Ｔｗｏ Ｒｉｓｋｓ Ｅｎｄａｎｇｅｒ Ｃｈｉｎａ’ｓ Ｅｃｏｎｏｍｙ

What do you think of the middle- and long-term prospect of the Chinese economy? How to judge whether the asset bubbles will be continued or broken? This is the core of the current Chinese economy.

The experts thought that the Chinese economy has hit bottom but not yet seen the recovery. The risks which will endanger the Chinese economy in the future include the “secondary deflation” and the bursting of asset bubbles. However, the inflation and the stagflation are not likely to happen.

Hit Bottom but Not Recovered

In the experts opinion, Chinas economy has entered a new growing period since 2002. In 2007 it reached the apogee of this economic growing period. In 2008, the economic growth was greatly eased under the influence of the subprime credit crisis in the USA. But the economic decision-makers had to make clear whether this was the shock wave or the periodic wave, which was the key to understanding the direction of Chinese economic development.

The so-called economic shock wave means the economic wave arising from a phenomenon which happens outside of an economic system and is exerts influence over this system later. The influence of SARS in 2003 is a typical example. The so-called periodic economic wave means that a periodic adjustment occurs to an economic system, resulting in the breakout of the contradictions in the system and the decrease of economic growth rate. During the adjustment process there will appear the surplus production capacity as well as the increase of unemployment ratio.

It seems that the decrease of Chinas economic growth rate is attributed to the shock from the outside. However, this is only an inducement. Actually, the basic reason of the decrease is Chinas defective economic system which is haunted by the problems of “too much saving and too little consumption”. In contrast, the US economic structure has the problem of “too little saving and too much consumption”. Both countries need effective measures to change the structure.

The relationship between consumption and saving is the most fundamental macroeconomic variable relationship. It will take a long time to dismiss the unbalance between the two aspects. For China, it is necessary to turn the surplus saving – the demand of export – into the demand of consumption. But such a turn can not be finished in one or two years.

Attention should be paid to the fact that the fast economic growth will be ended if the unbalance between the consumption and saving is settled. The long-term potential economic growth rate may fall to between 6% and 8%.

After going through fast development, Japans economic growth rate fell to 6% in the 1970s. China must prepare well for keeping the economic growth rate at a moderate level. Right now the urbanization of Chins is still on its way. The decrease of the long-term potential economic growth rate will not be large. In addition, the increasing stress for environmental protection also keeps Chinas economy from growing at 10%.

If taking the October 2007 as the turning point of Chinas economy to have downwards performance, it is only 20 months till June 2009, which can be said to be the middle part of the whole adjustment period. Therefore, the economic development can not be said to recover after hitting the bottom. The most optimistic saying is that the decrease of the economic growth rate has bottomed out.

Danger from “Secondary Deflation”

The most dangerous risk for Chinas economy in the future is the “secondary deflation.”

The danger comes from three aspects: the first one is the governments economic stimulus package, which stops the decline trend of economic performance in a short time and lengthens the process of production capacity adjustment. For example: the steel production capacity in China is estimated to be 670 million tons while the actual demand is only 400 million to 600 million tons. Stimulated by the government expansion financial polices and loose monetary policies taking effect in the second quarter, the Chinese steel market became active again and the steel price rallies, which will undoubtedly impair the impetus of the steel enterprises to cut down the production capacity.

The second one is the experience from last macroeconomic adjustment. The effect of the government investment in pulling the economic development is becoming smaller and smaller. Once this effect is completely run out, the macro economy will take on a downward development trend. In 1998 when the Asian financial crisis happened, the Chinese government issued the economic stimulus package, making the current economic growth rate increase from 7.2% in the first quarter to 9% in the fourth quarter. However, when the effect of the stimulus package was gone, the economic growth rate fell back to 7% in the fourth quarter of 1999.

According to the relevant reports, there have been the problems of insufficient reserved financial investment projects. From the second quarter the scale of financial investments from the central government saw a drastic decrease. At end of 2008 the investment amount was 104 billion yuan (USD 15.22 billion). Then it was 130 billion yuan (USD 19.02 billion) in Q1, 2009, 70 billion yuan (USD 10.24 billion) in Q2 and 80 billion yuan (USD 11.71 billion) in Q3. This July the growth rate of the investment of central governments projects decreased to 5.5%, 26.1 percent lower than June.

The third one is the loose monetary policies. This may result in the new unbalance of the economic system, which is to support the stability of entity economy with the prosperous asset market, or in other words, to establish a stable entity economy based on the bubbles of asset market. After the 9/11 event, the US Federal Reserve, with the aim of relieving the US economy from the damage from the overheated new economic, adopted the low interest rate policy, through which the cash fluidity was released and a large amount of social capital flowed into the real estate market. Then the real estate market became extraordinarily prosperous. But this kind of prosperity separated from the entity economy didnt last long. Now, many large enterprises in China have entered the real estate market, which is worth worrying about.

Whats more complicated is that the Chinese economy has been highly incorporated into the world economy. Therefore, the Chinese economy can not be free from the influence from the outside. The shock from the foreign countries can directly affect the stability of Chinese economy.

