China is far away, but its bursting bubble will hit close to home
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The Trump administration would be ignoring the recent signs that the Chinese credit bubble might be bursting at its own peril. This is not simply because China is the world’s second-largest economy and has been the major contributor to global economic growth over the past eight years.

Rather, it is also because a slowing Chinese economy is bound to increase China’s trade surplus with the United States, and it is bound to have a large negative impact on the rest of the Asian economy as well as on international commodity prices.

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The real risk that China poses to the U.S. and global economies is that its rapid economic growth since the 2008-2009 global economic recession has been powered by a credit bubble of epic proportions. Since 2008, Chinese credit to its non-government sector has increased by almost 100 percent of its GDP.

 

This rate of credit expansion far exceeds that which preceded the U.S. housing and credit market bust in 2008 or that which preceded Japan’s lost decade in the 1990s. As the International Monetary Fund has recently warned, experience elsewhere with credit bubbles of anywhere near this size is that they generally presage economic and financial crises.

The Chinese authorities themselves recognize that their country’s credit bubble is unsustainable. Until recently, however, most Chinese watchers thought that the Chinese government would not do much to rein in that bubble in the run up to the all-important Communist Party Convention that is scheduled for this autumn.

The People’s Bank of China’s recent interest rate hikes from 2.5 percent to 4.5 percent would now suggest otherwise. So too would the sharp deceleration in China's credit expansion from a peak of over 25 percent at the start of 2016 to around 15 percent at present.

The Chinese government’s control of its banking system makes it implausible that China will experience an economic shock similar to that experienced by the United States on the bursting of its credit bubble in 2008. Rather, it appears more likely that the bursting of the Chinese credit bubble will be followed by a prolonged period of very slow economic growth similar to that experienced by Japan after its bubble burst at the end of the 1980s.

As has been the case in Japan, one would expect that the Chinese banks will be saddled with a very large amount of non-performing loans to zombie state enterprises for a very long period of time that will leave them with very little room to extend credit to the more productive sectors of the economy.

A prospective long-period of slow Chinese economic growth should be of considerable concern to the Trump administration for at least two fundamental reasons: The first is that slow Chinese economic growth is bound to result in a very much less favorable global economic environment for U.S. exporters.

A slowing Chinese economy would almost certainly have a strong negative impact on the economic prospects of China’s Asian economic partners whose economies are closely interconnected with that of China. It would also have a large negative impact on the major commodity-producing emerging market economies, like Brazil, Russia and South Africa, particularly considering that China is now the world’s major commodity importer.

A second reason why China’s economic slowing should be of concern to the Trump administration is that it will highly complicate the administration’s goal of reducing the U.S.-China bilateral trade deficit. A slowing Chinese economy will almost certainly weaken Chinese demand for U.S. imports.

In addition, one must expect that a slowing Chinese economy might weaken its currency to the advantage of its export sector. It would do so by giving fresh impetus to Chinese capital outflows through the need for lower Chinese interest rates as well by heightening domestic economic uncertainty.

In its dealings with China, the Trump administration would do well to keep in mind that in a closely integrated global economy, U.S. economic prospects are closely interlinked with those of China. It would also do well to remember that the Chinese economy will be challenged for the foreseeable future by the bursting of its credit bubble.

In those circumstances, the last thing that either China or the U.S. now needs is a ramping up of protectionist measures against the Chinese economy.  

 

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


The views expressed by contributors are their own and not the views of The Hill.