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What’s Behind Growth Forecasts?

By Ichiro Suzuki

The U.S. economy is rebounding fiercely from what could have been the deepest recession since the Depression. Goldman Sachs has recently raised its 2021 growth forecast to 6.8%, higher than the Federal Reserve’s 6.5%. On the other hand China’s President Xi Jinping targets his economy to grow at 6% or above. Who would have thought the U.S. to grow stronger than China even for a year?

President Joe Biden’s fiscal stimulus amounts to whopping $1.9 trillion that is 9% of the U.S. economy. This comes on top of $2.4 trillion in CARE’s Act and $900 billion in COVID relief. Put these altogether, the U.S. is spending in excess of 20% of the economy to cope with potentially a very severe economic dislocation.

In contrast, China is spending approximately only 4% of GDP on this downturn. Its fiscal policy this time stands in sharp contrast to an aggressive boost in 2009-10 when the global financial crisis was engulfing the banking system and economies around the world. That RMB 4 trillion fiscal stimulus was well over 10% of the Chinese economy at that time. It is fair to say that the fiscal package saved the global economy from sinking into a black hole.

China has chosen to sit out this time, leaving economic leadership to the U.S. As China found out later, the country paid some great costs on that RMB 4 trillion fiscal stimulus. It added a boost at the end of the age of frenetic growth through the time of the 2008 Olympics. The Beijing Games coincided with the deepest global financial crisis in seven decades. (Less than a month after the Olympics were over, Lehman Brothers blew up.) In order to hold onto double digit growth rates, Beijing threw money into infrastructure developments. Building roads, bridges and railroads were the cornerstone of economic growth in the early years of the 21st century. Enough of them might have been built already by the time of the Olympics. While pouring more money into infrastructure did keep the growth rate above 10% for a moment, roads and bridges were laid out at where they were not in urgent need. Debt was accumulated on that spending though a boost to the economy might not have been as large as it was hoped. While China’s debt to GDP ratio was a healthy 30% at the time of the Olympics, it is reaching 60% today.

The reality is a great deal worse than this. The debt burden that amounts to 60% of the economy is the one owed to Beijing. In response to aggressive monetary easing by the Federal Reserve Bank and other major central banks, local governments went on a borrowing and investment binge. (Chinese local governments were not the only ones. A variety of governments in the developing world did it, too, while developed countries were relatively inactive on the fiscal front.) The state of Chinese local governments’ borrowing is so opaque that no one knows how much they really owe, but it might have to be eventually taken care of by Beijing if the worst comes to worst.

Then there were Chinese private corporations. Anbang was an insurance company established in as recently as in 2004. In the last decade, the company went on an acquisition spree on premier real estate assets, on borrowed money, in the U.S., including luxury hotels in New York City, Waldorf Astoria and Essex House. Such fierce investments dismayed regulatory authorities. In 2016, the overextended Anbang was taken over by the insurance regulator and was later liquidated. Anbang represented the most extreme case of debt-financed growth and it is probably too much to say it was a tip of the iceberg. That said, it is far from an isolated case. Private corporations were lured by low interest rates on the greenback and accumulated dollar-denominated debt. Then the RMB stopped rising against the USD. (Accumulation of dollar-denominated debt was an emerging market-wide phenomena. China was still relatively light on it. Other regions, Latin America, notably, did this more aggressively.)

Then the household sector. Chinese households in aggregate racked up debts to a level that well exceeds the size of the economy, to levels that can be comparable to developed countries. Though China is the second largest economy, its per capita GDP is only $10,000 as opposed to $40,000 or higher in the developed world with the U.S. well in excess of $60,000. China’s household sector would have to beg the financial markets to tolerate further debt accumulation for further prosperity.

Debt binge was already in place before the Beijing Olympics, or the global financial crisis. Chinese banks dominated the list of the world’s ten largest banks in terms of assets, with seven Chinese banks on the list. That was exactly how Japanese banks fared on the top ten list in the late 1980s. One had better not take too much pride in the size of bank assets. Bloated asset size can often be a proof of too aggressive lending without serious consideration of creditworthiness of the borrowers and the health of their own balance sheets. Only reckless lending can drive the country’s banking sector way up high in the rankings in a relatively short period of time. Such lending activities are always not as profitable as they had hoped.

On its way to the dominance on the world’s top ten banks, Japanese banks aggressively financed real estate development in the country. Bubble’s burst turned much of such lending into non-performing loans, as the economy was grounded to zero growth or lower from the highest growth rate in G-7. Chinese banks’ lending had been aggressive, too, prior to the global financial crisis. Burst of China’s real estate boom also worked against the banking sector. However, here is a difference. The bubble’s burst brought down China’s growth rate only to 6-7%. Double digit growth in the recent past does not go all the way down to zero on a single shot, as it happened on Japan. Growth rates of 6% is a still a very high number the standard for any country, especially those in the developed world. Zero growth of the economy keeps creating new NPLs for banks. Every time banks thought they have worked out NPLs, new ones sprung up amid persisting recession. This is how the Japanese banking system were crippled in the 1990s. The Chinese economy’s material slow down to 6% growth from perennial double digits could be a price China paid on its burst of the bubble that spanned several years, a few years before and after the Olympics. However, adverse effects of this material slowdown on the banking system were not brought to light immediately because continuing growth enabled banks to earn profits, even at lower levels than in the boom years. The RMB 4 trillion fiscal package saved the global economy from the precipice of Depression II, but China ended up with a problem of excessive debt accumulation in all segments of the economy. Being well aware of the problem the Communist Party wisely chose not to do anything this time.

While China is still a developing country from per capita income perspective, the country already has well-developed, sate of the art infrastructure. Building more of it would not materially lift productivity from this point on. On the other hand, the U.S remains the wealthiest country on a per capita basis among those with significant size, and its infrastructure is visibly run down after decades of under-investment. It’s an irony that the wealthiest country is left with a room to build bridges, highways, airports, and most notably high speed railways.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.


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