The China Bubble

Note from the author: This article was written in early 2010. It could take some editing for which I can’t spare the time, so I’ve decided to publish as is, because its thesis rings true, and could be received with interest today.

Thousands of students take part in a stunning display of kung fu choreography at the Tagou martial arts school in China

“We will bury you!”—One popular myth has Nikita Khrushchev banging the UN delegate desk with his shoe as he blurts out this infamous threat. Another one takes its gist to have been military, rather than … economic. This second myth is harder to dispel, owing to the difficulty of imagining today, decades since the spectacular failure of the Soviet Bloc economies, just how formidable their prospects had once seemed. Yet throughout the 50s and early 60s, their swift transformation from peasant societies into industrial powerhouses was generating much awe and panic.[ref]Paul Krugman, “The Myth of Asia’s Miracle,” (Foreign Affairs: 1994)[/ref] Poor and backward as they started out, these economies could boast growth rates of 6 to 8 percent—unheard of in the West—sustained like clockwork year after year and punctuated by stunning technological achievements, such as the launch of Sputnik 1 and the mission of Yuri Gagarin.

These early success stories inspired many attempts at an explanation, some of the most radical of which called into question the very soundness of liberal democracy, let alone that of the free market. Voter caprice in capitalist societies was thought to wanton without control, preventing long-term planning and derailing economic growth. Command economies, by contrast, let nothing stand in the way of progress—certainly not any scruples over the well-being or civil rights of their citizenry. Disciplined, farsighted, and unmolested by electoral upheavals, they pursued a deliberate course of industrialization that would surpass the uneven, unplanned, and disjointed performance of free enterprise. Such, at any rate, were the advantages imputed to the collectivist rising powers of the East by many puzzled intellectuals in the West. But as reliable data began to leak from the Iron Curtain, it it quickly undeceived those who could understand it.

Far from representing the inherent superiority of central planning, the performance of the Soviet Union and its satellite states turned out to be fully explicable by the large share of inputs they commanded.[ref]Ibid.[/ref] That an economy should grow faster when it employs more resources toward future production has always been understood: more input yields more output. Bringing women and rural dwellers into the workforce, uprooting illiteracy, enforcing compulsory schooling, and amassing physical capital into infrastructural and industrial projects can all lead to what economists term extensive growth.

That is what the economies of the Soviet Bloc experienced after adopting just such measures, what they owed their brief meteoric rise to, as well as their ultimate undoing.[ref]William Easterly and Stanley Fischer, “The Soviet Economic Decline,” (International Bank for Reconstruction and Development / The World Bank: 1995)[/ref] For even if the workforce could be thoroughly educated and gainfully employed, its growth must run into natural constraints. Not even the sustained accrual of physical capital, with all the sacrifices and deprivations it entails, can prevent extensive growth from drooping—for the simple reason that capital-intensive production is inevitably subject to diminishing returns. To expand forever it takes intensive growth—that is, increases in output for each unit of input—achievable through improvements in technology and ever more efficient use of resources. This is what the economies of the Soviet Bloc couldn’t do. In fact, by the 1960s they started deteriorating to an extent not fully comprehended until their dismal collapse.

Today the Communist experiment is nearly extinct. Only a few sad relics still linger—in Cuba, North Korea, Laos, and Vietnam. But there is one elephant in the room—one specimen bent on gainsaying everything the world has ever learnt from the Soviet breakdown. And that is the People’s Republic of China. As of this writing, its economy ranks the world’s fastest growing and third largest, not to mention its biggest exporter.

It was a comparative advantage in the manufacturing of cheap, labor-intensive goods that has dragged China out of the muck where it was stagnating since Mao’s days. That China ever harnessed it marks a monumental break with precedent for a Communist country: the Soviet Bloc could have tapped into the very same comparative advantage, but didn’t,  having decided on principle against trade with developed, capitalist countries. China broke the mold in the late 1970s with its debut in the global market and has since become the “workshop of the world.”

As evidenced by this economic miracle, Vladimir Lenin must have been ahead of his time when he urged the Politburo to relax its grip on agriculture and small businesses and to tighten it over “the commanding heights” of the economy instead. In China the Communist Party dictates top-down growth through currency manipulation, infrastructural undertakings, and demographic controls, while foreign investment, private or semi-private endeavors, and natural advantages in the manufacturing sector all contribute to bottom-up growth. If there’d ever been a golden mean between central planning and free enterprise, the Chinese must have come closest to striking it.

