What Would a Chinese Economic Crash Look Like?

Is the Chinese economic miracle running out of steam? There is increasing reason to wonder, given that the economy shows more and more symptoms of previous financial crashes in other countries. Most obviously, the Shanghai stock exchange has been in decline for over four years, as the Yahoo chart of it indicates:

To be fair, the stock market is not nearly the presence in the Chinese economy that it is in an advanced economy, or even in other middle-income Asian countries. Relatively few Chinese are stockholders, and so there is no substantial direct effect of this decline on the wealth of the average Zhang San.

But the stock market is interesting not as a cause of trouble but as a symptom. There are numerous anecdotal reports of excessive building of factories for political rather than economic reasons. Every mayor, it seems, has to have his own high-technology center, his own steel mill, etc. The Asia Times reports that computer chip factories in particular are being overbuilt at a ridiculous rate. When you are spending other people’s money, as ambitious politicians are wont to do, you tend to be less concerned about long-term consequences, such as whether opportunity cost and generation of consumer value justify that use of those resources. And whether the Chinese growth rate even now is what it is claimed to be is questionable. The University of Pittsburgh economist Thomas Rawski questions the reliability of Chinese macroeconomic data, although he attributes it more to statistical immaturity than to malice by Chinese bureaucrats. But when every province reports a higher growth rate than the national growth rate, as is said to have happened a few years back, that is a sign of trouble. That the Chinese government is apparently contemplating propping up the stock market through share purchases is another warning flag, another example of shooting the messenger.

Many recent financial crashes in developing countries have occurred because economies with tremendous potential because of fundamentals – entrepreneurial drive, natural resources, human capital, etc. – but tremendous waste because of years of corrupt mismanagement of their economies have opened themselves to the merciless competitive probing of foreign investors and domestic entrepreneurs. People can suddenly try new resource combinations and see if they work, in the sense of providing more value to society than the cost of creating that value. Some of those experiments are wise, and some are foolish, but the less transparent and more corrupt the society the more difficult it is to tell which is which. For awhile there is immense excitement when an economy reforms, but eventually the economy’s opacity (both innate opacity because it is young and uncertain and aggravated opacity because of corruption) creates a backlog of mistaken ventures which must eventually break loose. A shakeout financial crash then ensues. This is the story of Mexico 1994, East Asia 1997, Russia and Brazil 1998, Turkey 2000, Argentina 2001, etc.

So is China vulnerable to such an event? Probably. But how would it play out? China’s currency does not provide the means of speculative attack that undid several other countries in recent years because of restrictions on taking it out of the country. And the problem is generally acknowledged here to be an undervalued currency rather than, as in Asia in 1997, overvalued ones. But markets tend to find a way. Improperly priced assets that are subject to government price controls get properly priced one way or another, as anyone who pays a huge finder’s fee to get an apartment in New York City or waits in line for hours to buy gasoline can tell you. The thing to look for as a sign that the yuan is vulnerable would be the setting up of overseas accounts in the currency at a more realistic rate, similar to the Eurodollar accounts of the late 1960s that undid Bretton Woods.

But in any event currency attacks are again the symptom and not the disease. If China is overbuilt in a short-term sense things can collapse even without the currency channel to get the ball rolling. Among the symptoms to look for would be falling property prices (perhaps already begun in Shanghai, according to this report). Unlike stock prices, that is an event that immediately affects large numbers of people, and so could precipitate a larger bust, even as it is also a symptom of other problems. One way or another, if China has accumulated a lot of economic mistakes, those mistakes will be pruned from the economy.

But lest things sound too pessimistic, it is worth noting that these are short-term issues. That China is overbought and overbuilt right now does not mean that the Chinese miracle is a mirage. More on that later.