Is The China Miracle In Trouble?

Conventional wisdom has it that China is the "upcoming" superpower that will challenge the U.S. and ultimately take a position of world supremacy.  Long time readers of Marko's Take know why this cannot possibly be true (http://markostake.blogspot.com/2009/12/baby-boomer-bust.html).

China's demographic structure is not conducive to longer-term growth, as the result of their population control measures.  In general, demographic structures need to be pyramidally shaped.  If the lower end of the structure is curtailed through drastic measures, such as infanticide and limiting children, the pyramid shape gets warped and growth will ultimately cease.

In addition to the inevitable longer-term problems, a spate of shorter-term stresses are becoming known. Most private analysts who study China think its economic recovery lost some momentum in the fourth quarter of 2009, a new poll by The Wall Street Journal shows. The finding runs counter to official statistics that indicate a recent acceleration in growth and highlights the conflicting signals China’s economy is sending at a time when the leadership is trying to contain potential bubbles without derailing the expansion (http://blogs.wsj.com/chinarealtime/2010/02/17/wsj-poll-shows-chinas-growth-slowed-ahead-of-government-tightening/?mod=djemChinaRTR_h).

The median estimate in the Journal’s poll put growth in China’s Gross Domestic Product (GDP) in the fourth quarter at 10.1% over the previous quarter on an annualized, seasonally-adjusted basis — the way that most major economies measure growth. That’s down from the median estimate of 10.7% growth for the third-quarter.

China’s statistics bureau reports GDP growth in year-over-year terms and the difference can be significant. It said last month that the nation’s GDP grew 10.7% in the fourth quarter from a year earlier, a growth rate that accelerated from the third quarter’s 9.1%.  Even before those strong numbers were released, China’s central bank had already signaled a new and tougher stage in policy by starting a series of increases in banks’ reserve requirements, measures that reduce funds available for lending.

Complicating the picture further are newly-revised quarter-over-quarter growth estimates from the People’s Bank of China. These show a remarkably smooth trajectory.  After bottoming at 4.3% in the fourth quarter of 2008, annualized growth had recovered to 11.4% by the second quarter of 2009, eased to 11.0% and then picked up again to 11.3% in the fourth quarter.

That’s quite different from what most economists in the WSJ poll think happened:  a growth surge in the second quarter last year as the stimulus hit, and then a gradual slowdown as its impact waned.  While the central bank’s previous estimates had been within the range of figures that other economists had come up with, several private economists told us they did not understand how the central bank had arrived at its revised figures.

The problems don't stop there.  As the result of tremendous stimilus programs, China faces massive inflation pressure, which is affecting its currency, the Yuan.  With China’s economy surging and flirting with a property bubble, most analysts are prescribing the same remedy: a stronger Chinese currency that would help contain inflation (http://blogs.wsj.com/chinarealtime/2010/02/16/an-alternative-route-to-appreciation-for-chinas-yuan/?mod=djemChinaRTR_h).

A few economists are now turning that argument on its head and proposing that China allow inflation to do the work of currency appreciation.  Rather than adjusting the currency upward to make Chinese goods more expensive abroad, authorities should just allow rising wages and other costs to make Chinese goods more expensive, they say.  To put it in the language of economists, they think China can get the needed adjustment in the real exchange rate without actually moving the nominal exchange rate.
 
China is under tremendous pressure from the U.S., Europe and other nations to shrink its huge trade surplus, which some blame for contributing to the financial crisis.  A stronger currency could do that by making Chinese goods less competitive.  But, Premier Wen Jiabao and other government officials have pushed back against outside pressure on the currency.  They have kept the Yuan, or Renminbi, fixed against the dollar since mid-2008, and a big, rapid move is widely seen as unlikely.
 
Higher inflation could have the same effect — albeit indirectly — and be less contentious politically within China.  If average prices in China rise 5% more than in the U.S. and the currency doesn’t move against the U.S. dollar at all, the result is effectively the same as if China revalued the Yuan by 5% and the two countries had the same inflation rate.  In both cases, Chinese goods have gotten 5% more expensive in U.S. dollar terms, or to put it another way, the real exchange rate has increased 5%.
 
All of this suggests that China will need to undergo, at the minimum, a very painful transition process.  It also underscores the truly GLOBAL nature of the "Double Dip Hyperinflationary Depression".
 
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