But how much higher will China rise as a Communist mongrel? Predictions differ, though evermore over when—rather than whether—it will overtake the U.S. as the world’s economic hegemon. Jim Rogers, hailed as a commodities-investment guru, recommends “Teach your children Mandarin” as the surest recipe for surviving not only the recent financial crisis but also others yet to storm, and is practicing what he preaches when it comes to his young daughters’ education. The late Nobel-laureate economist Paul Samuelson believed China’s supremacy to be just around the corner. In his last op-ed contribution[ref]Paul Samuelson, “Heed the Hopeful Science,” (New York Times: 2009)[/ref] to the New York Times, he wrote: “We begin now a new era in which China will increasingly make obsolete America’s 1950-2009 world leadership. Your children and my grandchildren will live in this new and challenging era. … [T]he day will come when China’s total real GDP will exceed America’s. Boohoo.”

Leading analysts from Deutsche Bank and PricewaterhouseCoopers have divined the early 2020s as the time when the scepter shall be passed. Unnerving as the prospect of quietly falling behind the Chinese may seem, some fear an even worse outcome: active sabotage by the Chinese authorities, who control the world’s largest pool of dollar reserves and could liquidate it at any point, thus bringing the U.S. dollar—and by extension, the U.S. economy—to its knees.

So should we all resign to our fate and get busy learning Mandarin?

Before deciding the question, Americans better take into account their long history of glamorizing foreign rivals. The alarm over Soviet superiority has already been adduced to establish some perspective, and can be readily supplanted by modern equivalents, should China enthusiasts dismiss it as either dated or too “ideologically charged” to be relevant. In the 1960s and 1970s it was West Germany—that indomitable arsenal of high-quality exports, whose disciplined workforce never tired or blundered—that surely would leave the U.S. economy in the dust. Close, but no cigar.

No sooner had one threat proved unworthy of much concern than the American public fixed its feverish imagination onto the next. At some point in the 1980s, Japanese buzzwords started haunting the lexicon of business management: kaitzen, tokkin funds, baburu, keiretsu, zaitech, etc. American students—needing no prompting by Jim Rogers—were taking crash-courses in Japanese so they could speak the language of their future bosses. American businessmen, for their part, if too old to learn the language, could—and often did—at least straighten out their hair and dye it black.[ref]2003, William Bonner and Addison Wiggin, “Financial Reckoning Day,” page 118[/ref] And who could blame them?

Japanese banks had become the biggest in the world. Japanese companies were wolfing market share in every sector they had their eye on. And adding insult to injury, Japanese tycoons were conspicuously hoarding trophy properties all over the United States—among them Hollywood studios in California and the Rockefeller Center and Exxon building in New York. The Japanese were clearly the smartest race among men; their regimented variant of Capitalism, manifestly superior; and their takeover of the world, inevitable … until 1989. That year the laws of physics broke down, leaving the stock market of Japan to crash and its economy to enter an unprecedented era of stagnation through which it is still plodding.

It looked as though Ezra Vogel’s bestselling prophecy Japan as Number One would not be fulfilled after all. Americans had scarcely heaved a sigh of relief when their anxieties rekindled, this time over the so-called Asian Tigers. That frenzy lasted well into the mid-to-late 90s, until put an end to by the Asian financial crisis. And now it’s China. But of course, this time, we are assured, it’s different.

So it is every time. The particulars are never the same. Yet all these cases of overblown alarm seem to share at least one trait. And that is the premise on the alarmists’ part that whichever up-and-coming economy is poised to take over the world will continue to enjoy nearly forever its outstanding growth rates of the moment. From this naive assumption the crudest, most unrealistic extrapolations often ensue. No predictions as to when or whether China’s economy will outdo America’s are worth taking seriously unless the growth rates they forecast for China stand a chance of reflecting reality. And for that future growth to be modeled realistically, its sources and constraints must first be understood.

