Guest Post: The Making Of China's Epic Hard Landing

Tyler Durden's picture

Submitted by Dee Woo,

The Making of China's epic hard landing

1. The unsavory episodes of China's economy

For the better part of the past year, my concern about Chinese economy was constantly aggravated by the depressing stories of entrepreneurs who committed suicide, fleeted the country or emigrate to the western world in droves. Much of the media has blamed the credit crunch and monetary tightening for all these unsavory episodes. The public outcry for the deteriorating conditions for Chinese entrepreneurship climaxed with the seemly positive step the People's Bank of China(PBOC) took to alleviate the liquidity crisis: cut the reserve requirement ratio (RRR) to 21 percent from a record high 21.5 percent on Dec 5 2011.

Right now the outlook for Chinese economy is looking rather confusing: should it continue the painful structural adjustment to burst the economic bubble built up after so many years of high growth? Alternatively, should it adopts the expansionary policy to reinvigorate the flagging economy? Either way China is approaching dangerously close to an epic hard landing.

2. It's the structural problems and not a liquidity crisis

For one, it's easy to lay the blame on the tightening monetary policy. Nevertheless, nothing can be further from the truth. The main overseas markets for Chinese goods, Europe and the US, are both battling a possible recession, which greatly tightens their purse string. To make the matter worse, the cost push inflation, especially the wage inflation,is eating away the comparative advantage of China’s manufacturing industry. All this has nothing to do with the tight monetary policy but the structural change of Chinese economy.

(The manufacturing sector is bleeding. Purchasing Manager Index(PMI) has dropped to 49, lower than market expectation. This is the first time since Feb 2009 PMI contracted. The orders are declining, especially overseas orders, and the stocks are piling up.)

In any case, the difficult access to credit for Chinese private small and medium businesses (SMBs), the driving force behind China’s manufacturing industry, is a chronic problem long before the monetary tightening.  More than 70% of the Chinese banking market is controlled by the “big four”--- Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China. These state-owned commercial banks skew the monetary resource towards the state-owned enterprises or other privileged corporations. This allocation deficiency of Chinese banking system provides the breeding ground for China’s huge and complicated shadow banking network, where most credit-starved private SMBs seek costly funding. The shadow banking system is awash with cash fleeting the negative real interest rate in the commercial banks, hardly regulated and monitored. In April 2011, 467.8 billion yuan of residential deposit left the commercial banks. We all can guess where the money ended up. Money is chasing positive yields into the wild wild west of shadow banks.

Contrary to what many might like to assume, China now is not even close to suffering a liquidity crisis under the tightening monetary policy. There is more than enough liquidity to go around. China’s M2 has surpassed that of the U.S. or Japan, as China’s M2 is around US$ 11.55 trillion, exceeding the U.S.’s US$ 8.98 trillion and Japan’s US$ 9.63 trillions. Regardless of all the hype of tight monetary policy, in 2010, Chinese banks issued 7.95 trillion yuan of loans, breaching the government's target ceiling of 7.5 trillion yuan. In 2011 the total new loan will stand comfortably close to 7.5 trillion. As of October 2011, the outstanding balance of RMB deposits totaled 79.21 trillion yuan,whose year on year growth rate is 13.6%. The PBOC's rate hike only removed 4.75 trillion yuan from circulation. According to Fitch rating, China's total social financing in 2011 may top 18 trillion yuan (US$2.8 trillion), a rise of 3.5 trillion yuan from the official target due to inflow of non-banking liquidity. Meanwhile, the PBOC claimed the total social financing of the first 3 quarters in 2011 is 9.8 trillion yuan, 1.26 trillion yuan less than that of last year. The PBOC's data suggests an effective tightening monetary policy while the Fitch report implies the opposite. The PBOC proves to be an inadequate central bank to rein in the liquidity binge Beijing have indulged itself in for so long during the boom time. Under such a gloomy context, China's credit expansion against all odds is still breath-taking.

(Over the past decade, China's M2 surges past the US's by a wide margin from as low as nearly one third of the US's.)

We obviously can't blame the tightening monetary policy for the sorry state of China's economy. We can't really pin our hopes on the loose monetary policy to turn around its fortune either.

3. The undoing of Beijing Consensus

Monetary policy alone won't fix the structural deficiencies of Chinese economy. The well-being of Chinese economy is hugely leveraged on the consumption economy of the US and Europe. American and European economic turmoil together puts a massive strain on the demand for Chinese export. The substantial and increasing wealth gap in China has shackled the domestic demand so much that it fails to pick up the tab left over by the US and Europe markets. China is now saddled with a serious excess capacity problem, which forces down the marginal returns on the investment and makes investment more effective incurring inflation and bubbles than propelling GDP and employment ahead. This is the serious sign for over-investing and overheating. In 2010, China's export/GDP ratio is about 37% ,and Investment/GDP ratio is 45.8%. According to David M. Kotz and Andong Zhu's research, China's export plus fixed investment contributes almost 70% of GDP growth since 1999 while domestic consumption contributes roughly 30%. Using the export/investment combo to power economy ahead is what we know as Beijing consensus. It works beautifully for the past decade when the world is prospering in the globalization and free trade. However, now its good run is finished for good.

