal” means “farewell to prosperity.” It implies that the rapid growth seen in China over the past two to three decades is not likely to continue into the future.
The Chinese people may not even be aware of the causes behind China’s rapid growth over the past two to three decades. I will summarize it here in two stages. The first was the export boom, the second the construction boom.
The “export boom” mainly refers to the trend of many countries going to China with large investments, and transferring their manufacturing to low-wage countries as a result of economic globalization after China formally joined the World Trade Organization in early 2002. This led to China’s rapid export growth, five or six years in a row, of more than 25 percent and sometimes even 35 percent. Such growth was indeed astonishing.
The question is whether a country as big as China can sustain a continuous export growth rate of 25 to 35 percent for two decades. Looking at it rationally, we know it’s impossible. China has a large population and a quarter of the world’s labor force. If China maintained such an export growth, all factories in the world would have to close down, because the size of the world market has an upper limit.
In 2008, China’s export boom was halted by the subprime mortgage crisis in the United States. Consumption in developed countries shrank rapidly. This stopped the boom after nearly seven years. At present, it is obvious that the golden era of China’s export growth has ended. A couple of years ago, China’s export growth dropped to 6 or 7 percent, and in 2015 it fell to 3 percent - the boom was completely over.
With declining exports in recent years, how did China’s economy manage to sustain a high growth rate? The Chinese government, fearing that growth would dry up, released a four trillion yuan stimulus package after the 2008 subprime crisis. One of its key consequences was authorizing local governments to engage in real estate development using bank loans. This strategy was also adopted by China’s state-owned enterprises.
This move transformed the country into a big construction site. The Chinese economy went through a huge change from export oriented to real estate oriented. Related industries, such as steel, aluminum, building materials, cement, glass, and so on all flourished. China’s steel production, which supported large-scale domestic construction projects, more than doubled in a few years, reaching nearly a billion tons per year.
This real estate boom saved China’s economic prosperity for another several years. But can it be sustained? Not likely. Despite so many houses having been built, if they cannot be sold, the local governments and real estate corporations who borrowed money to build them will go bankrupt. This is exactly what China is facing right now.
According to a survey conducted by Peking University last year, over 60 percent of urban households in China already own one residence, 20 to 30 percent of whom own two or more residences - and then among them, several tens of millions own more than six residences.
When houses are sold not for people to live in, but for rich people to hold as investments, this is of course a very unhealthy real estate market. This deformity of supply and demand has led to a short-lived real estate boom. Buyers plan to sell houses eventually, but who will buy them? Not many people can afford such expensive residences.
When housing prices so far exceed income, the real estate market becomes saturated and houses are no longer marketable. Real estate investment companies began suffering losses that resulted in broken funding chains and disillusionment with the real estate boom - this is what happened last year.
‘The New Normal’
Specific factors and opportunities led to China’s past two decades of rapid growth. With all these factors now having gone away, China has entered a period of low economic growth from here on out. As far as how low it will be, we are unable to predict. Calamities, such as a real estate crash or further world economic turmoil, may cause the economy to slide down further.
Earlier in 2016, China’s National Bureau of Statistics announced that China’s 2015 GDP growth had declined over the previous year. In other words, the “New Normal” may imply that the decline of China’s economic growth rate has no bottom, while the ceiling will not rise higher than the current level. Perhaps the present economic state is the best that China will see for a long time.
Dr. Cheng Xiaonong was trained as a sociologist at Princeton University. This article is an abridged translation of a Jan. 25, 2016 interview with Radio France International.
© Dr. Cheng Xiaonong
If It's Bad, Just Stop Reporting It
By Valentin Schmid
China removes data about capital flows from report, and it's not the first time ...
By and large, the market is used to China fiddling with its economic numbers, or making them up completely, like GDP figures.
The market, however, mostly believed the figures on foreign exchange reserves as well as capital flows released by the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE). At least until now.