The Past, Present, and Future of China’s Growth

Many forces are propelling China’s export-driven growth—the main two being a spring-back effect and a catch-up effect. The former denotes the gradual unwinding of the most debilitating policies and regulations from the Maoist past—as soon as they are rescinded, things get done less backwardly and growth bursts free. Short of removing themselves from power, the Chinese authorities cannot eliminate many more roadblocks to development than they already have. And so, the impetus of the spring-back effect is mostly exhausted. But to the more lasting benefit of China, it has precipitated a catch-up effect, which is what economists call the empirically observed tendency of poor countries to grow faster than developed ones.

For the most part, this economic convergence is a positive externality of globalization. China need not traverse the long and arduous learning curve attendant to the discovery of technologies that are now commonplace in the West. It need not devote time, capital, and manpower to the transition from the eight-bit to the 16-bit to the 32-bit to the 64-bit microprocessor. Everything the ingenuity of man has already produced, China can readily imitate, whereas technologically innovative countries must break their own records, so to speak, in order to grow. But if the Western look and feel of major Chinese cities is any indication, the country has run out of commonplace technologies to adopt.

International trade too works at bridging gaps in development. The poorer a country is, the cheaper its labor and the more attractive its exports. Yet the more China grows, the richer it gets. Workers’ wages begin to soar and so do production costs. Were it not for aggressive mercantilism, China’s comparative advantage in durable goods might soon peak—especially given fierce cost-competition from other big emerging markets such as India. Accordingly, the impetus of the catch-up effect is well on its way to teetering.

Manipulations of Labor

But Chinese authorities don’t just lubricate the export machine and leave the rest to God’s will. Rather, they do what central planners do best—that is, marshal resources on a grand scale to achieve fast industrialization.

Through sweeping educational reforms, they have slashed illiteracy and greatly improved the quality of higher learning. This ever more educated workforce has contributed a great deal to China’s growth so far. From now on, however, diminishing returns set in, as it is neither possible nor worthwhile for all Chinese youths to obtain Ph.D. degrees. Besides, the farther removed from the high-school level, the less of a commodity education becomes—and the less amenable to central planning.

Also thanks to Communist reforms, a good 45 percent of Chinese women now work—whereas almost none did before 1949. But although China can do better in this direction, it is at least halfway there. And since the 1980s, hundreds of millions of impoverished peasants have been encouraged to resettle from the countryside into the cities, where their hands can be put to industrial use. But the balance cannot be tipped much further, as today the Chinese population is split rather evenly between urban and rural.

In the 1940s, the Second Sino-Japanese War and the revolutionary turmoil that followed it had laid most of the country to waste. But as soon as China settled into Communist rule and began to enjoy some stability, a baby boom ensued, briefly interrupted only by the Great Leap famine. This population burst was at first considered a drag on economic development because it suddenly burdened families with a barrage of children—mouths to feed, too young to work.[ref]For a discussion of China’s demographics and policies, see H. Yuan Tien, et al. (1992). “China’s demographic dilemmas.” Population Bulletin 47; June.[/ref] To check this bothersome trend, the authorities resorted to draconian controls over people’s fertility—including but not limited to the notorious one-child policy—as a result of which, just as the baby-boomers came of working age there were fewer and fewer children to take care of. With such a surge in workers and slash in dependents, all the while the population was still growing, China’s dependency ratio fell drastically and its economy felt a staggering boost. In fact, official Chinese statistics credit this factor alone with over a quarter of the country’s economic growth between 1982 and 2000.[ref]“Demographic Dimensions of China’s Development,” Eduard B. Vermeer, Population and Development Review, Vol. 32, The Political Economy of Global Population Change, 1950-2050 (2006), pp. 116.[/ref]

But what looms ahead now is one catastrophic reversal. In traditionally patriarchal families, the restriction to one child has often led to the death by neglect of newborn girls. Aborting female fetuses when their sex becomes known is also common. In the upshot, Chinese young men are so prevalent today that a full 17 percent of them will never find wives. This lopsidedness, together with the low fertility rates, will whittle down the Chinese population soon and fast. Worse yet, as the baby boomers reach old age, there will be fewer and fewer young workers to support them. Here it is worth noting that for all its Communist pretensions, China lacks a social safety net. Rather, adult children are charged by the Chinese constitution with providing for their parents. Starting in the 2020s, the Chinese economy will be squeezed hard between a shrinking population and a deteriorating dependency ratio.

