The Days Of The Super-Powered Chinese Economy Are Over

Tyler Durden's picture


Authored by Michael Pettis, originally posted at Foreign Policy,

In the months leading up to last week's liquidity crunch, in which the cost of short-term loans in China spiked and roiled global markets, most financial institutions had been lowering their growth forecasts for China. In mid-June, the World Bank revised its 2013 Chinese growth forecast from 8.4 percent to 7.7 percent; HSBC, Credit Suisse, and Goldman Sachs, among others, have also downgraded their Chinese growth forecasts several times over the last two years, as quarterly data have kept revealing lower-than-expected economic growth and higher-than-expected credit growth. Many banks now estimate around 7 percent to be the new normal.

But the banks' numbers are likely still too high. China's economy is at a turning point in its transformation from one driven by export and investment to one driven more by domestic household spending. Growth predictions are underestimating the impact of this shift.

The recent liquidity crunch, and its cause, illustrates some of the difficulties China's economy will face in the future. Over the last two years, and especially in 2013, mainland corporations with offshore affiliates had been borrowing money abroad, faking trade invoices to import the money disguised as export revenues, and profitably relending it as Chinese yuan. As China receives more dollars from exports and foreign investment than it spends on imports and Chinese investment abroad, the People's Bank of China, the central bank, is forced to buy those excess dollars to maintain the value of the yuan. It does this by borrowing yuan in the domestic markets. But because its borrowing cost is greater than the return it receives when it invests those dollars in low-earning U.S. Treasury bonds, the central bank loses money as its reserves expand. Large companies bringing money into the mainland also force the central bank to expand the domestic money supply when it purchases the inflows, expanding the amount of credit in the system.

In May, however, the authorities began clamping down on the fake trade invoices, causing export revenues to decline. Foreign currency inflows into China dried up, as did the liquidity that had accommodated rapid credit growth. The combination of rapidly rising credit and slower growth in the money supply created enormous liquidity strains within the banking system. This is probably what caused last week's liquidity crunch and this week's market convulsions.

The surprising thing about this process has been the government's determination to see it through. Policymakers in Beijing have not backed down from the implications of rebalancing China's economy away from its addiction to investment and debt, even though economic growth is slowing and banks are pleading with the government to turn back on the liquidity spigots. Whereas the administration of President Xi Jinping's predecessor, Hu Jintao, never allowed growth to slow much before losing its nerve and increasing credit, Xi seems determined to stay the course.

There are two important lessons to be drawn from last week's panic.

First, the central bank and the leadership in Beijing seem determined to try to get their arms around credit expansion -- even if that means, as it absolutely must, that growth will suffer and the banks will come under pressure. The extent of the freezing of the money markets on June 20 surprised many, including probably the central bank itself, but there will likely be more disruption in the markets over the next few years as Beijing tries to control what has become a runaway process.


Second, reining in credit won't be easy: the financial system and a whole host of borrowers -- including real estate developers, capital-intensive manufacturers, and local and municipal governments -- are too addicted to rapid credit expansion. Attempts to constrain credit growth will create significant strains in the financial sector, as borrowers find it hard to roll over debt that they cannot otherwise repay. Constraining credit growth will also mean a significant reduction in economic activity over the next decade.

Last week is a reminder that Beijing is playing a difficult game. The rest of the world should try to understand the stakes, and accommodate China's transition to a more sustainable growth model. As policymakers in China continue to try to restructure the economy away from reliance on massive, debt-fueling investment projects that create little value for the economy, the United States, Europe, and Japan must implement policies that reduce trade pressures. Any additional adverse trade conditions will further jeopardize the stability of China's economy, especially as lower trade surpluses and decreased foreign investment slow money creation by China's central bank. A trade war would clearly be devastating for Beijing's attempt to rebalance its economy and have potentially critical implications for global markets.

