China's Economy: a cycle of arson and firefighting (I)

China's Economy: a cycle of arson and firefighting (one)
Written by He Qinglian on September 22, 2011
(translated by krizcpec)

In this past six months, I have almost completely stopped discussing China's economy. There's nothing more to say after I have done repeated analyzes of its various aspects. However, it's interesting that Premier Wen Jiabao, despite being responsible for managing the country's economy, has been talking enthusiastically about politics instead of economy for more than a year now.

The reasons behind Premier Wen Jiabao talking about politics instead of economy
From his speech that raised the issue of “Political system reform” last year, to the talk “The Path to China's Future” delivered on June 27 at the Royal Society in London, Britain stating that “Without freedom, there is no real democracy; without guarantee of economic and political rights, there is no real freedom”, and to the “five points about political reform” highlighted on September 14 when he met with CEOs at the Summer Davos Economic Forum in Dalian, Premier Wen's talks on politics have become increasingly specific. In spite of that, Wen doesn't win much applause.

It has become a clear awareness that the Chinese people, who have been made physically and mentally exhausted by the inflation, unemployment, corruption, and the deluge of the privileged, can no longer be pacified by calls for political system reform.

From Wen's focus on politics, however, I decipher a sorrowful message: nothing more can be said about China's economy. It has become irredeemable. From restructuring industries to boosting domestic demand; from attracting foreign investment to searching for new economic growth point, there is nothing that can be done about it.

Some say Wen talks so much about political system reform is out of consideration of his reputation. But I think there's more to it than that. The actual reason is that after serving more than a decade as vice-premier and then premier, he has tested one formula after another and is aware that nothing more can be done.

The engine of China's economy is started by the government. From the start of premier Zhu Rongji's macroeconomic regulation and control in 1993, China's economy could at best be said to have gone through one cycle of “overheating and cooling off” after another; at worst, it has time and again been subjected to the cycle of “arson and firefighting”.

The Chinese government stimulates economic development in ways that are like arson; and hurriedly imposes restrictions once the situation spins out of control. And so results in the phenomenon that the Chinese economic sector sum up as “things run wild whenever the regulations are loosened; and are doomed as soon as there are tough restrictions in place. (“一放就乱,一管就死”)”

With the problems of the economy originated from the government, what good does it do for the person responsible for economy to talk about economy? To talk about it more would be no different from self-contradiction. That's one of the main reasons premier Wen talks about politics instead of economy.

Why does inflation go hand-in-hand with China's economic growth?

Let's first outline the occurring times and the main features of the four rounds of overheating since the Chinese economic reform.

The first round of overheating took place from 1987 to 1988. China's GDP growth rate in these two years was as high as 11.6% and 11.3% respectively, resulting directly in an 18.8% increase in consumer price index in 1988 and 18.0% in 1989 respectively, and causing serious inflation.

The second round occurred from 1992 to 1996. In each of these years the GDP growth rate was more than 10%.

The third round spanned from 2002 to 2007. China recorded rapid GDP growth for six consecutive years, five of which had a growth rate of over 10%. But the consumer price index in those years seemed to have remained low if the extremely rapid rise of real estate and other consumer goods were excluded.

The fourth round of economic overheating—mainly in investment and real property market—was caused by the Chinese government's attempt to bailout by pumping four to five trillion yuan into the market. A typical "investment-driven economic overheating", it by and large could be attributed to the government's excessive investment that was funded chiefly by the banknotes the banks had printed. The inflation tiger had finally been released from its cage.

If the root causes of inflation in today's China that is difficult to tackle, and the economic structure that is hard to improve are traced, one would see that these could be ascribed to the third round of economic overheating.

FIRST, the third round of economic overheating has been significantly different from the previous two rounds.

The first two rounds were triggered by “Seller's market” under the circumstances of “economic shortage”, the inflation manifested itself as a rapid overall price surge in short periods.

The third round however, was caused by a booming market supply that was translated into the situation which most of the consumer goods formed a “buyer's market”, and the inflation demonstrated itself as a process of “initial structural rise and subsequent overall leap with accelerated speed”. From this we could see the inflation phenomenon in China had become more structural in nature and harder to spot.

SECOND, the first round of economic overheating was accompanied by high inflation only; the second round was oppressed by Zhu Rongji's macroeconomic regulation and control as soon as the bubbles in stock and housing market began to form.

But in the third round, the four pillars of wealth growth were land, mineral resources, finance and stock market. China's financial industry and gigantic state-owned enterprises needed to go public so as to grab money; while all levels of local governments started to become highly financially dependent on land in this period.

This combination inevitably resulted in bubbles being formed in both stock and housing market. The relation of these two bubbles was one that of a reciprocal causation; they were the catalyst for each other, and together they drove up the prices, laying down the foundations for the fourth round of economic overheating.

THIRD, while the first two rounds of economic overheating were set off mainly by domestic factors, the third round was sparked off by various external factors, some of which were determined by the economic growth model of China.

For instance, China's economy has entered the phase of highly dependent on foreign/external resources. Be it petroleum, iron, aluminum or other minerals, once the "China factor" is added, the pattern of world market supply and demand would change immediately, and result in prices shooting way up.

And the fact that the central bank need to issue currency to “purchase” the huge foreign exchange reserves China has accumulated from foreign trade surplus and other economic activities has become a significant antecedent of future inflation.

As for the fourth round of economic overheating, it is solely the result of the Chinese government's inflated ego. While the entire world could not avoid the shock waves from the financial crisis, and each of the countries sought ways to shrink, to adjust, and to squeeze the bubble, China did things the other way round.

It did not squeeze the bubble or carry out structural adjustment. On the contrary, it injected huge amount of funds to bailout the market, with the hope to maintain the false prosperous image of “China's economy outshining all others”. The Chinese government became so obsessed with this image that it lost its head and indulged itself in the saying: “China has saved the world's economy”.

(For analysis on the fourth round of economic overheating and the current status of China's economy, please see the next article)