To overcome the current economic malaise, the US and Europe must check their deficit-fueled consumption economies into the rehab. They must increase their chronic low saving rate, produce more and import less. That means the export-led growth engine for Chinese economy may be gone for good.


(According to Economist Intelligence Unit and US bureau of economics analysis, China will depend on an export-led economy late until 2030.)

4. The consumption-led economy is the only way out

The dire situation in the US and Europe calls for another round of quantitative easing. With both Japan and UK firmly committed to QE and deteriorating market conditions, the embattled US and Europe will be more and more reduced to monetary aggressiveness. In the end, we will see a global competition of currency devaluation. China will lock horns more frequently with the US, Europe and other export nations over currency issues. The trade tension will flare up.

The only way out for China is turning its economy into a consumption-led one. Or else fight for the overseas markets in vain and be prepared for trade wars. Or else try to reignite the economy with more wasteful investment and be prepared for a colossal asset bubble and epic hard landing.

5. The outlook for China's inflation and economic bubble

And also, don't be too optimistic about China's inflation prospect. Indeed, China's CPI tumbled to 4.2%,the lowest level since September 2010. Nevertheless, the battle against inflation is far from over. China is the world's biggest importer of food and commodity. With the global competition of loose monetary policies, the food and commodity inflation will be persistent, to say volatile at least. China will face the serious threat of imported inflation and cost-push inflation regardless of whatever monetary policy it adopts. That combined with negative real interest rate and diminishing marginal return in industries will push more and more money into asset investment and speculation. The inflation will be lurking if these structural problems persist.

Overall, there are both internal structural factors and external global factors, which contribute to the making of an epic hard landing in China. China will be really vulnerable when the US and Europe both unleash the quantitative easing. These are things China has no control of. Nevertheless, the best China can do to avoid the worst is to continue the painful structural adjustment: marketize the “big four”-dominated banking industry to allow for more efficient monetary allocation; Transform the labor intensive low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honor its promise of a consumption-led economy.

China's hard landing would be a tragedy not only to China but to the world. Without China's growth of consumption economy, the global economic recovery will be a prolonged and painful process.The icing on the cake for this article would be what I said in “The Boom And Bust Of China's Rise”: Hedge funds and Fed’s QE2 are not all to blame for all these. The Chinese economy already stands close to the edge. What speculators do is to push it over and profiteer handsomely from the chaos.

While the US enjoys the luxury provided by the dollar’s world currency status and diplomatic alliance with many major trade partners to export its liquidity and inflation, China enjoys none of that. They should look at the dollars in their hands with fear and doubt. So called Beijing consensus makes little sense, because the world is fast changing, pegging a country’s growth to a certain set of policy tools or a certain reserve currency(the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proven the only consensus is to adapt and change. Right now China needs to adapt and change fast. Or this will be the best time in history to short China.

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Michael's picture

The empty vacant brand new residential property of China could house the entire population of the United States comfortably.

Michael's picture

The only problem is; Chinese drywall.

Michael's picture

You know what my pet peeve is? Video surveillance cameras at every major street corner throughout the entire United States.

Look up when you're stopped at a traffic light and tweet your location when you look up atop the traffic light you're stopped at today.

The USA network of traffic light surveillance cameras pointed at you are recording your image in real time.

Who are these cameras really for? Their for you and you're paying for them, not criminals or terrorists.

Element's picture

All over Australia as well, they're down all the motorways and freeways, traffic lights , all public areas, Govt buildings, most city street corners, ATMs, Taxies, Buses, Trains, Subways, airports, hire car companies, anywhere you want to be mobile ... it's just endless spying on our movements.

And people generally don't even realise they're there, don't even realise these cameras and microphones are spreading like wildfire into the suburbs. Everywhere you go in any city now you are under almost constant surveillance of some sort.

And at the same time, we are continually being told of how the cyber criminals keep getting smarter and better equipped, to rip us off, and how it's so necessary to greatly increase on-line surveillance, and now smart-phone surveillance, and broad-spectrum pro-active pre-emptive interdiction strategies.

There was yet another Govt national broadcasting fear spreading story about all this just today.

So ... we have all this undreamed-of mega surveillance, actively spreading outwards in every conceivable way ... yet the criminals are somehow more prevalent and threatening to us than ever before?

This makes sense, right?

We are being actively conditioned by Govt agencies to accept it all as normal and prosaic and necessary, but it is obviously anything but that.


