China: On the Way to a Deflationary Crisis
By Sam Vaknin
Author of "Malignant Self-love: Narcissism Revisited"
Consumer price inflation in China is down to 4.2%. The growth rates of industrial production (output), exports, and imports are all down. China is on the path to deflation.
Mounting sovereign debts crises in Europe and an anaemic rebound in America's economy were more than offset by the emergence of Asia – and, in particular China and India - as a global powerhouse. Yet, the warning signs are there: China's economic "miracle" has long been based on an artificial rate of exchange for its currency, the yuan (RMB); on unsustainable dollops of government largesse and monetary quantitative easing which led to the emergence of asset bubbles (mainly in real-estate) and to pernicious inflation; and, frankly, on heavily-redacted statistics.
Real wages have been declining in China for quite a few years now as rural folk moved to burgeoning cities, bad loans proliferated, and consumption remained subdued as savings rates reached malignant, self-defeating levels. In an effort to sanitize humungous export proceeds, China amassed trillions of dollars worth of foreign exchange reserves, mostly invested in American treasury bonds, creating a dangerous exposure to the vicissitudes of the increasingly-more decrepit US dollar and to America’s downgraded sovereign credit rating.
The Chinese authorities' attempts to clamp down on rampant speculation and price gouging are too little, too late, not to say irrelevant. The economy will screech to a shuddering halt in the mother of all hard landings. The Chinese house of cards and hall of mirrors will collapse ominously and swiftly. This will bring the entire global economic edifice into disarray with mounting imbalances and increased risk-aversion among investors. The second phase of the global crisis will resemble closely the Great Depression with massive write-offs in the values of equities, across-the-board crumbling of entire banking systems, and mounting, two-digit, unemployment rates everywhere.
How to reconcile this doomsday prognosis with China’s uninterrupted string of decades of stellar (often two-digit) annual growth figures?
By seeing China for what it is: the world’s greatest-ever Ponzi scheme. Behind the hype, spin, propaganda, and outright confabulations, China’s economic miracle is founded in its entirety on a simple premise, a breathtakingly audacious prestidigitation: a large (equal to two-fifths of GDP) and steadily soaring balance of payments (current account) surplus (mainly with the USA, its addict-partner in this danse macabre) serves to disguise and directly underwrite the fetid outcomes of an all-pervasive state. These include a mountain-range of rotting credits in the state-owned banks and local government; neglected sectors of the lopsided economy; and egregiously misallocated economic resources (mainly in the construction and retail sectors and via huge stimulus packages.) In many countries government spending translates into GDP “growth” – but China is a special case: most of the seemingly inexorable mushrooming of its GDP had been faked this way in 2007-9.
Indeed, it is China’s very dependence on a weary and wary US consumer which spells its doom when the American music stops. Once it does, China’s investment-driven economy will revert to crippling overinvestment, overcapacity, hidden unemployment and underemployment. In one word: history’s worst deflation (or, worse yet, stagflation.) We have seen it all before with Japan. The only difference being that Japan had a real and thriving private sector while China doesn’t: its “private” sector – albeit officially accounting for three-fourths of its GDP - is mostly foreign-owned, export-oriented, or immersed in non-productive operations (read: speculation.)
Large swathes of China’s economy – including and especially the mission-critical financial sector - are in the incompetent and venal hands of China’s decidedly uncivil service and are “managed” (mismanaged rather) by bumbling and provincial party apparatchiks. To this toxic brew one should add a devastated environment, a dysfunctional judicial system, shoddy accounting practices (including by Western multinationals), stunted capital markets, an obliterated countryside and dying agriculture, and a demographic time bomb: owing to the “one child” policy, China’s population is ageing faster than any other major country’s. This is not to mention political risk in an age of Facebook-driven Tweeted revolutions.