China’s ‘Treadmill to Hell’ Is Worth Mind Game: William Pesek

Fitch Ratings is performing a timely mind experiment: Pretend Chinese growth fell below 5 percent.

Fitch isn’t forecasting a halving of Chinese output in 2011. And Tony Stringer, head of Asia Pacific corporate ratings in Hong Kong, is quick to say there’s no specific reason to expect the second-largest economy to bog down anytime soon. Bears haven’t made much money betting against China.

Yet if you said in 2005 that Bear Stearns Cos. would collapse, the Federal Reserve would emulate the Bank of Japan, Ireland would need a bailout, Indonesia would be a role model and North Korea would be killing South Korean civilians, you would’ve been laughed at. The supposedly unthinkable has an uncanny way of becoming reality in this upside-down world.

Envisioning China stalling is a vital what-if exercise given the increasing importance of an economy that’s still an emerging market. That outcome would shake markets from New York to Tokyo.

“Any credible prediction below 8 percent would spark a huge risk sell-off,” says Simon Grose-Hodge, head of investment strategy for South Asia at LGT Group in Singapore.

With the U.S. walking in place, Europe embroiled in a debt crisis and Japan deflating, investors wonder when or if emerging economies can fill the growth void. China sits at the center of this debate. In 1980, its share of world gross domestic product was 2 percent. By 2008, it was around 12 percent. As 2011 approaches, no one doubts the pivotal role Chinese growth will play in the global recovery.

What If?

If China did slow markedly, Fitch says, the fallout would have negative consequences for sovereign and corporate credit risks of trading partners such as Australia, Hong Kong, Malaysia, Singapore, South Korea and Taiwan. Commodities markets would take a sizeable hit, as would industries such as auto making, chemicals, heavy manufacturing and steel. All export industries would be rocked.

Increased market volatility would be another side effect. Risk aversion and potential financial contagion emanating from China would be the last thing the world economy needs. The hobbling of a key economic pillar might shock markets already on edge.

A big slowdown would be a blow to multinational companies expecting major things from Chinese subsidiaries. Industries from consumer products to restaurants would generate lower profits and cash flows if Chinese demand weakened.

Whither Treasures?

I also wonder about the U.S. Treasury market. Conspiracy theories about China dumping its vast dollar holdings to annoy the White House haven’t come to fruition. What if China suddenly needed the money?

For a nation at China’s level of development, 5 percent growth is crisis territory. The chances of social unrest would explode among the nation’s 1.3 billion people, putting the onus on the government to take drastic measures to boost growth. It would be very tempting for Beijing to sell large chunks of China’s $2.6 trillion of reserves to finance public-works projects.

There’s also a bad-loan risk. Recent data show that Chinese credit growth hasn’t really slowed from 2009’s rapid pace. The reason: new bank lending has been offset by a surge in off- balance-sheet loans. So in other words, all those efforts in Beijing to rein in credit are coming to naught.

The Fed is part of the problem. Its policies feed a hot- money pipeline that dumps into Asia. Also, the Fed last week provided a detailed accounting of its efforts to shore up the financial system. The data-dump showed the extent to which it helped other nations’ banks in Europe and Asia.

Overseas Assistance

Among the beneficiaries of the Fed’s emergency liquidity facilities were Mizuho Securities USA Inc. and Daiwa Securities America Inc. Perhaps we should rename the Fed the Central Bank of the World.

The trouble for Asia is what happens to all this lending once growth slows. One risk is the infrastructure arms race unfolding in dozens of cities around China -- all vying to be the next “it” destination for capital, companies and tourists. Once the music stops and all those debts are tallied, China may be looking at a bumpy few years.

Soaring real estate prices have prompted analysts like former Morgan Stanley economist Andy Xie to call China’s asset markets a bubble destined to burst. China is “on a treadmill to hell,” with growth driven by the “heroin of property development,” New York hedge-fund manager James Chanos has said.

China’s most-vocal critics have little to show for their pronouncements. The place is still growing at 9.6 percent. The determination in Beijing to keep things that way explains why officials there refuse to let the yuan rise.

No country ever grows in a straight line, though, and China is no exception. Even if the odds don’t favor an abrupt slowdown, it’s wise to contemplate that possibility and prepare for it. Stranger things have happened in this crazy world of ours.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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