It is hard to know what to make of Nouriel Roubini’s prediction last week that China’s economy faces the possibility of a hard landing. Having convinced the world’s media that he is “the economist who predicted the global financial crisis”, as Reuters again reported last week, Roubini has been under surprisingly little pressure to prove himself.
Despite his reputation as a prophet, he has made some dubious calls since the crisis and very few that would help anyone to make any money. He described the S&P 500’s rise as a “sucker’s rally” in March 2009; a call that has stayed wrong for more than two years. Even his famous prediction of America’s recession first aired as early as 2004. His analysis was fair enough, but anyone who paid attention missed out on three years of huge gains.
Now, Roubini is betting that China’s growth will soon turn sour. “There is a meaningful probability of a hard landing in China after 2013,” he was reported to have said at a financial conference in Singapore last week.
He is certainly not alone this time. Even rating agencies have been sounding alarm bells (or, to be more precise, sounding alarm bells about the possible need to sound alarm bells at some point in the near- to medium-term future). And our readers are nervous, too. Responding to our web poll last week, they reckoned there was a roughly 50% chance that China’s economy could come crashing down.
US-listed Chinese internet companies are coming under scrutiny for lax corporate governance and dodgy accounting, and influential short-sellers have hammered Sino-Forest and several other stocks. Even Prada’s Hong Kong IPO couldn’t shake the funk, pricing in the middle of the range after retail investors decided to save their money for shoes and handbags rather than share certificates.
Once again, Roubini’s analysis makes sense. Over-investment invariably ends in a hard landing, he argues, as Asia learned after excessive spending during the 1990s. In China today, investment contributes roughly half the country’s economic growth, which Roubini says is unsustainable.
The size of China’s problem became apparent at the end of May, when the government declared its intention to spend up to $450 billion to bail out thousands of local government investment vehicles — which have kept the economy alive for the past two years by bankrolling countless infrastructure projects, including a high-speed rail network built alongside brand new motorways and airline routes, all of which are little used.
While China has kept credit flowing to pointless state-run projects, it has choked private investment in a bid to keep inflation under control. That is a dangerous game, but China’s economy could continue to defy gravity thanks to its ample liquidity and captive banking system.
Roubini’s 2013 call could come true if capital starts to flow out, but if any country is capable of sustaining the unsustainable it is China. After all, investors have few other opportunities to earn decent returns right now and the long-term story remains compelling, even if there are too many new roads and bridges.
Sinophiles often praise the Chinese for their shrewd economic management, but it is hard not to assume that government would have been better off channelling trillions into spurring domestic consumption, rather than investment. Indeed, Chinese officials must have known in 2008 and 2009, when they approved most of the infrastructure loans, that they were a waste of money.
“The experience of these two years shows that a large part of the Chinese economic miracle has been built on a foundation of ill-considered lending and accounting sleight of hand,” wrote Carl Walter and Fraser Howie, co-authors of Red Capitalism, in a Wall Street Journal opinion piece yesterday.
Those policies have had non-financial effects, too — building vast new projects usually means displacing people, and forced land acquisitions have clearly added to the public’s growing discontent.
China has made it this far thanks to good luck and plentiful supplies of cash, and investors looking to profit from its economy will probably need more of the same.