MachoMan's picture

It's my understanding that, here at least, the things that look like cameras sitting atop street light posts are actually traffic counters...  (so they don't have to run the wires across the road).  Needless to say, there is no local governmental body that watches any of the camera footage from hundreds of intersections...  (that function alone would probably render them the largest employer and would be too big to keep secret).

Not saying this doesn't happen elsewhere, where bigger budgets are the norm and there is less fiscal prudence (not that we're a bastion of that, but we're at least a little better than the average bear).

FeralSerf's picture

License plate numbers are read automatically.  They don't need a human to watch screens.  One (official) reason is to catch red light violators.  A lot of work has been done and more done in the future on facial recognition software.

Maybe at some point problem proles can just be "turned off" (ie killed) automatically by computer.  Think how efficient and cool that would be.  sarc off/

JohnG's picture


My main residence is in the middle of nowhere Ga...

I keep a house near Atlanta because my wife refuses to quit her "job." We do not need the income.

For now, I go there with her during the week.  This is a constant bone of contention with us; I do not want to be anywhere near Atlanta.  I like living two hours away where I am left alone.

Big Brother.  Disgusting.  And the article promotes it as a "good thing....."

Scanners, cameras EVERYWHERE.  I can protect myself on the net, but physical location, automated, worries the hell out of me.

tarsubil's picture

Be good for goodness' sake and because you are being watched.

JPM Hater001's picture

You know my pet peeve?  Back to back to back posts.

qussl3's picture

Didnt you hear?

New family formation in China is EXPLODING!

They are breeding like rabbits man, babies by the dozen, .......


Oops, wrong country.

Bicycle Repairman's picture

How much of the US could be housed by the USA's shadow inventory?

Kayman's picture

Bicycle Repairman

And the Fed wants to create more supply.  What else can you do when you are a money printer.

pkea's picture

imo, the real black swan event would be not the geopolitical tensions itself but the true consequences of the upcoming war or a natural disaster such as an earthquake this spring / summer that will slow down the globe triggering defaults in 2013 and possibly in the fall this year. what will China do without iranian oil, who/what does it need more, iranian and russian oil and commodities or western markets? what comes first? what sort of landing can you get without all of these ingredients? what is all that pile of western paper that they have surplus of is really worth? answer that and you again will get the picture. 

Doña K's picture

The most important element you left out is demand. There is no demand for products as there is no money velocity.

TheSilverJournal's picture

There's always demand for products. People always want stuff. The Chinese are perfectly capable of consuming their own stuff. The question is how many of these goods are worth how many of those good..and that's how trade works. When the Chinese discover that the US isn't trading real goods and is instead trading pieces of paper from a printing press, they'll be much better off when they stop and instead trade their goods for other actual goods.

Kayman's picture

Doña K

There is no demand for products

1. because 25% of employable Americans are not working

2. we have our satiation point.  How many ipads and iphones can you use ?  Isn't this just a modern day Slinky ?

ekm's picture


I was born and lived in communism in Eastern Europe for 20 years. Hombres, you can't run an economy for long by telling people what to do. Hear me!? It always ends up in hard landing.

All that crap about China surpassing the west and shit and shit and shit. Anybody knows any country that resorted to totalitarianism and did not end up hard landing? All Eastern Europe did right after 1990. How about talking about North Korea? China is no exception.

wandstrasse's picture

so you think the West is NOT a centrally planned command economy where people are told what to think and to do??? Hombre.. That it looks different does not mean it IS different.

jeff montanye's picture

it is different but the difference is narrowing and our "leaders" seem proud of it, cocky almost.  pride goeth before the fall.

TheSilverJournal's picture

The US is centrally planning housing, which is the largest asset that most own. The US backs 95% of all newly issued mortgages in an effort divert resources from the economy to prop up housing, which seems pretty socialist to me.

ebworthen's picture

ekm - I appreciate your perspective.

nah's picture

like america would let them starve to death


e92335i08's picture

Short chinese banks

TBT or not TBT's picture

The trick is, how to do that.

lewy14's picture

You cannot.

Which is why there will be no hard landing.

What's unique with China is that while some part of the economy is undergoing speculative boom, monetary/credit expansion and cost-push inflation (the private / shadow) sector, another part of the economy is undergoing balance sheet recession and debt deflation - that would be the big 4 banks and the state sector.

How will this resolve? It won't, and it doesn't need to.

In a debt deflation, the destruction of balance sheets becomes a problem of apportioning losses - the Chinese state arrogates the power to so apportion. And it does so ruthlessly, and efficiently.

The "fiscal buffer" is financial repression of Chinese citizens - the big 4 banks and the state sector can absorb whatever losses they need to, via the negative real rates. They'll simply suck in whatever they need to in the form of reserve requirements and Captain Renault-style raids (shocked - shocked! - to find shadow banking going on. Winnings to be deposited - in Bejing).

