Friday, July 4, 2008

Is China Facing a Boom and Bust?

Everyone seems so mesmerised by the rapid economic growth of China, it has generated a feeling of almost invulnerability about the Chinese economy. China has become the new holy grail; people talk in reverential tones about the inevitability of the China becoming the new economic superpower (if it isn't already). The talk is only of when they will become the biggest economy in the world and how this will change the global economic outlook.

However, with recent experiences fresh in the mind, economists should perhaps be more cautious when people start proclaiming the 'inevitability of growth'. The truth is that the Chinese economy faces serious signs of overheating. Could the correction be as painful as the past growth has been spectacular?

Chinese Inflation

Chinese inflation has steadily been rising (currently 8.7%) as supply constraints increase. The government are also unwilling to tackle the problem of rising inflation as they are mostly concerned about creating jobs for the unemployed. (see: Chinese inflation)

House Price Inflation.
Source: Chinese property price bubble

Even more spectacular than inflation is the growth in house prices. Especially around Beijing and the South east coast, house prices have risen at extraordinary rates. This has made capital gains for many property investors and has encouraged a wave of speculative property building. Some worry the rising prices are becoming unsustainable. But, as we all know, property prices can never fall can they?....

Undervalued Exchange Rate

Because of credit controls and low interest rates, the Chinese government has succeeded in keeping the Yuan relatively undervalued compared to its true market value. This has encouraged inflation. A low exchange rate boosts exports and increase the cost of imports. With the recent rise in commodity prices such as food, oil and energy; this is even more problematic. China is now facing both demand pull inflation (fast growth) and cost push inflation (rising prices). It is a combination leading to rising inflation and rising inflation expectations.

Despite these factors pushing up inflation, the government seem reluctant to address the problem. Real interest rates are very low; the government show an almost blindness for the damaging effects of inflation. The problem is they have got so used to magnificent growth statistics they assume that they will continue for ever. It is true to some extent that the Chinese economy is in a different situation to OECD economies; but, it is also true that if the government fails to act and rein in inflation now, the future could see a very painful correction.

Other Problems in China.

As well as the potential for boom and bust. China already has serious economic problems:
  • Inequality between rural and urban; north and south
  • Unemployment, especially amongst rural north
  • Corruption and inefficiency of state officials.

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