Of these many attempts at demographic engineering, some have borne fruit already and others are about to backfire. It is obvious that the Chinese authorities like to meddle with their country’s human capital but recently they have started to play with physical capital as well.

Manipulations of Capital

Notwithstanding its market reforms, China still remains a country ruled by the five-year plan. To exalt the Communist leaders and prevent civil unrest, GDP must grow by at least 9 percent every year. This is considered an end in itself, dictated by the central committee and taken to heart by the local officials, who hold considerable sway over the sources of credit, the real-estate market, and the workings of state-owned enterprises. In turn, these enterprises control nearly half the Chinese industrial output and, being exempt from most market pressures, ground their business decisions on quotas, bribes, political favors, and propaganda value. All these entities work in concert to make the GDP numbers add up.

One ever-tempting shortcut is, of course, to make them up. Chinese statistics often contain double counting, flawed, missing, or lagging data, and sometimes fly in the face of proxy measures of GDP growth, such as electric output. All of this suggests that Chinese growth might in fact be over-reckoned—but not by much. What they cannot fake, the authorities must bring about. And they do. How?

Of all resources, physical capital lends itself to central planning the best: it can be accumulated almost at will, substituted for brute force, and put to specific use. For this reason, command economies tend to drive it hard. China is no exception: fixed-asset investment—into factories, equipment, infrastructure, commercial and residential real estate, etc.—has made up well over 33 percent of its GDP growth for every year of the last nine. Such numbers are astonishing.

Although large developing countries can be expected to amass capital apace, what we are witnessing in China is an instance of force-feeding rather than healthy appetite. That much is betrayed by the trend of the Chinese economy, which has grown at a near constant rate—however high—over the past decade, in spite of more and more capital fueling it every year. The incremental capital-to-output ratio (ICOR) has risen steeply in China since the early 90s and now measures well above that of Japan, South Korea, and Taiwan at their heyday.[ref]John Wong, China’s Surging Economy, 2007, page 260[/ref] Diminishing marginal returns on capital must already be at work.

When their returns taper off, capital-intensive projects attract fewer and fewer private investors, leaving a vacuum for the government to fill. The well-known inadequacies of commend economies with respect to allocating resources profitably and efficiently get even more accentuated when fixed capital is their medium. For underused infrastructure, empty shopping malls, vacant office buildings, and idle factories must contend with the annual costs of upkeep to counter depreciation, in addition to their upfront costs. And that it to say nothing of the unseen, though all-too-real, opportunity costs—that is, the alternative uses of that capital, which free enterprise could have directed to fruitful ends. When approving such projects, central planners often forget about these strings attached. Once the true costs hit home, they are liable to throw good money after bad if by doing so they can prevent the man in the street from noticing that his leaders make expensive mistakes—skyscrapers, factories, malls, and even entire cities eaten by rust if left to their own devices.

Consider South China Mall, by far the largest shopping center in the world, twice as big as the previous record holder, built by a “local boy” undeterred by the absence of airports or freeways or bustling cities nearby. Here workers clean the water canals every day, janitors sweep the dust, shopkeepers read and listen to music, and teletubby mascots run around with no children to entertain, for the entire complex is eerily empty. Instead of filing for bankruptcy, the mall has merely changed hands and is now owned and run by the government.

Note also the splendid Potemkin villages dotting the mainland today. Huaxi, for example, right outside of Beijing, is the world’s “tallest village.” On its amenities and housing projects the government has squandered over $360 million in fixed assets. It boasts the 15th tallest skyscraper ever built, with an even taller one under construction, and bestows on each family—courtesy of the Village Committee—a brand-new Mercedes, BMW, or Cadillac; a luxurious house worth $150,000; a generous cash allowance; free education and health insurance; as well as complimentary cooking oil. Talk about idyllic bliss! The village song blaring out of the ubiquitous loudspeakers reminds the “peasants” of Huaxi that the skies above them are the skies of the Communist Party and that their land is the land of Socialism. For the benefit of stunned Western guests, a voice interrupts the music to ejaculate, in English, “Actually, we like this kind of Socialism!”

Huaxi Village, Jiangyin, China -
Huaxi Village, Jiangyin, China – “A model socialist village.”

