x Abu Dhabi, UAEFriday 19 January 2018

China's bubble has kept more than its own economy afloat

It is clear that a measure of correction will be needed to right China's economy. But the world – like China – needs a soft landing.

Is China a bubble?

This question - once the domain of a small group of China sceptics in the global investment community - has gone mainstream. Time magazine posed the question on its cover, warning its readers to "Be Very Afraid of the China Bubble". Global news agencies such as Reuters and Bloomberg are raising troubling questions about China's over-leveraged banks, inflated housing prices and highly indebted local governments. A Wall Street Journal columnist recently wrote: "Forget Greece. Forget Italy. Forget 'Occupy Wall Street', The really ominous news right now? China."

The well-known Wall Street short seller Jim Chanos said recently: "China is in the midst of the biggest real estate bubble in human history." From Forbes to Foreign Policy magazine, from The Financial Times to The New York Times, one cannot open a newspaper or view a mainstream western media website without viewing the latest commentary on "the Bubble".

The argument is compelling. Banks are overleveraged. Developers have overbuilt. Municipalities have overspent. Housing prices are at historic highs. Information on bank debts is opaque. Investors are beginning to panic, fleeing bank stocks and property bellwethers. The short sellers are circling. It smells a bit too much like the United States, circa 2008.

Middle Eastern media, however, have been slower to see the China "bubble". Admittedly, news of the Arab uprisings and the dramatic events of the past year crowd out other stories. But for major oil-exporting countries, particularly the GCC states and Iran and Iraq, the fate of China matter as much to their future as the fate of Libya or Egypt.

The reason is simple: China represents the future of oil demand. The International Energy Agency estimates that China's oil consumption will more than triple by 2030. China is already the world's largest energy consumer, and soon will be the largest oil consumer. The Middle East has already benefited from China. As economist Ben Simpendorfer, an observer of Middle East-Asia relations, wrote recently: "China's thirst for oil, in particular, has played a big role in the Gulf's economic success over the past decade."

When King Abdullah of Saudi Arabia ascended the throne in 2005, he chose as his first state visit neither long-time ally the United States nor fellow Arab power Egypt. He chose China. He, too, saw the future of Saudi Arabia's most important commodity.

So, what would happen if the doomsayers are correct? Major housing busts devastate economies because of the ripple effect on banks, middle class consumers, construction companies, local governments and raw materials providers. The United States is still struggling to shake off its 2007-2008 housing crisis that shattered financial markets, spread contagion across the globe and led to the demise of venerable institutions such as Lehman Brothers.

China would be no different, despite its record $3 trillion (Dh11 trillion) reserves. The property sector accounts for 12 per cent of China's GDP, according to the IMF. Once housing prices collapse and banks get infected and consumers stop spending, a vicious cycle ensues. What would then be needed is another round of government-led stimulus, although China's massive stimulus after the 2008 financial crisis has raised local government debt levels and encouraged reckless bank lending.

The old investors' adage that "when America sneezes, the world catches a cold" is no longer true. America needs to get much sicker than just some sniffling and sneezing. But what if China catches a cold, or worse? Global commodities producers in emerging markets have been riding a decade-long China wave. That wave would slow. Oil producers, as noted, look to China as their future source of demand growth. That, too, would slow.

The story of the past decade has been the growth of trade and investment between emerging markets - the so-called South-South trade. That, too, would slow. And the teetering world economy, already reeling from a crisis of confidence, could hardly handle a big blow from China.

The story has been hidden because one of the key sources of the problem is not the central government in Beijing, but local governments that account for most state spending. Local authorities use property revenues as collateral for bank borrowing to fund more property development and infrastructure projects. If prices fall precipitously, their revenues fall, their ability to borrow falls and a downwards spiral begins.

Must China pop? It is clear that a measure of correction is necessary. This is already happening. It is also clear that many banks and municipalities will face their day of reckoning. This, too, is already starting. But China is still projected to grow at a robust 9.5 per cent in 2011 and 9 per cent in 2012, according to the IMF. Many a country would envy that kind of growth. But the writing is on the wall. What remains to be seen is how soft the landing is.

The China growth story of the past three decades represents one of the most remarkable periods of social and economic history in centuries. Some 300 million Chinese have been lifted out of poverty. A world power has re-emerged. There would be no talk of an "Asian century" without the rise of China. And it should be noted that China's world power grew not with nuclear weapons or a bankrupt ideology, but when it embraced free markets and traded with the world.

The world needs a soft landing in China. Amid today's uncertain economic times as Europe enters a period of slow growth, the United States muddles along unremarkably, Japan sputters amid its second "lost decade" and several Arab states have entered rocky, transitional periods, we need global economic anchors like China to drive global growth.


Afshin Molavi is a senior fellow at the New America Foundation and a senior adviser at Oxford Analytica. Follow him on Twitter at @afshinmolavi