China probably won’t rescue the global economy as it did in 2008

In the post 2008 recession the global economy was significantly reflated by a huge credit boost in China which was spent on a truly gigantic investment program. This time the Chinese won’t be in a position to do that partly because this shock has hit them internally in a way that the 2008 shock didn’t but primarily because the entire Chinese growth model was already rapidly running out of steam just as the Corina Coach happened. This time round the Chinese probably won’t save the global economy.

The Chinese growth model which has delivered such impressive GDP growth in the last couple of decades is actually very similar to lots of previous growth models such as Nazi Germany, the Soviet Union, Brazil in the 1960s, etc. It basically consists of vigorous government action to suppress internal consumption and to either replace that income with export income through a large trade surplus and/or, and more usually, a massive program of state sponsored investment projects. The only unique feature about the Chinese growth model is its size and the scale of the internal imbalances that are being generated inside the Chinese economy.

All such growth models have previously run out of steam as the investment programs generates ever more debt per unit of GDP growth that it delivers as the opportunities for productive investment dry up and increasing bad debt is incurred to fund unproductive investment (in China see the empty carriages of the unneeded high speed train links and the large empty ghost towns left by speculative construction projects). In these growth episodes typically the years of high GDP growth are always followed by even more years of low growth and stagnation as the debts incurred by the unproductive investments are paid down and as the economy slowly internally adjusts, a process that involves the essential transfer of wealth and income to the general population so that internal consumption can grow and replace the clapped out spending of the investment drive. The timing, duration and success of the internal adjustment is determined by a political struggle with the owners of the wealth and income generated by the old growth model (in China the party elite especially in the regions, and the managers of the state owned enterprises, etc).

Initially and prior to the 2008 financial crisis the Chinese growth model was heavily dependent on exports, although internal investments also played a big role. After the 2008 crash exports declined in importance and were replaced by a massively ramped investment program. All export surpluses are indicators of suppressed internal demand and depend on importing foreign demand to replace the suppressed internal demand, thus surpluses usually export unemployment or debt to other countries (this is the current German model). This strategy of building GDP growth on exports creates vulnerabilities because it depends other countries being willing to absorb the exports and the surplus by running persistent deficits which means the entire growth model is dependent on decisions taken in other countries.

In 2008 the Chinese experienced the post Financial Crash shock as a sudden drop in demand for their exports, and this was a threat to their growth model so they adjusted the growth model by downgrading the role of the export surplus and doubling down on the investment program (which was much more under their control). The result was a massive ramp up in the internal credit/debt fuelled investment program, mostly consisted of infrastructure programs and speculative construction projects. This investment program has been running for over a decade now. The result was a new surge in Chinese GDP growth, which during the post 2008 recession helped keep afloat large chunks of the global economy especially in the emerging economies that relied heavily on exporting primary commodities and raw materials to China. But it also led to a huge surge in debt levels in China as ever more and larger unproductive projects have been funded. Debt in China is already in excess of 300% of GDP. Just prior to the Corona Crash the Chineses leadership were engaged in an intense internal debate about whether it was time to start significantly addressing the internal imbalances, which would mean accepting much lower GDP growth in the foreseeable future, or continuing with the growth model and thus building up even more debt. Postponing the necessary adjustment means that the adjustment when it does inevitably come is going to be even deeper and therefore even more painful. The Chinese leadership has to wrestle with both dealing with internal opponents of restructuring (I.e. big chunks of the ruling elite whose wealth and power is built on the growth model mechanisms) and with general unrest caused by the pain of the adjustment (structural unemployment as workers shift from investment related production to consumption and service production). Xi Jinping response to the potential stresses of the looming adjustment was to centralise power and impose a much more authoritarian system on the elite and general population, a strategy which is working but which makes the entire political system more rigid and hence more brittle. Great if it works but catastrophic if it ruptures.

The initial indicators are that the Corona Crash has halted the internal debate and there is now an acceptance in the leadership that another round of internal stimulus is inevitable, that means another round of credit stimulus, more debt and a deeper imbalance. But it’s not going to be of a scale and duration that can act as a general recovery mechanism for the global economy as it did in the decade after 2008 and nobody knows how long the current debt build up and internal imbalances can be sustained. In the decade since 2008 China has, through its One Road One Belt initiative, funded a lot of investment in developing economies, this constituted part of the stimulus that China supplied after the last crash. In essence this was part of the Chinese investment led growth model but it externalised the investment and the debt. But in recent years as part of the beginnings of moving away from that growth model China has already massively scaled back on its investment funding so it is unlikely to offer a new similar foreign investment stimulus program after this crash.

Note: the Chinese may take the opportunity of the bargain basement sale conditions post Corona Crash to try to buy up foreign firms rendered insolvent or whose share price has crashed but this would not act as a major economic stimulus. The EU led by Germany is already moving to block this sort foreign purchase of devalued assets.

The last crash in 2008 presented itself in China as a fall in exports and given the Chinese state’s power over the credit system and huge footprint in the economy switching to internal debt fuelled investments was relatively easy to implement. But that investment program has run it’s course over the last decade and China is full of new airports, high speed rail links, new metro systems, power plants, and huge numbers of empty cities and apartment blocks, if a new investment program is unleashed what will it spend the money on? A new investment program the size and duration of the post 2008 program would quickly run out of even remotely productive investment opportunities and the amount of debt that needed to be generated to create a given increase in GDP would rise drastically. We cannot rely on China to save the world’s economy.