Professor Sufi: An Ironclad Rule of Economics Suggests China Is Headed for a Downturn

Excesses in debt and durables.

Don't hold your breath waiting for a soft landing.

Photographer: Kevin Frayer/Getty Images

It's possible that the world's second-largest economy is already in recession, according to Amir Sufi, professor of economics at the University of Chicago and co-author of House of Debt.

Because of concerns about the quality of Chinese data, and in particular the manner in which nominal figures are deflated, economists have a number of different proxies to try to get a more accurate picture of the economy's health.

At the Chicago Booth School of Business' 2016 outlook presentation, the professor pointed to flat-lining electricity consumption growth and tumbling freight traffic volumes—both of which are components of the Li Keqiang index—as indicative of an economic downturn:

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Bloomberg

Being a centrally planned economy will not prevent China from hitting a wall, said Sufi, who added that Beijing won't be able to make up for a shortfall in aggregate demand.

The quasi-command structure of the Chinese economy, however, does make nailing the timing of any inflection point more difficult, as its economic activity is somewhat sheltered from market forces.

Nor is the ample current account surplus a panacea, according to the professor, who highlighted that Japan's elevated trade surplus in the late 1980s didn't prevent a collapse of asset values and the onset of the country's famous "Lost Decade."

For Sufi, whose book focuses on the role of leverage in preceding recessions and prolonging a return to normalcy, excesses related to the two Ds—debt and durables, such as cars, commercial real estate, and residential housing—offer additional cause for concern. China has swapped out a debt-fueled foreign demand binge for a debt-fueled local government spending spree, he said, after which it will be very hard to generate demand.

There is a robust statistical relationship between sharp increases in debt to GDP and an ensuing recession, asserted Sufi, and China's rapid leveraging entails that it won't be immune from this ironclad rule.

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