According to the South China Morning Post, the PBOC removed a key number about foreign exchange transactions in the banking system for January 2016. The report in question is titled “Sources and Uses of Credit Funds of Financial Institutions.”
The January report only includes foreign exchange transactions by the central bank and excludes the remainder of the banking system. It also merged another item related to foreign exchange transactions of banks and the central bank into an “other” category, making it harder to distinguish economic actors.
Not the First Time
This change in methodology comes at a crucial time for China, which is bleeding foreign exchange reserves and foreigners as well as citizens are pulling out capital in record numbers.
Foreign exchange reserves at the central bank level decreased by $99 billion and the Institute of International Finance (IIF) estimates as much as $113 billion in capital left the country in January.
Emre Tiftik, who tracks the data for the IIF, says he started to notice strange moves in the data regarding capital flows after the surprise devaluation of the renminbi last August.
“Starting from the third quarter, there are so many outliers in tiny places which created the impression officials are trying to reduce the outflows,” he says.
An example is the category of “other assets,” in the capital account which represents “other” inflows into China.
Outward direct investment, the money Chinese are investing abroad also turned sharply negative, which means Chinese are selling foreign assets and repatriate the money. Another reduction in the total outflow figure.
“They completely changed the outward direct investment figures, they were -$30 billion now they are -$45 billion,” said Tiftik.
Robin Koepke, a senior economist at the IIF notes another instance where China just stopped reporting inconvenient data in the middle of 2015: “We had the same issue when they started reporting more data on equity portfolio flows in early 2014 and then stopped in the summer of 2015, right when the markets became volatile,” he says. The last number of June 2015 shows an outflow of $11 billion.
Without adjusting for all these erratic moves, the IIF estimates $637 billion left China in 2015.
But the people at the IIF and the South China Morning Post aren’t the only ones missing data on China’s foreign exchange holdings or transactions.
Last October, Harvard professor Carmen Reinhart noted the Federal Reserve had stopped separating official and non-official foreign holders of Treasury securities in the Flow of Funds report.
“They always reported ‘Rest of the World,’ and then within ‘Rest of the World’ they segregated ‘Official Institutions’ from ‘Non-Official.’ In the last couple of reports, they stopped separating into ‘official’ and ‘non-official.’ ‘Official’ were foreign central banks. Within foreign central banks, China was in a league of its own. I don’t know really what prompted that change,” she said.
What Happens Next
When officials stop releasing certain data, it usually doesn’t bode well for the future. In 2006, the Federal Reserve stopped releasing data on M3, a measure of the money supply, which included so-called repurchase agreements or repos.
In 2008, Lehman Brothers went bankrupt after financial markets found out it funded itself almost exclusively with short-term repos, had borrowed too much to begin with, and most likely wasn’t able to repay its lenders.
As for China, Tiftik thinks Chinese people are going to move money out of the country wholesale and foreigners won’t move a lot of money in.
“We believe that non-residential inflows [investment by foreigners] are going to be weak in 2016. Residential outflows [investment abroad by Chinese] are going to increase in 2016. China is becoming the capital provider to the rest of the world. This is unavoidable, this will happen,” he said.
This is only possible, however, if China sticks to its agenda to liberalize the current account and does not impose more capital controls because of outflows.
With a closed capital account and stable exchange rate “the Chinese [regime] invested foreign exchange on behalf of private parties. They collected reserves and invested them in Treasurys. Now the residents and the corporates are starting to provide capital to the rest of the world with the capital account liberalization,” says Tiftik.
Will this move lead to a rapid devaluation of the yuan versus the U.S. dollar?
“We have this on our radar as a significant risk to watch for. We are not the only ones who are worried about this.”
Valentin Schmid is the business editor of the Epoch Times. His areas of expertise include global macroeconomic trends and financial markets, China, and Bitcoin. Before joining the paper in 2012, he worked as a portfolio manager for BNP Paribas in Amsterdam, London, Paris and Hong Kong.
© Valentin Schmid