China’s relentless quest for growth is a toxic feedback loop of its own making

By Ambrose Evans-Pritchard

One cardinal fact governs the world economy today. China produces 31 per cent of global manufactured goods: it accounts for 13 per cent of total consumption.

The rest of us must absorb China’s increasing excess capacity. If the country is to meet the Communist Party’s growth target of 5 per cent over the next decade with the current hyper-investment model, it can do so only by eating further into the industrial core of Europe, America and India.

Chinese President Xi Jinping.
Chinese President Xi Jinping.Credit: AP

“Other major economies must be willing to reduce investment and manufacturing shares to accommodate China. Needless to say, this is very unlikely,” said Professor Michael Pettis from Peking University.

Xi Jinping is not reforming the old model. He is reverting to galactic overinvestment in everything from clean-tech, semiconductors, and steel – all tradeable goods that find their way onto global markets – to offset the deflating property bubble and to prevent youth unemployment rising further above the political danger threshold of 20 per cent.

This is intolerable for the world. It is ultimately even more destructive for China itself.

Beijing’s Central Economic Work Conference last month was a punch in the stomach for those hoping that Xi would take steps to end this mercantilist ratchet.

There was instead much talk of “vigorously” promoting further industrialisation, underscored by his new mantra of “establishing the new before abolishing the old”.

‘Xi Jinping is not reforming the old model. He is reverting to galactic overinvestment in everything…’

China’s pro-market weekly, the Economic Observer, says ruefully that this means sticking to “the traditional growth model that overly relies on infrastructure investment”. In crude terms, it means building more factories, and foisting the excess supply onto the world.

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Pettis says investment is already 42 per cent to 44 per cent of GDP. No major country in modern economic history has come close to these levels before. Other Asian tigers peaked in the low-30s before dropping back as they matured.

By the end of next year, China will have built enough solar and battery capacity to quadruple the entire global demand for these products in 2022.

It already has enough EV plant to meet global demand three times over. This surplus supply is hitting foreign markets with tidal wave force and at cut-throat prices. Car exports rose 84 per cent from January to November.

Xi Jinping likes artificial intelligence (AI), advanced electronics, aerospace and digital tech (when under total party control) but he is still flooding the world with “old” products.

China’s steel exports were almost 90 million tonnes last year, equal to the combined output of the UK, Germany, France, Italy and Spain. The surplus is approaching the extremes seen in 2015 when Britain’s steel industry came close to collapse.

China’s current account surplus is officially 2.2 per cent of GDP. Brad Setser, from the Council on Foreign Relations, says the real surplus is twice as high once you drill into the customs data.

Furthermore, China’s foreign exchange reserves exceed the declared $US3 trillion ($4.5 trillion). They are closer to $US6 trillion. Large sums are being placed abroad through state banks. This suppresses the yuan and gives China an extra edge in global trade.

Whether or not China is actively ducking surveillance by the US Treasury for currency manipulation, its economy is now so big that its $US900 billion annual goods surplus is destabilising world trade, like an elephant in a rowing boat.

China’s exports over recent months have been weak in dollar terms but strong in volume terms. Firms are escaping the slump at home by slashing prices to gain global share. Or put another way, the country is exporting its deflation on a grand scale.

The European Central Bank says Chinese export prices have fallen 6 per cent over the past year in yuan, 12 per cent in US dollars, and 18 per cent in euros. This is turning into a serious trade shock for Europe. America has been quicker to defend itself.

China is now in a toxic feedback loop of its own making. The latest PMI (purchasing managers index) surveys show that Chinese firms are cutting prices further as new orders fall.

Raymond Yeung from ANZ bank said the regime was dribbling out just enough stimulus to keep the economy afloat but not enough to break out of a bad equilibrium. “Clearly a stronger dose of countercyclical measures is needed,” he said.

Yeung forecasts real GDP growth of 4.2 per cent this year but nominal GDP of just 3.8 per cent, and it is nominal that matters for debt dynamics.

China risks slipping into a debt-deflation trap where interest costs rise faster than output in money terms, pushing up the debt ratio mechanically via the denominator effect. Chinese local governments already face $US850 billion of annual debt service costs.

Shang-Jin Wei from Columbia University said the People’s Bank should heed the lesson of former European Central Bank president Mario Draghi and do “whatever it takes” to prevent a deflation psychology taking hold. A blast of helicopter money or turbocharged QE (quantitative easing) would do the trick, but Beijing is deeply suspicious of this sort of Western advice.

China’s property crisis has weighed on investor sentiment.
China’s property crisis has weighed on investor sentiment.Credit: Bloomberg

China seems to be betting on a global recovery to pull it out of the doldrums. Meanwhile, it is mobilising the propaganda department and leaning on journalists, financial bloggers and academics to talk up the economy.

The reason why China invests so much – that is, saves so much – is not because families are maniacally thrifty, though people do save heavily as a form of healthcare insurance, and the middle class is squirrelling away money in the current mood of cosmic gloom.

The pathology stems from the structure of Leninist state capitalism and the role of the giant state enterprises. Xi Jinping is unwilling to let go of these behemoths because they are a key tool of party patronage and control. If anything, he is reviving them.

Professor Pettis says a reinvention of the Chinese state is needed to break the investment addiction, involving huge transfers of money from the state to the people. That is incompatible with party ideology and control.

If China sticks to the current strategy, there will be two consequences: the arithmetic of excess investment will push China’s debt ratio from 300 per cent of GDP to 450-500 per cent within a decade, precipitating a crisis; before that happens, there will be a global trade war, also precipitating a crisis.

The world will protect itself, either by forming an anti-mercantilist front, or by splintering into blocs.

The template is the 1930s, although it is hard to disentangle trade from the failures of the interwar Gold Standard.

The US was then the great surplus disruptor. It foolishly picked fights with the McCumber and Smoot-Hawley tariffs, setting off a collapse of the trading system that had worked so well to its advantage.

The deficit countries came out best from that rapid deterioration. The British Empire was able to stop its stimulus leaking to free-riders, and was able to retool its industries behind the tariffs of Imperial Protection.

It was the US that crashed into depression. The 1930s were the only decade in a century when Britain outperformed America.

Whether by intention, or misjudgment, or inertia, Xi Jinping’s regime seems to have chosen a trade war. This may take years to unfold and does not preclude a reflexive rally on the Shanghai bourse in 2024, but it does set the longer pattern of world affairs.

The outcome will not be kind to China.

The Telegraph, London

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