This game can and will go on for quite some time because growth and nominal interest rates are still quite positive - China has yet to "roll down the curve to zero" in the way that Japan, and now the US and EU have.

So no hard landing.

Again, the power to survive debt deflation is the power to apportion political and financial pain - it's only a "crisis" when that power is contingent and disputed. TPTB in the west are themselves attempting to arrogate that power...

Element's picture

Maybe working bankruptcy and writedowns into that, as vital and essential as well as forthright and trust enhancing restorative systemic processes, would be helpful.

ucsbcanuck's picture

don't really like ultrashort stuff

ucsbcanuck's picture

Indirect way - buy puts on FXI.

qussl3's picture

Consumption led economy only works with a relatively flat wealth distribution. Even then only until and up to debt saturation.

Long tax havens and BS luxury, this pig is done it's just going to take a while to stink.

Either that or the Chinese attempt to print their way to a middle class, companies paying increased wages have to get the money from somewhere no?

snowbaall's picture

China's crash isn't a surprise.  You can't go around building half a million dollar condos if nobody has a pot to piss in.

The Chinese crash will also bring down Australia and New Zealand.

But Chinese girls are pretty.

Canada might also take a hit.

2012 is gonna be rough.

pkea's picture

Chinese consumption led economy is another hopium....

ekm's picture

Right on. How can a nation with 49c/hr average salary resort to consuming?

Freddie's picture

LOL!  Some Dem junked you for the hopium.    Well the Tyler's seem to be getting that TARP fiat because I keep seiing banners on ZH for the Democrat Party's Allah.

fnord88's picture

The adds are different for every user. It shows you adds based on your browsing habits. Analytics are a powerful tool, and it appears they have rooted out your deep dark secret. Perhaps you did not even realise, but on some level, deep in your subconscious, google knows you love bambi. Hell, you probably voted for him last time, and have just blocked it out.

Do you ever wake up and not know how you got there?

ucsbcanuck's picture

Yes, normally accompanied by a headache, dry mouth and general feeling of shittiness. Occassionally next to cougar as well.

Kayman's picture

I think most people wake up not wanting to admit they know damn well how they got there.

QuietCorday's picture

If this is true, why do I get so many Russian/Thai brides ads on ZH?

I am not even male.

*very confused*

ozziindaus's picture

The Google Oracle says you're a closet Lez.

ekm's picture

Can't advance buy printing credit. China has had 3 to 4 hard landings that were paperized, just money printed (money is credit). It's come to the point that any credit printed will increase the price of food taking up most or all of incomes. A little bit more food inflation and booooooooooooom, Tian An Men number 2.

George Huxley's picture

This hard landing is going to piss off a lot of Chinese. I hope they don't scapegoat a certain western nation that owes them a lot of money that it can't pay back right now.

DaBernank's picture

The US can pay it back with the click of a few keystrokes. The Chinese would be on the losing end of that deal. I am amazed at the Chinese M2 number, just astounding. As long as their population is OK with never getting any of their money back from the big 4 banks, things will be ok, but these Chinese are not the Chinese of Mao's era.

Interesting times.

non_anon's picture

that's how the fortune cookie crumbles

electricgorilla's picture

Scott Minerd from guggenheim also believes China could see a hard landing. Short Chinese Real Estate ETF's?

spiral_eyes's picture

"Transform the labor intensive low value-added economy to the high value-added knowledge economy; reform the wealth redistribution system to empower the broad consumer base and honor its promise of a consumption-led economy."

This is nuts. Many of America's modern problems can mostly be attributed to losing her productive economy, and replacing it with pen pushing financialism. China's strength can mostly be attributed to picking up the slack in global productivity that has allowed America to live beyond her means as a parasite for the last 20 years. 

How can America be an independent nation — in energy, in politics, in spirit — while she is chained by the shackles of maintaining and controlling an oil-dependent global empire? 

qussl3's picture

Shoot your way there.


spiral_eyes's picture

That costs more than America can afford in dollars, manpower, productivity, etc.

qussl3's picture

As long as the USD is the reserve currency and the dingbats recycle their current account surpluses in USTs then they are paying for it.

Why the heck do you think the Chinese are experiencing inflation when they produce a healthy portion of the world's goods?

spiral_eyes's picture

A lot of Eurasian countries are breaking out of the dollar reserve system and using either their own currencies or the Euro or the Yuan. Even Japan has joined this trend, ditching the USD for the yuan and yen for bilateral trade with China. 

We're approaching the Bretton Woods endgame. 

Chinese inflation is a different but also related issue. It's mainly to do with global resource pressures. But have no doubt: if China cuts exports and consumes more of their productivity at home (when you have a multi-trillion dollar hoard that could be used as a monetary base that is very easy) aggregate inflation could drop like a stone.