Several financial holding companies last week held earnings conferences in which they tried to assure investors that they have been slashing their exposure to China in the past few years and would continue to adjust their overseas operations to diversify away from the world’s second-largest economy. They also told investors that China is facing multiple economic challenges and would no longer enjoy the prosperity it once had. An executive at E.Sun Financial Holding Co summed it up, saying that China is like an elephant that has fallen and must get up by itself, as the little animals nearby cannot help it.
Another executive said that if China cannot cure its economic woes and fails to develop a new engine, its rapid-growth economy would run out of steam and the country would become stuck in the “middle-income trap.” This is when an emerging economy cannot transition into a high-income economy due to rising costs, declining competitiveness, poor administration efficiency and a lack of high-end talent, among other factors.
Obviously China’s rapid GDP growth would slow over time as its economy matures. A few countries in Asia have managed to free themselves from the middle-income trap such as Taiwan, South Korea, Hong Kong and Singapore, which they achieved through their own efforts and with help from globalization. The question is whether China can benefit from a changing global economic landscape as the rule book is rewritten amid trade tensions in the past few years? Can China become rich before it gets old?
Some economists expect China to move forward with modest annual growth in the medium to long term, but many say that the country might never overcome its structural weaknesses and lack of reform plans, economic as well as political. Issues include the real-estate bubble, the imbalance between investment and consumption, the rising debt accrued by local governments, the Chinese Communist Party’s strict control of private businesses, the shrinking workforce and the expanding cohort of retirees.
This long-term, unbalanced development has led to China’s economic woes, with more economists believing the country is facing a scenario of “balance sheet recession,” as consumers and businesses stop borrowing and investing even though interest rates continue to fall. Instead, they focus on paying down debt first as economic growth faces a bottleneck, asset prices plunge and cash flows dwindle.
This is what happened in Japan during the “lost decade” of the 1990s, when its real-estate bubble burst. It took Japan about 20 years to emerge from a balance sheet recession, and it appears much more difficult for China to solve this problem in the short term. Beijing would need to loosen the grip it has had on private businesses, political power and Chinese society over the past few years. This would not change any time soon under Chinese President Xi Jinping (習近平).
China should address the balance sheet recession by repairing the imbalance in its economic balance sheet over a long period of weak demand. China’s economic downturn is likely to continue, and the phenomenon of deflation is reflected in the slump in demand.
Another solution to the balance sheet recession is to transfer private debt to the government, and then monetize the debt by printing a large amount of money. The price of that process is a sharp depreciation of the yuan, which is another unlikely scenario in the foreseeable future.
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