Regardless of what happens next, the consensus expectations that China's economy will grow at roughly 7 percent over the next few years can be safely ignored. Growth driven by consumption, instead of trade and investment, is alone sufficient to grow China's GDP by 3 to 4 percent annually. But it is not clear that consumption can be sustained if investment growth levels are sharply reduced. If Beijing can successfully manage the employment consequences of decreased investment growth, perhaps it can keep consumption growing at current levels. But that's a tricky proposition.

It's likely that the days of the super-powered Chinese economy are over. Instead, Beijing must content itself with grinding its way through the debt that has accumulated over the past decade.

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Fri, 06/28/2013 - 20:40 | 3705196 LetThemEatRand
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Western sheep can't afford even their cheap feed.  Pretty simple.

Fri, 06/28/2013 - 20:49 | 3705219 bank guy in Brussels
bank guy in Brussels's picture

Off-topic thread hijack ... Totally Pathetic Dept

Al Jazeera reports Edward Snowden is negotiating to go back to the USA

According to his father Lonnie, there is an offer to Obama's gangster Eric Holder, that Snowden will go back to be on trial if he stays out of prison before the trial and does not have his freedom of speech banned during that period.

Father also claims son Snowden is being 'manipulated by Wikileaks'.

Sickening, either way ... whether Snowden really was a CIA shill from the beginning ... or is just a total idiot.

Fri, 06/28/2013 - 20:55 | 3705233 LetThemEatRand
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He made the mistake of trusting the ultimate New World Order fascist Putin.  Or we've all been had.  Either way, fuck you NSA.

Fri, 06/28/2013 - 21:40 | 3705334 DoChenRollingBearing
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+ 2

And plus another one for buying gold!

Fri, 06/28/2013 - 21:50 | 3705353 LetThemEatRand
LetThemEatRand's picture

What I want to know is how many MREs I can buy in camp.  I'll share with you, DoChen, as I am a commie.

Fri, 06/28/2013 - 21:58 | 3705366 akak
akak's picture

What's this about eating MREs --- are you saying that the body and blood of Ayn Rand are not good enough for you?

Fri, 06/28/2013 - 22:08 | 3705389 Jam Akin
Jam Akin's picture

And here I was always thinking he was talking about eating Rand Paul.  Thanks for clearing that up.

Fri, 06/28/2013 - 22:39 | 3705413 TeamDepends
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Threadjack jack:  At 9:00 a.m. this morning Four Star General Carter Ham, head of AFRICOM while the Benghazi compound was under attack on 9/11/12 (so he knows exactly who gave the "stand down" order),  testified before the House Oversight Committee in a "closed door" hearing.  We are anxiously awaiting the hard-hitting expose on CNN......

P.S.  Fuck you Valerie Jarrett and all your Muslim Brotherhood pals.

Fri, 06/28/2013 - 22:40 | 3705441 LetThemEatRand
LetThemEatRand's picture

This government is so transparent that when it looks in the mirror, it sees nothing.   Cue Vlad.

Fri, 06/28/2013 - 23:17 | 3705488 TeamDepends
TeamDepends's picture sees nothing.  As in nussing. As in:  I know nussing.  Well guess what, Lucies?  I was only following orders ain't gonna work this time.

Sat, 06/29/2013 - 02:35 | 3705659 Richard Chesler
Richard Chesler's picture

Fuck you China.

Sat, 06/29/2013 - 07:53 | 3705773 Go Tribe
Go Tribe's picture

Um...the camps are not for commies. Unless you're implying you'll be a Camp Guard?

Fri, 06/28/2013 - 23:20 | 3705497 Bringin It
Bringin It's picture

Trusting the Guardian and WikiLeaks were both bad ideas.

fascist?  Could be no one gets they high anywhere w/o a good deal of ego.  NWO - the jury's still out.  It's acknowledged he took on the oligarchs and look what became of his arch oligarch enemy Beresovski in London.  It was in London, btw where Beresovski bragged that he would get rid of Putin.  That doesn't seem very NWO friendly to me.  Then we have Georgia and Syria on the world stage.  Again not NWO friendly.