In recent years, lavish experiments with steel and concrete have mushroomed all over China at a manic pace, which the stimulus program of 2008-2009 has only exacerbated. In proportion to the Chinese economy, this stimulus of $586 billion dwarfs even its American counterpart of $787 billion, a good $144 billion of which merely subsumes existing liabilities of the State and local governments. Not so in China, where far from receiving relief from the stimulus, provincial and local governments are borrowing afresh to finance it. At $150 billion, the current Chinese deficit bespeaks a rate of dissaving comparable to that of the U.S. government. This fiscal rush is exciting even more infrastructural development and construction projects—which is where Chinese capital and scarce resources seem to go to die.

Take for example the new municipal building somewhere in the remote province of Anhui—an exact replica of the U.S. Capitol. And in Inner Mongolia one can find New Ordos, a city built from scratch with government money to house over one million people, virtually none of whom have moved in yet. Anyone who has bought condos there is holding them “as an investment”—a telltale sign of real-estate speculation run amok.

In fact this trend of buying two to four condos and keeping all but one unoccupied is spreading like fire among the wealthy and upper-middle-class Chinese and evokes the same exuberant mentality common in the U.S. at the height of the recent housing bubble. Even in cities of red-hot economies such as Shanghai and Beijing, vacancy rates in new housing units and office buildings are crossing 25 percent. Yet the construction orgy continues. With prices of urban real estate inflating by as much as 80 percent and now claiming up to 20 times per capita income, major Chinese cities have become expensive places to live in, almost overnight. Innumerable families have tied up their multigenerational savings into steep down-payments for condos and apartments that will almost certainly turn out to be grossly overpriced. Out of a due consideration for them, it bears repeating that China has no social safety net. When this gigantic bubble bursts, rich and poor alike will be swept away.

Manipulations of Currency

China’s exports have long claimed a disproportionate share of its GDP—40 percent last year, doubled from a decade ago. Growing a colossal trade surplus requires excellent relations with trading partners from the First World, at which prospect the Chinese autocrats are not at all thrilled. Yet much as they begrudge this prickly dependence on the West and talk of boosting domestic consumption instead, they know that the export industry has been the main source of that wealth they love to squander on such grandiose projects as empty cities and picturesque skyscrapers.

Over the past couple of years, however, the global slump in demand has put the brakes on Chinese exports. To ease the twinge, the authorities have taken some ill-thought-out steps, such as building more factories even as existing ones either lay idle or cut production by at least half. This manufacturing boom is, of course, yet another outcropping of the stimulus program, as a result of which overcapacity now plagues many sectors of the export industry—in metalwork, textiles, chemicals, etc.—and commits China to more production and more exports in the future in order to keep these new costly workshops open.

This renewed need to promote exports breathes fresh vigor into the already thriving mercenary practices of Beijing. Currency manipulation, perhaps the favorite, is growing vehement. The Chinese resort to it to fatten the goose that lays the golden eggs. Formerly de jure and presently de facto, the yuan has been pegged to the dollar at an exchange rate that makes Chinese exports irresistibly cheap to Americans.

To keep the currency undervalued, the Chinese central bank must—and constantly does—buy dollars in exchange for yuan, so that the demand for the former can grow with the supply of the latter. As a result of such transactions carried out over many years, a mountain of dollars has accrued in the coffers of the People’s Bank of China, which, until recently, it could not but sit on or invest into U.S. government debt so as to earn a modest return. Thus it is crucial to understand that the largest pool of foreign exchange reserves the world has ever seen—$2.45 trillion and counting—belongs to the Chinese not because they deliberately set out to accumulate it for strategic purposes. Rather, it is the inevitable and increasingly unwelcome byproduct of their mercantilist policies.

One frightful fantasy which the American foreign-policy intelligentsia are prone to indulge is that, thanks to these reserves, the Chinese can wield all-powerful leverage over the U.S. economy—that they can dump all the dollars in their possession and thus debase the value of the American currency. In short, that they can wage economic warfare against the U.S. and win. These apprehensions spring from a fundamental misunderstanding of the subtle interdependence between China and America. True—the Chinese are our creditors and we are their debtors, but they hold no collateral: Over the years, they have sold us an endless stream of goods for less than those goods were worth. In return, they have accumulated inherently worthless paper currency—most held as Treasuries—whose only backing is the health of the U.S. economy.

