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OPINION: China Can’t Stop a Crash

FAM: Note that the following Bloomberg excerpt reflects the opinion of the author.

(Bloomberg) After many years of 7- to 10-percent growth, economies tend to overheat, creating bubbles that burst.

That’s what happened to South Korea and Japan in the 1980s and 1990s. But China’s economy keeps plugging along (though probably not at its published growth rate of 6.7 percent), defying the predictions of doomsaying pundits. Some indicators show a recovery this year.

That doesn’t mean that the danger of a crash has passed, however. There is growing evidence of a real-estate bubble, and the economy seems increasingly dependent on government stimulus and private-sector credit growth.

I see a few reasons why the Chinese economy really is different from most Western models, and these imply that forecasting the Chinese economy is more like predicting the winner of a race than analyzing a bubble.

Unlike the U.S., China is full of large, state-owned enterprises. That gives the Chinese government the ability to manipulate a large stock of asset wealth. The U.S. government is more dependent on flows of revenue from taxation and the private sector.

When bad economic news arrives, the Chinese government can instruct the companies it owns to spend wealth to keep workers employed. Think of this as using the companies to conduct fiscal policy rather than laying off workers, building another bridge or erecting another steel plant. Whereas Western economies take an immediate hit to income in bad times, the Chinese have been converting this into a hit to wealth, insulating themselves from major downturns.

That can be useful, but it also can be abused. Indeed, China has ended up with too few bankruptcies and significant excess capacity and lots of low-performing firms.

One problem comes when the stocks of corporate wealth are nearly exhausted, or perhaps sooner when managers of state-owned companies rebel against this policy and demand alternatives. Another problem is that too many low-productivity firms survive. So when the dramatic Chinese recession finally does come, it will be without the protective buffers of wealth that the U.S. had during its financial crisis.

Not only is China a poorer country to begin with, but it has been spending down its buffers to postpone a crisis. The decline in foreign-exchange reserves and the recent rapid run-up in debt levels are further signs of this phenomenon, namely that adjustments to wealth are substituting for shorter-run declines in income.

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