In my post last week about China (see China: Beyond The Hard/Soft Landing Debate), I wrote that one of the side-effects of the CNY/USD peg was an inappropriate monetary policy, which served to coddle the State Owned Enterprises (SOEs) at the expense of the Small and Medium Enterprises and the household sector. Not so coincidentally, Party cadres and insiders have made out like bandits as the power of SOEs have grown. While the central government's stated policy is to re-balance growth away from big ticket infrastructure spending toward household spending, such a policy is unlikely to get implemented because it gores the Party insiders' ox.
The conclusion that I came to was that, when faced with the prospect of a slowdown, China's leadership is likely to panic and implement another round of stimulus, which would lead to another round of unbalanced infrastructure-induced growth, despite its stated policy of trying to re-balance growth toward the household sector.
That's precisely what seems to be happening. Outgoing Chinese premier Wen Jiabao warned last week that the "country's economic rebound is not yet stable and economic hardship may continue for a period of time". That statement prompted speculation that we would see another round of stimulus.
If you want immediate growth, then the easiest policy is another round of infrastructure-based stimulus spending. Bloomberg echoed my sentiments about policy direction in an editorial titled China's Economy Needs Spending Power, Not Steel Factories:
Wen is focusing on homegrown methods to boost growth, such as promoting domestic investment. This strategy risks repeating the excesses of the 4 trillion yuan ($586 billion at the time) stimulus package of 2008, which fueled inflation, pushed credit beyond sustainable levels and led to a property bubble. It also favors large, and often inefficient, projects by state-owned enterprises over small and medium-sized companies: Witness the government's decision in May to approve an $11 billion steel plant, for an industry in which there is already excess capacity.
Also consider this Bloomberg story about increased railway spending, another classic form of infrastructure fueled growth (see China Echoes 2009 Stimulus With Railway Spending Boost) [emphasis added]:
Full-year spending will be 448.3 billion yuan ($70.3 billion), according to a statement dated July 6 on the website of the National Development and Reform Commission's Anhui branch. The document indicates a 9 percent increase from a previous plan of 411.3 billion yuan. Spending was 148.7 billion yuan in the first half.
China's fixed-asset investment has already started to pick up and a jump in spending on railway construction would echo the expenditure on rail lines and bridges that was part of stimulus during the global financial crisis. A decline in foreign direct investment reported by the government today underscored the toll that Europe's debt woes and austerity measures are taking on Asia's largest economy.
In the meantime, China's property prices are seeing signs of a turnaround.
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All this is happening while the government's stated goal is to restrain the effects of the property bubble. But faced with economic weakness, the reaction is to spend more money on steel mills, railways and to allow the property bubble to reflate.
In the short-term, this is good news as it means a soft landing is in the cards for China. In the long-term, more unbalanced growth means that when the next real downturn hits, the authorities may not have sufficient resources to cope with its effects. I worry that in the down leg of the next cycle, we may see a crash landing - defined as negative GDP growth from China. That's a prospect that's not in anyone's spreadsheet model.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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