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China did it again, growing 5.3% against all odds to dispel worries that Asia’s biggest economy is in trouble.
Yet there are two problems with this stronger-than-expected year-on-year gain in the first quarter. One, this economic equivalent of a magic trick masks hints of weakness. Two, it might give Beijing the mistaken impression that its job is done to defeat deflationary pressures.
Signs since the January-March period have been less promising. Retail sales increased just 3.1% in March year on year, below forecasts for a 4.8% jump.
It means consumption “slowed from a very robust” 5.5% in February, “pointing to weaker demand,” observes Union Bancaire Privée senior economist Carlos Casanova. “This suggests that domestic consumption lost momentum in March, in line with broad-based consumer-price index declines.”
Industrial production, too, belying optimistic signals from manufacturing data. “In our opinion,” Casanova notes, “this could suggest that manufacturing is not benefiting from the cyclical recovery in global trade as much as previously thought, due to overcapacity constraints in key sectors.”
This overcapacity issue is the big problem. The deflationary currents working their way through the economy aren’t nearly as virulent as those hitting Japan 25 years ago. Unless, that is, Xi Jinping’s team fouls up the endgame.
Japan sure did. The 12 Japanese governments since 1998, around the time Tokyo realized deflation had become deeply ingrained in the economy, have been grappling with past mistakes.
The biggest was slow-walking efforts to address the bad-loan crisis that followed the implosion of the 1980s “bubble economy.” Rather than get toxic assets off of banks’ balance sheets, Tokyo prioritized monetary easing and bailouts. That treated the symptoms of Japan’s stumble, not the root causes.
Students of that era can’t help but worry that China is making a similar mistake. Chinese leader Xi and Premier Li Qiang have talked a great game of ending the property sector crisis. There have been lots of smoke signals about heading off a giant debt reckoning for local governments.
But bold actions to slow the bleeding have been few and far between. Ideas about getting bad assets off developers’ balance sheets remain largely on the drawing board. It means an industry that can generate 25% of gross domestic product is stuck in neutral, at best.
Municipalities, meanwhile, are the unsung heroes of China’s rapid growth since the 2008 global crisis. Since then, an infrastructure arms race has seen the construction of GDP-boosting skyscrapers, roads, bridges, ports, apartment villages, shopping complexes, public squares, international airports and hotel facilities, amusement parks, cutting-edge power grids, white-elephant stadiums, you name it.
This greatest construction boom in modern history has its roots in Communist Party incentive dynamics. The goal is to make a name for yourself locally to turn heads in Beijing and propel you to national power. The economic excesses inherent to this ethos can be seen in the $9 trillion mountain of local-government-financing-vehicle (LGFV) debt.
We’re talking about a debt load twice the size of Germany’s annual GDP, three times France’s and four times Canada’s. LGFVs are off-balance-sheet tools, and with all the opacity that suggests. Between all these LGFVs and the default drama surrounding China Evergrande Group and peers, it’s easy to see why analysts make Enron Corp. comparisons.
Others can’t help but argue that China is bumbling toward a “Lehman Brothers moment,” the point where a credit-and-debt fueled growth boom meets a nasty end. This trajectory isn’t a given, of course. Xi and Li have the power and the resources not just to repair the financial cracks but to build economic muscle. But only bold reforms can put China on a path to growing better, not just faster.
Japan spent years prioritizing big GDP readings over getting under the economy’s hood. Even today, Japan remains strongly addicted to the zero-rate regime that’s been the law of the land since 1999.
The best the Bank of Japan has been able to do is get short-term rates to a range of 0% to 0.1%. Decades of impossibly huge corporate welfare reduced the urgency to cut bureaucracy, boost productivity, modernize labor practices, empower women and incentivize CEOs to innovate and take risks.
A quarter century of free money made it safe for Tokyo to raise its debt-to-GDP ratio to roughly 260%, the worst burden in the developed world. Tokyo’s plan to grow its way out of debt continues to fail spectacularly amid a fast-shrinking population.
China must avoid this liquidity trap. That means stepped up efforts to shift growth engines from real estate to services and innovation. The question is whether China’s 5.3%, topping this year’s 5% target, warps incentives.
There’s zero room for smugness in Beijing amid deflation concerns. Xi’s inner circle needs to look no further than Tokyo to see what happens when the economic magic runs out.