Inflation Not Likely to Happen

People mostly worry about whether the inflation will happen in the future. The experts believe that the inflation is not quite likely to happen in this year.

The inflation is closely related with the economic overheating, which is one of its most typical features. But the present situation of Chinas labor market makes it unlikely to happen. Simply speaking, once there is a forecast about the inflation, the workers can add this factor in the salary negotiations, causing the spirally increase of the salaries and prices which finally leads to the inflation. It is hard to imagine that the Chinese workers have enough negotiation ability to require the increase of their salaries with the excuse of inflation forecast. Actually, the minimum wage guidelines in many places were decreased. According to the data from the National Bureau of Statistics, the employees in urban areas in the first year of 2009 saw 12.9% year-on-year growth in their average salaries. The growth rate was 5.1% lower than the previous year. In the coastal areas of Southeast China, no increase happened to the salaries, proving that there is no spiraling increase of prices and salaries in China.

In addition, the international food price decreased drastically from the beginning of 2009 and the domestic food price faces the stress of moving downward. Therefore, it is nearly unlikely to see the increase of agriculture product price push the product price upward. The impact from international oil price is the most uncertain factor. But in the system of price forming, the increase of international oil price is unlikely to push the overall increase of the products prices. In conclusion, the possibility for a cost-push inflation to happen in China is quite low. When the total demand was depressed, the inflation may not visit China in this year.

It is usually believed that there is a time lag of 12 to 16 months between the increase of money supply and the inflation. It means that the inflation may happen to China in the next two years. But some experts thought that the “secondary deflation” is more likely to arise than the fast economic recovery. Therefore, the inflation is probably not to happen in the next two years. The cost-push price increase may occur, but it will not last long.

In addition, the foreign experience told us that it is good for economic recovery to keep a certain inflation which is a 5% growth rate in price in the economic squeeze period. The standard of inflation is that the overall price has a more than 5% growth.

Continuation and Bursting of the Bubbles

According to the experts, though the inflation is not likely to happen, the related inflation forecast is not meaningless. Actually, such a forecast can exert their influence upon the price of asset market.

The currencies can flow into the asset market, pushing the prices of stocks and real estate upward. In the first half year, great rebounds happened to the stock price and real estate price. Currently, the price and volume trend (PVT) of the asset capital is different from the trend of entity economy. The surplus fluidity pushes the asset price upward, which is reflected in the realization of self-anticipation. Now many investors believe that there will be inflation and choose to invest in stock market and property market to avoid the risk of inflation. So it is certain to have bubbles in the asset market.

But thats not the main problem. Whats worth worrying about is whether the bubbles will be broken. The experts pointed out that the asset bubbles may not burst in recent years, because of the Chinese asset market featured with the special mode of “bubble bursting”.

The bubbles in the Chinese stock market are hard to be broken automatically. The main force leading the market reverse comes from the adjustment of the government. This is the so-called policy-oriented market. Therefore, the risks of the bursting of the bubbles in stock market are changed into the policy-related risks. Concretely speaking, whether the bubbles in the stock market will be broken depends on whether the government wants them to be bursted. The current polices of the monetary administration department is the most uncertain factor in the Chinese stock market.

We can see from various clues that the Peoples Bank of China (PBOC) is not likely to make directional changes to the macroeconomic adjustment in the near future. But this doesnt mean that the central bank will make no changes. After all, “to keep the stability of the currency value” is the prime task of the central bank.

The government department in charge of monetary administration has three ways to regulate the stock market. The most common way is to take tight monetary policies. Apart from it, there are two other ways. The first one is to encourage the listings of new stocks; the second one is to increase the stamp tax of the stock exchange. The former method has already been carried out, but the effect of pushing down the stock price is not so obvious. The second way is thought to be an effective method. Its function of pressing the stock market mainly depends on the psychological endurance of the market.

Different from the stock market, the real estate market exerts more influence over the entity economy. The investment in the real estate market can increase the total demand for investment and consumption more effectively. The credit business for real estate is the fastest growing business in the banks. Once the bubbles are bursted, the asset system of the banks is directly exposed to the threat which will cause the credit squeeze of the banks and exert great negative influence over the real economy.

Due to the close relationship between the real estate market and the entity economy, the government department in charge of macroeconomic adjustment a is put in a rock and a hard place. If the real estate market is not active, the plan of recovering economy is hard to be realized. If putting more money into the real estate market, the bubbles are inevitably formed, which will endanger the banking systems asset safety. In addition, the real estate industry is highly related with the peoples livelihood. The increase of house price makes it unaffordable for the ordinary consumers.

Comprehensively, the Chinese government should make a choice causing fewer damages. Therefore, the government will not intervene into the real estate market in the near future.

In addition, the commercial banks and the local governments, which are the dominant forces of determining the development trend of real estate market, are closely related with the real estate market in interests. For the commercial banks, the real estate credit business is the most profitable. For the local governments, the land finance is the most important income source. Nearly all the local governments of different levels in China list the real estate industry as their pillar industry.

In this situation, the bubbles in Chinas real estate market will be continued and will become larger than 2007. The real estate market and stock market in China support each other and push each other upward until the bubbles are broken, which is the fuse of the “secondary deflation” in Chinas economy.