Can China really save the world from the Greater Recession?

Posted on 28 July 2009 with no comments from readers

‘This is the question that everybody keeps on asking us,’ Standard Chartered Bank’s regional head of research for Asia, Nicholas Kwan remarked as we began our interview in his office high up in the headquarters of the bank overlooking the Hong Kong harbour.

He is a good person to ask. Mr Kwan heads a team of 14 highly respected economists researching the macro-economics of Asia, and spent many years with the Hong Kong Monetary Authority, the local central bank. So what does he make of China’s 14 per cent of GDP stimulus package and its aggressive bank lending strategy which has pushed $1 trillion into the economy in the past six months, equivalent to over 50 per cent of GDP?

China crisis

‘Well yes it is going to make the recovery very unbalanced and unhealthy but what other choice did they have? To have done nothing or less would have been far worse.

‘The problems lie ahead, in two or three years, not any time soon. The economy is half market and half government, and that is a strength in dealing with the crisis (which has brought exports down by a quarter).

‘The banks have to lend and are being obedient and taking their orders and lending, which is more than the Western banks are doing. Of course, this is not just subprime lending, I would say it is sub subprime.’

Mr Kwan thinks this does not matter a great deal in the short term because the problem of the collapse in trade is immediate, and it is working up to a point with growth rates remarkably good in the circumstances. He also explains that China is not in anything like the same debt position as the rest of the world, and so assuming more debt now is not such an issue.

‘Non performing loan levels at the banks are lower than two years ago and only four per cent compared with 10 per cent a decade ago and up to 25 per cent at the peak. Total public debt is around 20 per cent of GDP, and there is no external debt, so China is in a good fiscal position.’

Non performing loans

Where Mr Kwan sees problems ahead is in one or two years time when the banks can not get the money that they are lending now back. For example, some of this borrowing is going into the stock market fuelling a bubble which might well crash at some stage in the future.

But at the moment the stock market has upside with the main index up from a low of 2,000 to 3,000 points but still well shy of its 6,000 peak. Price-to-earnings ratios are down from 40-60 to 15-30 times. IPOs have started to emerge and are being heavily oversubscribed. Money has also gone into commodities, pushing up prices.

‘No official is going to get into trouble for buying commodities, even if the price later goes down,’ says Mr Kwan. ‘But there has certainly been a rush to approve projects. Some cities have got 20 years of funding for a metro overnight and suddenly have a lot of money to spend.’

Capitalist society

Indeed, the Achilles heel of China is that it remains a society deeply divided between rich and poor, and the poor tend to save rather than consume. Thus stimulation of the economy must be done through central government and not the consumer, and this can cause big economic distortions in the process.

As we wrapped up our conversation it became clear that my initial impression of the Chinese stimulus plan had been too simplistic. There is something going on with consequences but I was right to be critical. We have already seen one unforeseen consequence in the inflation of commodity prices in a period of massive global industrial demand destruction.

More will follow. But that still leaves the question: can China save us from the recession? I asked Mr Kwan whether it was realistic to expect a country that accounted for perhaps 10 per cent of global GDP to save the other 90 per cent from its collapse.

He tended to agree with me that it is not reasonable to expect that, and to this extent the China recovery story is a myth. The Chinese dragon is a bit of a paper tiger, and struggling to save itself, not the rest of the world.