China’s Worst Nightmare Is Turning Japanese
Few words strike greater fear in the hearts of economists and politicians than “Japanization.” That specter of chronic malaise, deflation and bad debt has driven central bankers from Ben S. Bernanke in the U.S. to Mario Draghi in Europe to flood markets with liquidity in an effort to avert their own lost decades.
It should worry China, then, that experts on this dreaded scenario are turning their attention to Beijing. Take Brian Reading, whose quest to understand what the world can learn from Tokyo’s mess dates back to his prescient 1992 book “Japan: The Coming Collapse.” He recently wrote a 40-page report with Lombard Street Research Ltd. colleague Diana Choyleva titled “China’s Chance to Avoid Japan’s Mistakes.”
Over at JPMorgan Chase & Co. in Hong Kong, investor inquiries on the similarities between China and Japan drove Grace Ng to revisit the topic. She warns that China today and Japan in the 1980s share an uncannily similar buildup in broad measures of credit to almost double their economies’ size.
So, just how susceptible is China to Japanization? Very, actually, and only bold and creative action on the part of President Xi Jinping and Premier Li Keqiang can avoid it. Think of their 10-year term that began in March as China’s make-or-break period to dodge a major debt crisis.
China is not impossibly indebted, considering it has $3.5 trillion in currency reserves. JPMorgan reckons its debt-to-gross-domestic-product ratio rose to 187 percent in 2012 from 105 percent in 2000, compared with Japan’s increase to 176 percent in 1990 from 127 percent in 1980. Japan’s has exploded since then and could approach 250 percent of GDP next year. That would mark a jump of 10 percent from 2012 alone in a fast-aging nation that’s losing global competitiveness.
China, also aging, couldn’t withstand a similar jump; it must rein things in now. Japan became rich before its society became old. It had decades to build a social contract between the public and private sectors, nurture a stable of innovative companies, and open the financial system. That legwork enabled Japan to muddle along for two decades without a huge debt meltdown or social unrest.
Yet Japan’s is also a tale of hubris and missed opportunities. Rather than quickly scrapping a model based on overinvestment, exports and excessive debt, Tokyo delayed change at all costs by relying on current-account surpluses, huge budget deficits and asset bubbles. In many ways, it still is.
Sound familiar? “China has so far followed in the footsteps of Japan,” Reading and Choyleva argue. “But its economy is not yet over-indebted. So there is time for China to avoid Japan’s mistakes if it changes course. The lesson from Japan’s experience in the 1970s and 80s is that change drives change and liberalisation becomes unavoidable. But unless policy is aimed at fundamental structural reform, the temporary solutions of running current account surpluses, budget deficits and spawning bubbles will eventually run out of steam and cause growth to stall. But China is far from having twenty more years to be blowing up bubbles.”
There are troubling signs that Beijing thinks it has plenty of time to deal with the problem. For every pledge to cut excess production capacity, audit government borrowings and tolerate sub-8 percent growth, there are two others assuring markets that growth won’t be allowed to slow too much. It’s that kind of doublespeak that sounds eerily familiar to longtime Japan watchers such as Marshall Mays.
“Even though Xi is reputed to have consolidated power quite quickly, there is still a lot of mess to clean up in the first year of formal rule,” says Mays, director of Emerging Alpha Advisors Ltd. in Hong Kong. “Li, meanwhile, doesn’t seem to have settled on a stable program of his own yet.”
The problem is one of politics over economics. Around China, dozens of local leaders are vying to put their cities on the global map and become the toast of the Communist Party. That means more than delivering rapid GDP. It also means building huge skyscrapers, international airports, six-lane highways, five-star hotel chains, sports stadiums, universities, giant cultural centers and swanky shopping arcades punctuated with Prada and Hermes shops -- all financed with fresh debt. If several of these metropolises go bust, Detroit’s $18 billion bankruptcy will look like small change by comparison.
A continued infrastructure boom promises ever-greater riches for vested interests both locally and in Beijing. (CNGDPYOY) There are ways Xi and Li could defuse the debt time bomb: greater oversight, expanding the municipal bond market, letting localities refinance with direct bond sales, increased transparency. China could borrow a page from the 1980s U.S. savings-and-loan crisis and set up Resolution Trust Corp.-like entities to dispose of bad debts.
But to do any of this, Chinese leaders must be willing to spend political capital at levels that are at least commensurate with the epic flow of ill-gotten gains heading back to the nation’s capital. It will take some serious mettle to avoid a Japan-like funk, and it’s unclear if Xi and Li have it.
(William Pesek is a Bloomberg View columnist.)
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