china - keep cooling the economy - can they?

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    Pressing problem
    Andy Xie says there should be no let-up in efforts to cool the Chinese economy. More vitally, authorities should focus on changing to an equitable growth model, and avoid printing more money at all costs
    Andy Xie
    Jul 08, 2011
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    China's economic growth indicators are turning downwards and, in the coming months, inflation could cool a bit, too. Is the fight against inflation won? And should stimulating growth be back on the agenda? The short answer is "no".

    The inflation cooling is temporary. Western governments are trying to lower oil and food prices by releasing reserves and looking into speculation. Such measures should be viewed as stimulus tools in an environment of zero- interest rates and high fiscal deficits. But they won't have a lasting impact. China's measures to cut import duties and highway tolls could cool inflation in the short term. But, the impact won't be sustainable, either.

    The slowdown in China's growth is a good thing. It has become too dependent on local governments spending borrowed money and the property bubble. In this model, more growth leads to bigger problems down the road. Slowing growth at least means the economy isn't getting into a deeper hole.

    Many voices argue for reversing the tightening policy on the grounds that cooling growth will lead to an employment crisis. This is wrong. China has a shortage of blue-collar labour. The slowdown won't lead to a general employment problem.

    The high unemployment of college graduates is due to the current economic structure: construction and low value-added manufacturing leads the economy. Only a shift to consumption and services can create enough white-collar jobs for graduates. Stimulating the economy by printing money isn't the answer.

    The real motivation for loosening monetary policy is to pump up the property and stock markets again. Local governments need to sell land to service their vast debts. Many businesses also need buoyant property and stock markets because their business model needs collateral for borrowing. Equally important, many vested interests need to cash out in rising asset markets. These forces cut short the macro adjustments in 2004 and 2007, and led to the massive monetary expansion in 2009, all in the name of creating jobs.

    Today's environment is still highly inflationary. Short-term price fluctuations won't change that. The massive stock of money is becoming inflation. The current growth target for the broad measure of money supply, M2, is 16 per cent; it isn't below the potential growth rate and, hence, isn't reversing the tide. Further, a large quantity of credit is being created outside the official monetary system. The supply and demand balance of factors of production favours inflation. The fundamental shortages of energy, labour and food make the transition from money creation to inflation very fast. Ignoring such dynamics would be perilous for China.

    Past episodes of monetary binges didn't cause an economic collapse. So why should it now? Because Chinese people have caught up with the game and learned to expect inflation when the government prints money. The public psychology is quite jittery now with regard to the government's intention to preserve the value of money. One more money-printing binge will lead to a collapse of confidence, resulting in bank runs, a massive hoarding of consumer goods, and capital flight.

    One must not be too confident in fooling the people; lost confidence may be impossible to regain.

    China has been trying to grow out of its problems. The promise of a rising tide from a growing gross domestic product lifting all boats gives people hope - the basis for social stability. In the past few years, growth has left more people behind than it has pushed ahead. Rising property prices have crushed the hopes of the middle class. Rising inflation has devalued the savings of all and left low-income groups unable to maintain their consumption. Growth through rampant government spending funded by printing money no longer benefits most people.

    Instead of focusing on short-term growth, China should try to change its model to benefit more people, use fewer resources and pollute the environment less. The current growth model benefits disproportionately the few who control government-owned assets and spending programmes. Judging from the profitability of state-owned enterprises and cost overruns of government projects, 10 per cent of GDP may have become grey income through leaks in these two areas. Considering the labour income for 1.3 billion people is about 40 per cent of GDP, such massive leaks cut economic efficiency massively, create unsustainable social inequality and sow the seeds of revolution.

    The system turns our best and brightest into speculators. Anyone without privilege is unlikely to have opportunities to realise their potential in a productive fashion, as the government controls virtually all opportunities. Hence, their energy has been channelled into stock market speculation, trying to make money from the less intelligent masses. This strategy may be good for stability in the short term. But, the masses become worse off.

    China's model worked because the factors of production - labour and natural resources - were underutilised. Hence, the unfair distribution of the benefits of growth still brought more to most people. When the factors of production are fully used, this model makes some better off and most worse off.

    Without changing the growth model, China may have problems maintaining stability. First and foremost, China should cut the leaks in the state-sponsored enterprises and activities. Of course, stopping the leaks would make many people in the system unhappy. It would take guts.

    Second, China should go back to basics: rewarding productive activities and avoiding asset bubbles. Interest rates should be raised in line with inflation. For example, the one-year deposit rate should be increased to 6 per cent as quickly as possible. Keeping deposit rates so low is to take from the poor and give to the rich.

    China's economic difficulties are a result of systemic problems. Printing money again won't even bring short-term relief any more. It's time to stop making bubbles and start reforming the system.

    Andy Xie is an independent economist
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