These growing forex reserves cannot serve China as a “war chest” because its currency is, if anything, vastly undervalued, and its ability to repay international debts, unquestioned. They carry immense “potential energy,” as it were, while they sit idle, but are worth very little if used. For one thing, their sheer bulk is so tremendous that the liquidation of even a small portion would precipitate such a fast and sharp depreciation of the dollar as to decimate the value of the rest. The corresponding steep appreciation of the yuan would grind the Chinese export industry to a halt and put nearly half of China out of work—yet another reason why extreme dependence on exports is dangerous.

China's Currency Bubble
Source: “What the Renminbi Means for American Inflation” (url)

As for the repercussions in the U.S. economy, they wouldn’t be entirely dreadful. The dollar as a vehicle currency might be dealt a crippling blow, though that is far from certain, given the many past indignities, such as the collapse of the Bretton Woods system, from which it has rebounded more or less unscathed. The export and hospitality industries would flourish, and after the bad blood cleared with the bad loans, confidence in future American investments would soar, for the dollar can only appreciate from its lowest low. The rocky experience might even chasten the U.S. government into confining its spending to its means and forswearing runaway debt. On the whole, the Chinese can hurt no one but themselves by liquidating their dollar reserves. Though Americans may not believe this, the Chinese themselves do, and, resigned to the prospect of holding their dollar-denominated assets indefinitely, have taken measures unprecedented in the history of finance to protect their value against inflation.

Until recently, nearly all of these assets were held in the form of Treasury and agency debt, whose meager yield could not keep up with inflation and the other transactional costs to holding a foreign-exchange peg. But in May of 2007, in a move that garnered surprisingly little publicity abroad, China invested $3 billion of its dollar reserves into a 9.9 percent equity stake at Blackstone Group LP, a major American private-equity financier. This investment marks a breakthrough in the management of China’s forex reserves: the start of a shift away from U.S. government debt, which until recently was considered a safe however low-yielding investment, and into private equities and corporate debt, always risky but of potentially high return.

The trend continued, and by the end of 2007, the State Administration of Foreign Reserves (SAFE) of China had invested an estimated $100 billion into U.S. mortgage-backed securities. By 2008, its holdings included minor stakes at Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco, and RBS. According to Brad Setser, a member of the National Economic Council, “SAFE has built up one of the largest U.S. equity portfolios of any foreign government entity investing abroad, including the major sovereign wealth funds…. It appears [as though] SAFE began diversifying into equities early in 2007 and, rather than being deterred by the subprime crisis, it continued to buy.” Such ill-timed speculative dabbling into equities and corporate debt ended sourly, with losses to SAFE estimated at $80 billion as of March 2009.

But this is not all, for in September 2007 a new sovereign wealth fund was established—China Investment Corporation (CIC)—specializing in the investment of over $200 billion of China’s forex reserves into the equity and credit markets. Its holdings include a 9.9 percent stake at Morgan Stanley and a minor percentage of VISA. The governance and operations of both CIC and SAFE, though shrouded in bureaucratic fog, seem firmly entrenched in the political establishment. Their forays into equities mark the latest stage in the evolution of central banks and their subsidiary institutions from lenders of last resort to monetary authorities to, now, portfolio managers.

If China’s experiments with its forex reserves end up subsidizing American businesses as opposed to the U.S. government, so much the better. But when Chinese bureaucrats playing venture capitalists, unconstrained by any accountability to their taxpayers, throw billions of dollars not their own at speculative ventures, dislocations and inefficiencies might develop across any markets in which they invest. Moreover, the trustworthiness of firms in contractual business with the U.S. government may be compromised if investors backed by the Chinese government have any say over their operations. But these are tepid concerns overall. Of far greater importance is the harm China is inflicting on itself with its policies.

A country committed to a fixed exchange-rate regime must sacrifice its independent monetary policy and submit to that of the country to whose currency it pegs its own. So too China has little to no control over its money supply, especially now that it seems to have given up on sterilized intervention, and must import whatever inflation the U.S. economy produces in order to keep the yuan pegged to the dollar. As measured by M1, the money supply of China has ballooned by 35 percent between the end of ‘08 and that of ‘09. As measured by M2, it has expanded by 25 percent since March of ‘09. Inflation too is creeping up.

