By James Saft
(Reuters) – What canâ€™t go on forever may be starting to stop in China.
China on Monday unveiled steps to curb runaway housing price inflation, including measures to make speculation less profitable and loans more expensive.
That sent stock markets down around the world but may prove less significant than new controls, reported in the Financial Times, which may be in the works to limit shadow banking, the taking of deposits and lending of money outside regulated channels.
Both point to what has long seemed inevitable – a slowing in Chinaâ€™s remarkably high rates of investment and borrowing growth.
If, or rather when, that happens the impact will be global, hitting Chinaâ€™s economy and also those of its regional trading partners while depressing the prices of the raw materials and commodities its boom has consumed.
The growth of debt and of fixed investment into things like houses and factories in China has been spectacular but very unusual for an economy as big and as developed. Between 2002 and 2011 fixed investment grew by 13.5 percent a year, much higher than economic growth, meaning that it is now somewhere in the neighborhood of 50 percent of GDP.
Debt too has been sky-rocketing, allowing China to grow while much of the rest of the world languishes, but, as in the U.S. a decade ago, building up potentially dangerous vulnerabilities in its financial system and contributing to what looks achingly similar to a bubble in real estate and in unwanted production.
Total debt, public and private, is now twice the size of Chinaâ€™s economy and every year Chinaâ€™s shadow banking system makes loans equal to 35 to 40 percent of GDP.
â€œThe quality of Chinaâ€™s growth has become increasingly poor, and the rate of growth is utterly unsustainable. The bigger the bubble, the bigger the eventual bust,â€ Mike Riddell, a fund manager at M&G Investments in London, wrote in a note to clients.
Riddell points out that no major economy has been so reliant on fixed investment, and those that have had fixed investment as half of output for two years or more form an uninspiring roster, including Botswana in the early 1970s and Chad in 2003-2004.
Chinese officials are thus put in a difficult position: the longer the debt buildup and reliance on building often unneeded structures and capacity lasts, the worse will be the adjustment, but any cutback now will bring pain and discomfort to important constituencies.
WHEN THE LEVEE BREAKS
Using a rule of thumb developed by Mathias Drehman and Mikael Juselius of the Bank for International Settlements China may be ripe for a crisis. Its debt service ratio, a measure of debt repayment and interest to income, is now growing 12 percent above its trend in the previous decade and a half. Thatâ€™s not only double the 6 percent figure the BIS sites as a danger zone, it is above where the U.S. was in 2007, Japan was in 1989 and Spain was in 2009. (here)
It is impossible to know if a crisis will come to China or how it might play out, but itâ€™s reasonable to expect that even an orderly reduction in the rate of growth of debt and fixed investment will be an onerous business. As fixed investment falls, even if it is still growing along with the economy, China itself will see lower growth as will its main trading partners. At the same time, demand will fall for the commodities needed for the roads, buildings and factories China has been churning out.
â€œAccording to the IMFâ€™s model, a drop in Chinese investment growth from 13.5 percent to 4.5 percent implies a 4 to 7.2 percent hit to the GDP of countries such as Taiwan, Korea and Malaysia. Some commodity prices would fall almost 20 percent,â€ Riddell said.
To be sure, there remains a significant chance that as the pain of lower investment begins to be felt, Chinese authorities will think better of continuing to tighten regulations on the banking framework which funds it. Chinese investors are habituated to rapidly rising prices and quick gains using borrowed money, or at least to trying.
All of that argues for a scenario where a slowdown in borrowing and investing is gentle.
Thatâ€™s not, however, how growth and investment slowed in the U.S. last decade or in Japan in the 1990s. In both of those places crowd psychology played a big role, even in Japan where a cooperative banking sector and official influence kept many zombie businesses going long after a market would have left them for dead.
China, with strong official control, may have an immaculate slowdown in investment but it would likely be the first to pull off the trick.
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)
(James Saft is a Reuters columnist. The opinions expressed are his own)
(Editing by James Dalgleish)