China: the coming costs of a superbubble

Written by: Xiaoling L on Mar 19, 2010 11:33 PM EDT

The world looks at China with envy. China’s economy grew 8.7 percent last year, while the world economy contracted by 2.2 percent. It seems that Chinese “Confucian capitalism” – a market economy powered by 1.3 billion people and guided by an authoritarian regime that can pull levers at will – is superior to our touchy-feely democracy and capitalism. But the grass on China’s side of the fence is not as green as it appears.
In fact, China’s defiance of the global recession is not a miracle – it’s a superbubble. When it deflates, it will spell big trouble for all of us.
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To understand the Chinese economy, consider three distinct periods: “Late-stage growth obesity” (the decade prior to 2008); “You lie!” (the time of the financial crisis); and finally,  “Steroids ’R’ Us” (from the end of the financial crisis to today).
Late-stage growth obesity

About a decade ago, the Chinese government chose a policy of growth at any cost. China’s leaders see strong gross domestic product (GDP) growth not just as bragging rights, but as essential for political survival and national stability.
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Because China lacks the social safety net of the developed world, unemployed people aren’t just inconvenienced by the loss of their jobs, they starve; and hungry people don’t complain, they riot and cause political unrest.
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Remember the 1994 movie “Speed”? A young cop (Keanu Reeves) had to save passengers on a bus that would explode if its speed dropped below 50 m.p.h. Well, China is like that bus with 1.3 billion people aboard. If the Communist Party can’t keep the economy growing at a fast clip, the result will be catastrophic.
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To achieve high growth, China kept its currency, the renminbi, at artificially low levels against the dollar. This helped already cheap Chinese-made goods become even cheaper. China turned into a significant exporter to the developed economies.

Normally, if free-market economic forces were at work, the renminbi would have appreciated and the US dollar would have declined. However, had China let this occur, demand for its products would have declined, and its economy wouldn’t have grown at roughly 10 percent a year, which it did during the past decade.

The more China sold to the United States, the more dollars it accumulated, and thus the more US Treasuries it bought, driving our interest rates down. US consumers responded to these cheap goods and cheap home loans by going on a buying binge.

However, companies and countries that grow at very high rates for a long time will inevitably suffer from late-stage growth obesity. Consider Starbucks: In 1999, it had 2,000 stores and was adding 1.8 stores a day. In 2007, when it had 10,000 stores, it had to open 5.5 stores a day in a desperate bid to keep growth rates up. This resulted in poor decisions and poor quality – a recipe for disaster.

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