Elliott Parker: China shouldn’t follow our fiscal path
January 16, 2012
This is the second of two parts exploring China’s economy.
As I explained last week, China’s growth rates during the past couple of decades are staggeringly high. This growth can be largely explained by high investment rates, and also by the movement of workers from low-productivity to high-productivity activities, especially for the hundreds of millions of peasant farmers making less than $1 per day. Enabling this economic growth is one of the major objectives of the governing Chinese Communist Party, and China’s exchange rate policy was an example of how this growth came first.
But a policy of keeping the exchange rate cheap and stable through buying foreign-currency reserves generally leads to rapid growth in the domestic money supply, known in China as the Renminbi (or people’s money). Inflation fears eventually pushed China into a gradual appreciation of the RMB starting in 2005, though it was interrupted by the Great Recession.
To help accommodate its internal migration to high-productivity sectors, China has tried to expand and privatize housing. Two decades ago, many of my friends in Shanghai lived in crummy little flats provided by their state-owned firms that cost less than $10 a month in rent. Now people buy their own apartments, and the government has not only pushed its state-owned banks to increase lending to developers for construction, it has also pushed banks to lend to residents for their mortgages.
With incomes rising and so many people moving to cities, housing prices have risen significantly. Many Chinese are awash in accumulated savings, and not surprisingly some Chinese have speculated in the market. But they have usually had to use their own cash, since Chinese banks normally require a 20 percent down payment for a first home and 50 percent down for a second.
In major cities, the current average price of housing is now about $130 per square foot, comparable to U.S. prices, though Chinese typically have much smaller residences. In some parts of Shanghai or Beijing, however, the purchase price for a nice place can equal the price you might pay in San Francisco.
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As in the U.S., China appears to have created a speculative bubble in housing prices. Chinese investors should have known better, since only four years ago an investor frenzy drove stock prices to rise five-fold in less than two years. When that bubble collapsed in 2008, and stock prices fell by 65 percent, Chinese investors simply moved their money into housing. We saw a similar pattern here after our markets tanked in 2001.
China’s government has been quick to use fiscal policy to make sure that growth remains high. In 1997, after the Asian Financial Crisis, and again in 2001, when the U.S. entered into a recession, China announced increased infrastructure spending programs.
When the Great Recession hit in 2008, this hurt China’s exports. Rather than taking steps to increase domestic private consumption, the government responded with a 4 trillion RMB spending plan, about 12 percent of GDP during two years, to be spent mostly on public investment by local and provincial governments. In contrast, the Obama stimulus program was only 5 percent of our GDP spread out during three years, and a third of our stimulus came in tax cuts, with another third going to states to dampen their budget cuts in education.
In some ways, China is our mirror image. We consume too much and save too little, while China consumes too little. We import and they export. We try to stimulate our economy with tax cuts, running government budget deficits even during good times, while China focuses on investment in public infrastructure but has nonetheless kept its budget deficits relatively small. China is increasing its spending on education, while we are cutting back. China focuses on the economy and growth, while we focus on politics and similar matters.
While we have been mired in the Great Recession, together with Europe, Japan and many other countries, China’s economy has continued to grow. Chinese housing prices also kept rising, and prices for goods and services rose as well. With fiscal policy plus private demand pushing investment rates to record levels, China’s economy was thought by many to be at risk of overheating.
This past year, Chinese monetary policy began to tighten, interest rates rose, and mortgage standards became stricter. For example, down payments were recently increased to 30 percent for a first home. This intervention may have successfully popped the housing bubble in China.
Housing prices have been falling for the last several months, and current prices are slightly below where they were a year ago. With fewer people moving into new homes, demand for household goods is falling. The government is now loosening back up a little, but there are still fears that all this might touch off a significant slowing of China’s growth (though nobody really expects GDP growth to turn negative).
If the bubble has popped, and if housing prices start to seriously decline, how bad can it get? The amount at risk is significant, since China’s banking system holds deposits equal to roughly twice China’s GDP, and long-term mortgages are more or less equal to GDP. But homeowners in China have much more of their own money at stake, and banks lack all of the fancy financial instruments – such as Credit Default Swaps and Collateralized Debt Obligations – that exploded here.
Furthermore, China’s government has much more ability to respond, and could feasibly bail its banks out. China’s banking system has $3.2 trillion (U.S. dollars) in reserves, and the central government has a gross public debt of only 35 percent of GDP. Our banks are not as exposed if Chinese banks start to lose money, and most Chinese banks are state-owned, so their deposits are implicitly guaranteed.
Still, a slowdown in China’s economy can threaten our recovery. Growing exports have been one of the bright spots of the U.S. economy, and if Chinese consumers begin to feel considerably poorer, this could ripple back to us pretty quickly. Let us hope that China does not follow the trail we blazed before them.
• Elliott Parker is professor and chairman of the Economics Department at the University of Nevada, Reno.