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The growth of the Chinese economy decreased this quarter as it has each quarter since the beginning of 2010. It is also much slower than the average growth for the past decade and the downward trend is pretty consistent. But that does not seem to matter. Most analysts mistakenly predicted that China's economy would start to accelerate in the second or third quarter of this year. They were wrong. Now the vast majority of them again believe that the Chinese economy is about to bottom in the third quarter and resume growth. This is despite indicators like electricity usage growth. This has been steadily declining since the middle of 2011. It is also running at roughly half the average rate of the last five years.

The real question is why are these analysts so optimistic despite the fact that they have been consistently wrong? The reason is that they have enormous faith in the Chinese government.

Their faith seems to have a good foundation. The Chinese technocrats engineered the fastest development of a country in history. China's economy has gone from one of the smallest in the world to the second largest. When the economies of more developed countries collapsed in 2008, China was able flood its economy with stimulus and rebound at a breathtaking rate that was the envy of the world.

China has been able to create this environment with state control of large segments of the economy. In a recession, China does not have to encourage banks to make loans to businesses to get the economy going as they do in the U.S. or Europe. The government simply commands state-owned banks to make loans set by quota. It doesn't stop there. The central government can command the local governments to finance infrastructure projects with these loans to create demand and jobs. It also can command state-owned companies to make investments to create more growth and more jobs. So China can prevent recessions, right? Wrong.

China's economic miracle has been based on private enterprise, not state ownership. For more than two decades the Chinese have loosened controls over various sectors of their economy. This does not mean that they have encouraged it. Quite the contrary, they have spent far more time and money nursing inefficient state firms. But once you start to loosen some controls, institutions and markets can start to act in ways that are not intended. The central government's control of the economy is not what it once was.

For example, look at the state-owned banks. Their loans prevented a collapse in 2009, but at a cost. They lent money according to commands, not necessarily to borrowers who could pay them back. The result has been the growth of bad loans. So now with the Chinese economy slowing, they have been less willing to open the coffers. In July, the Chinese central bank told the banks to lend at 30% discounts to the large state-owned companies. But this time the banks have been resisting. For good reason. Chinese corporate profits show no signs of recovery and estimates have been cut by the most since 2009. Bad loans in some banks in Wenzhou are reported to be at 3% and could be as high as 7%.

Loans to local governments are also in question. Local governments get most of their revenues from land sales. To stem a housing bubble, the central government placed restrictions on these sales. As their finances deteriorated, the locals started to ignore these commands. Land sales are supposed to pick up, but during the recent holidays, a time for real estate sales, the housing market suffered a 70% decline from last year.

Banks have more reason to worry about their loan portfolios. They now have more competition for depositors. Bad loans can no longer be written off from profits made by suppressing the amount of interest paid to depositors. Profit growth at banks has slowed to 6% from over 20% at the beginning of the year.

It is not just the financial system that has to adapt to the increased liberalization. Increased travel and international trade means that more Chinese can vote with their capital and their feet. Money has been leaving China as never before. At the height of the financial crisis, about $110 billion left the country in the 12 months prior to March 2009. According to the latest figures, about $225 billion left last year. So many Chinese, specifically communist party officials, have followed the cash that the Communist Party has set up a special 'Command Group to Fight against Communist Officials and Government Employees Fleeing the Country'.

The irony is that capitalist analysts' and economists' predictions rely so much on government policy rather than the market forces and not just in China. They should instead take heed of the biblical dictum: Trust not in princes.

Source: China's Slowdown: Why The Analysts Keep Getting It Wrong