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The Chinese Economy is On a Slowing Boat
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Dec 07

Why China is headed for a fall

Posted by Ron F in recoveryrecessionemerging marketseconomydemandChina

Ron F

The basis for bullish assumptions about global economic recovery rests heavily on continued growth in China. And while the optimists concede that China is experiencing an investment bubble, they argue that the Chinese consumer will save the day. How? GDP growth will be sustained by a tremendous boom in consumption by the notoriously parsimonious populace, and this "rebalancing" will occur without interruption.

But a closer look at what's necessary for that scenario to work out suggests it is not feasible, or at least historically unprecedented.

As China expert Michael Pettis points out in a piece posted last Saturday, annual consumption would have to rise by almost 9 percent a year, while GDP rose by 7 percent annually, to bring Chinese consumption in 20 years from its current level of 35 percent of GDP to 50 percent, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia.

"I think too many commentators underestimate the magnitude of the problem," Pettis writes.  "China's rebalancing process will even in the most optimistic of cases take many years before it can even reach the lowest consumption levels reached by other Asian countries that pursued investment-driven policies accompanied by too-low interest rates and undervalued currencies."

Actually, Pettis puts it mildly when he says such growth would be "a long haul." A research report published last August by Pivot Capital Management argues persuasively that the bulls' assumption that China can sustain its average annual GDP growth of 10 percent by shifting smoothly from investment to consumption is wildly optimistic.

 "It is hard to over-emphasize what this shift to consumption-driven economy means for China's overall growth rates," the report states. "On a simple mathematical level it means that average growth rates are going to be capped at 7 to 8 percent, so that the overall economy grows at 5 to 6 percent for the foreseeable future, and probably slowing down even more later on."

Remember, the Chinese consumer is supposed to make up for the end of the U.S. as the engine of global growth.

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