“The next economic crisis will be in China. And it is closer than we may think.”
These are the opening words of an article of mine, published on the Malaysian Reserve and on The Malaysian Insider on January 2014.
The Chinese crash, at the end, arrived. However, at that time, the majority of analysts was thinking that China could be considered the engine of a never-ending growth path, able to counterbalance, in the realm of the world economy, Western countries weaknesses.
Instead, I was arguing, China growth process was financed by debt, public and private, and by monetary expansions; the same elements which drove Western economies to collapse in 2007: debts and easy money, supported by central banks rulers, Fed in particular.
What is happening now in China, therefore, is not a source of surprise. Years of easy money created a situation in which many investment projects were initiated only because made “profitable” by monetary manipulations.
The result of an “inflated” economic activity is the continuous increase of prices, starting with capital good prices and following with consumer good prices.
At the beginning of 2014 Chinese rulers realised the situation was becoming unbearable and they had to take monetary counter measures in order to stop banks and local governments from bleeding money.
A sense of concerns started to emerge and some analysts started to write articles about the possible end of the Chinese miracle.
A miracle, in truth, that never happened to be. It was not necessary to be economists to realise that there was something wrong in the Chinese development path.
I travelled to China several times because of my job. The amount of new building projects is huge.
Malls sprout everywhere. Marvellous highways across the subcontinent. Investors and “entrepreneurs” are everywhere.
However, at a better look all these creations show a common element: they are empty. The age of easy money created investment processes which did not match with preferences from the consumer side; technically speaking, inflationary policies distorted the intertemporal structure of preferences.
The boom, therefore, was not justified by an economic system soundly moved toward a higher preference for the future.
Economic agents are now realising the fallacies of the boom, an expansionary process they created because of a distorted system of prices artificially created by monetary and political authorities.
The speculation fever is followed by a disinvestment fever, exactly as it happened in 1929 in the United States.
The situation is particularly dangerous because of the enormous private debt which financed the boom.
According to recent estimations, the private debt (companies and households) is now above 200% of the GDP in China. This will make the crisis particularly severe: in their downfall, families and investors will find themselves without saving, the better parachute.
Today China cut interest rate, in the hope to halt the fall. A movie we’ve already seen in Europe and America.
The attempt to fight an easy money bubble with more easy money. The result of such quantitative easing (QE) is now evident: Western world is not recovering. A recent study by the Federal Bank of St Louis demonstrated that there are no evidences that QEs generate economic recoveries.
What to do, then? It would be already a great result to learn the lesson: inflationary booms drive economic systems toward a crisis.
The only possible sustainable development is generated by investment processes consistent with the structure of the intertemporal preferences.
This means that investor intentions are consistent with consumer preferences. Such consistency can be distorted by debt and inflation oriented policies, bringing out crises.
There is no easy way out for China now. However, China can choose, as the West, for further “economic stimuli”, knowing that they do not bring anywhere.
Or, accepting the impossibility for planners to generate sound economic processes, let the market free to heal government-induced wounds through the free discovery process ruled by the price mechanism.
A free-market induced recovery will be no less painful. But it will be real, not just another bubble. – August 25, 2015.
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Carmelo Ferlito is a senior fellow at the Institute for Democracy and Economic Affairs.