All this liquidity has flushed the pockets of ordinary citizens with cheap credit, which ends up into speculative ventures in real estate, construction, and manufacturing. Bank lending in China all but doubled in 2009 from the year before. By comparison, U.S. banks swelled up their loan book by only 10 to 15 percent each year between 2005 and 2007—at the height of the frenzy. Such overflow of easy credit provides rich and abundant nourishment to asset bubbles. And though China has known its share of market bubbles throughout the 1990s, all fueled by the government and ultimately traceable to the side effects of currency manipulation, the magnitude of the one now ballooning is unprecedented, as is the recent growth of Chinese forex reserves, which graphed, mimic an exponential function. Unprecedented fiscal abandon is also fanning the flames of speculative folly nationwide.

Not if, but when…and then what?

There is no saying when this bubble will burst or how much destruction it will leave in its wake but the outlook is grim. Civil unrest and political disturbances are not out of the question, but how Chinese foreign policy will reflect the upcoming tumult is not to be guessed at. China could lean heavily on its military might to compensate for its eroding economic power. Or it could sober up and renounce or postpone its global ambitions. Economically, the fallout could signify the death of mercantilism—the root of most evil in China’s economy. Though it is just as likely that an autopsy performed by Keynesian scholars will implicate the high saving rate as the cause of the crash.

But one thing is certain: The “Chinese miracle” does not give the lie to the economic lessons of the 20th century after all. Without question, China is undergoing its own industrial revolution. The world’s fourth biggest and most populous country has lifted itself from abject poverty. Monumental changes must unravel. The momentum of transition may last for decades. The turbulent particulars can bewilder observers. Nevertheless, the overarching path of economic development happens to be schematically simple. If we look past its bells and whistles, the Chinese economy shows a core made of extensive growth, just like the Soviet Union in its heyday.

Sales people introduce properties to potential buyers at the 2010 Beijing Spring Real Estate Trade Fair on April 10, 2010 in Beijing, China.
Sales people introduce properties to potential buyers at the 2010 Beijing Spring Real Estate Trade Fair on April 10, 2010 in Beijing, China.

Slowly, steadily, and diligently, the country’s labor pool and capital base have been expanded as far as their natural limits allow. Friction is now getting uncomfortable: the demographic resources are depleted; inasmuch as education is a commodity, the workforce is already educated; and if the accumulation of capital accelerates, the economy will scarcely receive benefit but the environment will suffer such a strain as to make not only radical ecologists, but any men of common sensibility squirm.

Innovation—the Philosopher’s stone of economic growth—cannot be planned. Chinese authorities can choreograph rural migrations and erect skyscrapers to prettify city skylines. But that won’t do. It takes something very different to create a lively, self-sustaining modern economy capable of intensive growth: steady property rights, unrestricted labor mobility, developed credit markets, provisions for intellectual property, and limits on bureaucratic interference—all missing in China. Only under such conditions can Hayek’s economic calculation problem be solved, entrepreneurship thrive, and decentralized knowledge direct economic activity. But when all you have is a hammer, everything looks like a nail. So instead of setting the economy free, Chinese central planners continue to experiment with mercantilist schemes and boondoggles of fiscal largess because these are the only tools at their disposal.

Any fears that China can remain what it is and still continue to grow at a breathtaking pace are, to put it mildly, unfounded. In order to compete with America, China would have to become like America; but if it did, it would no longer be a country to fear—prone to aggression or supportive of rogue regimes the world over. Instead, it would join the ranks of peaceful capitalist democracies and cease to pose a threat to the West. Such a metamorphosis should be welcomed and encouraged, not dreaded and undermined. To this end, nothing is more important than one often overlooked sector of the American export industry—that of culture and ideas. So far, the U.S. has exported to China its recklessly loose monetary policy and its penchant for wasteful fiscal “stimulus”—neither thing worth sharing. By contrast, the spirit of laissez-faire and the appreciation of liberal institutions—these most quintessentially American concepts—lie dormant today. With the U.S. sliding toward statism itself, their supply is too scarce even for domestic consumption, let alone for export abroad. If only America could become more like itself, and China more like America, the world would be a much safer and more prosperous place.

Author: Kejda

Born: Tirana, Albania Residing: New York, NY University of Waterloo, Economics '08

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.