Fri, 06/28/2013 - 21:09 | 3705256 Jim in MN
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What if he just wants to make a bigger impact? 

I bet the US agrees to no such thing, as a bunch of chickenshits would be expected to act.

Fri, 06/28/2013 - 22:23 | 3705414 disabledvet
disabledvet's picture

he's done well. can he do better though? hmmm.

Fri, 06/28/2013 - 21:30 | 3705315 OpenThePodBayDoorHAL
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Obomba has tried to declare that the NSA programs are legal. They aren't by any stretch:

So Snowden is being pursued for truth-telling about a crime in progress. What's next, 911 callers being prosecuted for reporting crimes in progress?

Fri, 06/28/2013 - 22:24 | 3705417 disabledvet
disabledvet's picture

next up a huge book deal and a run for Congress!

Fri, 06/28/2013 - 20:40 | 3705199 Divine Wind
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I agree and disagree.

One would be amaed what 1.6 billion people are capable of when they set their collective minds to it.

Fri, 06/28/2013 - 20:42 | 3705202 LetThemEatRand
LetThemEatRand's picture

And we will soon be asked to join the collective.  Resistance is futile.  Objection is irrelevant.

Fri, 06/28/2013 - 20:45 | 3705209 Divine Wind
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If this is the case, prepare for the future and learn Mandarin.

At a minimum, make sure your kids learn it before Spanish or French.

They will be worlds ahead of their peers.

Fri, 06/28/2013 - 20:50 | 3705221 LetThemEatRand
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The bright side is that they get free trampolines thanks to FoxCon.

Fri, 06/28/2013 - 20:51 | 3705224 Divine Wind
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Dude, you crack me up.

One of the funniest people on ZH.

Fri, 06/28/2013 - 20:58 | 3705237 LetThemEatRand
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I'm here all week.  Hold on, there's someone at the do...

Fri, 06/28/2013 - 22:27 | 3705422 disabledvet
disabledvet's picture

is it this guy? "thank, God. the police!"

Fri, 06/28/2013 - 22:42 | 3705448 LetThemEatRand
LetThemEatRand's picture

Ich bin ein Sarah Conner.

Sat, 06/29/2013 - 06:45 | 3705734 SimMaker
SimMaker's picture

I have often wondered what SciFi future awaits us. Mad Max? Threads/TheDayAfter? FreeJack? Terminator? 2001? (haha)


I have come to the conclusion that it is going to be Soylent Green mixed with Blade Elite, and those who service/work for the elite......and then the rest of us.

Sat, 06/29/2013 - 06:53 | 3705739 Bearwagon
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I'd like to suggest another SciFi story to be considered:

John Brunner, 'The Sheep Look Up'

Fri, 06/28/2013 - 21:23 | 3705295 post turtle saver
post turtle saver's picture

Well, I was supposed to learn Japanese in the '80s, but that ended in Lost Decades, corruption, and Fukushima.

Since China already has corruption and pollution perfected, all that's left are the Lost Decades. Color me surprised.

Fri, 06/28/2013 - 23:24 | 3705505 Bringin It
Bringin It's picture

The difference is that China used to be the center of the world.

Fri, 06/28/2013 - 23:49 | 3705534 RideTheWalrus
RideTheWalrus's picture

All holes eventualy lead to China

Fri, 06/28/2013 - 23:51 | 3705537 RideTheWalrus
RideTheWalrus's picture

All holes eventually lead to China

Sun, 06/30/2013 - 10:28 | 3707559 Ion the Ion
Ion the Ion's picture

china was the center of the world the same way the world was the center of the universe

Fri, 06/28/2013 - 20:47 | 3705215 Seasmoke
Seasmoke's picture

i wouldnt even be part of a collective with a group of people here at ZH who i like fucking way am i going along

Fri, 06/28/2013 - 21:12 | 3705265 Jim in MN
Jim in MN's picture

I just sent in my second ZH guest post, called 'Preserving Values in a Time of Evil'.

