new economy

　　

The "terracotta warriors" who are optimistic about China are back. It has been more than a year since the Chinese economy showed signs of a sharp improvement. At that time, investors were preparing for an economic "hard landing" and currency devaluation. Since then, China's economy has improved significantly. The most direct impacts are the stocks of Western companies whose income is most dependent on the Chinese market, and the prices of commodities purchased by China.

    This sentiment was eventually passed on to international investors. According to data from the Institute of International Finance, China saw a net capital inflow rather than a net outflow in February, the first in three years. China continues to dominate capital inflows from emerging markets. Emerging market stocks are up 41% from their January low last year. At the same time, the issuance of emerging market bonds hit a record high this quarter, and their currencies have appreciated sharply because of the waning of concerns about the US, which pursues an “America First” stance, that undermines global trade.

    These statistics actually prove the victory of Chinese people who are optimistic about it. For a very long time, China's economy will grow. Few people deny this. But people have reason to worry that as soon as they received information about China's latest credit-driven recovery, this recovery has already peaked and is beginning to reverse.

    The increasingly pressing questions in recent years have still not been answered. Can China avoid the "middle income trap"? The "middle income trap" has caused many countries to stagnate after reaching a level of wealth comparable to China's current level. Can it somehow avoid following in the footsteps of all those countries with such rapid and widespread growth, and prevent a "sudden stop" or financial crisis at a certain point in time?

    The middle-income trap is an acute problem. Many countries have quickly transformed from underdeveloped or poor countries to middle-income countries, but in the last 30 years, only two countries with a population of more than 20 million have successfully escaped the middle-income trap—Poland and South Korea.

    Those who are optimistic about China believe that China can get out of the middle-income trap. This is the core argument of a long report recently published by Morgan Stanley, which unambiguously uses "Why we are bullish on China" as the title. The investment bank predicts that if China can shift from the current export-led economy to a domestic consumption-driven economy, it will be able to become a “high-income” country by 2027, with per capita income increasing from the current US$8,100 to US$12,900.

    The biggest risks facing this prediction include the return of trade protectionism and the demographic problems that have emerged as China begins to age.

    But can China avoid a financial "sudden stop"? China’s economic stimulus package has reached a level that seems to ignore the dangers. The New York Federal Reserve said that China accounted for half of the new global credit since 2005.

    The signs of imbalance that led to Lehman's bankruptcy have become obvious: the latest data on China's real estate market shows that in the past year, prices of new homes in Beijing have risen by 22.1% and in Shanghai by 21.1%. The US$11 trillion wealth management product market shows similarities with the "financial engineering" before Lehman's bankruptcy. Wealth management products are invested in the currency market, aiming to obtain higher returns than bank deposits. Some wealth management products are invested in other wealth management products, just like using collateralized debt (CDO) to invest in each other to create a "secondary CDO."

    How can China avoid this ending? Morgan Stanley’s optimistic view is that China’s debt is mainly financed domestically (in other words, “China is misallocating its excess savings”). China is still a creditor country with a current account surplus and is not facing inflationary pressures, so the People's Bank of China can continue to inject liquidity to "manage any potential risk aversion in the domestic financial system."

    A more cautious view comes from George Magnus of the China Centre at Oxford university. He pointed out that China's financial system has undergone tremendous changes since 2008 and is unhealthy. "Financial system assets (basically loans) have increased from approximately 250% of GDP to 440% in 2016."

    He added that China’s “credit gap” (the deviation of credit growth from the long-term trend) is 27%, which is very high “compared to countries such as Japan, Thailand, and Spain”. Before the crisis and subsequent deleveraging, there was a small credit expansion gap."

    His pessimistic view is that "the size and duration of the credit expansion gap is positively correlated with the outbreak of a severe financial crisis. China's debt to GDP ratio (various estimates range from 260% to 300%), the rate at which this ratio rises, and The continuous rise for about eight years has turned China into a classic case of crisis risk."

    Obviously, China is now trying to moderate the brakes, which in turn will mean reduced economic activity and lower commodity prices, but international funds have begun to arrive.

    China’s economic model is very different from that of the United States, and China’s economic growth is much stronger. It should be avoided to speculate on China directly based on the Western financial crisis 10 years ago.

    But the similarity of the basic factors is undeniable. For the global market, nothing is as important as China's efforts to avoid a similar outcome. At present, China's growth has boosted the situation in many other parts of the world.