Last month’s data is positive for Chinese prospects
Special points to highlight in this issue:
• Investment growth decelerated sharply in May. This was already pretty clear from the year-to-date numbers released by the NBS, but even more clear once the May data was disaggregated. In May investment grew by around 6%, bring year-to-date growth down from 10.4% in April to 9.6% in May. Private sector investment was flat or even negative in May, while public sector investment may have been up by a rather disconcerting 40-50% on an annualized basis.
• A few years ago such a sharp break in investment growth would have horrified the market. This time around the market reacted negatively, but not overwhelmingly so, suggesting that little by little the market is learning to read slower investment growth as consistent with better longer-term prospects.
• For all the wailing about the disastrous impact of Brexit, there is very little one can say about its net impact on England or the world over the longer term. In the short term, however, the amount of uncertainty it has raised can only have a negative impact on demand within Europe, and so a negative impact on European imports, including imports from China. But any downward pressure on the Chinese current account surplus means, by definition, downward pressure on the excess of savings over investment, and assuming Brexit does not increase political pressure enough to speed up the transfer of wealth from the state sector to the household sector, Beijing has no choice except either to force up its debt burden faster than expected or to allow unemployment to rise by more than expected. If Brexit-related uncertainty were to encourage Chinese households to increase their savings, the choice would be starker.
• There is evidence that senior leadership is becoming increasingly frustrated with the failure of one reform policy after another to deliver any improvement in the economy. They should be frustrated. Policy-advisors are still under the impression that China needs vigorous implementation of efficiency-enhancing reforms aimed at boosting productivity by enough that the reforms allow China to grow its way out of its debt burden.
• Like most economists, they seem unaware of the very bleak history of similar attempts to deal with excessive indebtedness. No country has ever been able to grow its way out of similar levels of indebtedness until it has either explicitly or implicitly written down its debt and assigned debt forgiveness costs to one sector of the economy or another.
• The arithmetic of the policy reforms aimed at improving productivity shows why. The proposed reforms must improve the productivity of investments generated by new debt by anywhere from five to eighteen times that of existing new investment. No country has been able to pull off such a reform miracle, and there is no reason to think China can do it.
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