I hope the Tylers like it.  It has a bit to do with this topic.

Fri, 06/28/2013 - 22:31 | 3705428 disabledvet
disabledvet's picture

i never get to do a guest post.

Sat, 06/29/2013 - 07:54 | 3705774 Go Tribe
Go Tribe's picture

Yep, let me know when the Chinese become as stupid as Americans. Never going to happen.

Sun, 06/30/2013 - 02:02 | 3707197 Andre
Andre's picture

Given the level of corruption, they won't put thier minds to it because too many will be scamming it.

Fri, 06/28/2013 - 20:46 | 3705211 PacOps
PacOps's picture

I guess I missed the story on what happened to the trillions in cash reserves they had not that long ago,

Fri, 06/28/2013 - 20:57 | 3705236 Schmuck Raker
Schmuck Raker's picture

Are they relevant?

Fri, 06/28/2013 - 20:49 | 3705217 lolmao500
lolmao500's picture

Just breaking, a big explosion happened in Port Said, Egypt during big protests... then a gun battle kicked off...

It's happening NOW.

Fri, 06/28/2013 - 20:50 | 3705222 NoDebt
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They at least have the option of trading growth for price stability.  We have no growth to trade.

Fri, 06/28/2013 - 21:09 | 3705228 Schmuck Raker
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More,similar Pettis here>>>

I was just this minute reading it at Mish's, though he posted it Thursday.


If demand for WMP drops, where will the money that until now went into WMP show up? I can only think of the following: more outflows from China, higher deposits in the banks, stock markets, real estate markets, cash hoarding.



Fri, 06/28/2013 - 21:07 | 3705253 strangewalk
strangewalk's picture

I lived in China for 10 years. The people are taught from infancy that they are intellectually superior to others, that China was the most advanced nation in the world throughout all of human history and that their government is infalliable. Where have we heard this story before?--Nazi Germany, Imperial Japan, Peronist Argentina...while I hope their mythology doesn't lead to the same end...I think it will. 

Fri, 06/28/2013 - 21:09 | 3705257 Mr. Hudson
Mr. Hudson's picture

Israel. The Jews are superior to the Chinese.

Fri, 06/28/2013 - 21:22 | 3705292 Seasmoke
Seasmoke's picture

how many Jews are in China ?

Fri, 06/28/2013 - 21:11 | 3705261 Jim in MN
Jim in MN's picture

There's a saying....'the loudest duck gets shot'.

Kind of says it all.  Their version of 'the squeaky wheel gets the grease'.

Fri, 06/28/2013 - 21:13 | 3705263 akak
akak's picture

Their widespread penchant for openly and shamelessly crapping on the sidewalks and roadsides tends to, in my mind anyway, belie such self-important and chauvinistic beliefs.

Make me laugh.

Fri, 06/28/2013 - 21:43 | 3705344 DoChenRollingBearing
DoChenRollingBearing's picture


Fri, 06/28/2013 - 23:36 | 3705519 TheFourthStooge-ing
TheFourthStooge-ing's picture

Now, Chinese citizenism is first and all a state of mind and very possibly, backed up by a specific genetics configuration.

Chinese citizenism citizens exist in most groups. In US, there are a lot of Chinese citizenism citizens bidding their time to take control.

Just like the Syrian rebels are Chinese citizenism citizen material, covering an ethnical laundering under humanitarian guise of Tyrannosaurus arm squirrel, Syria might be one day overtaken by Syrian Chinese citizenism citizen material.

If this day comes, in the few following decades, one will notice a dramatical increase in terms of excremental waste along the roadside to Damascus.

Sat, 06/29/2013 - 10:29 | 3705908 presk_eel_pundit
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What you mean?

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