Chinese Economy is on Peril

China’s economy, the second largest in the world, twice the size of Japan’s, were to lapse into a meltdown situation such as this one, the effect would more than likely send the world economy into a tailspin. Its impact could be the worst the world has ever seen.

And here we were thinking our calls that China’s debt and excess capacity bubble would negatively impact global growth, are audacious.

But wait. Further on in the same paper, in its outlook for the Japanese economy, Daiwa says this:

Fears regarding the worsening economic situation in China are currently on the rise, but even if China’s economy worsens a bit more, assuming that the cause of said worsening is a decline in personal consumption and investment (in other words domestic demand) then the extent to which this would influence China’s imports – in other words the extent to which it would influence the world economy is thought to be minimal.

The other factor here is that the main driver of the world’s economy remains the US, not China….US retail sales moderately lead world industrial production. In other words, the US occupies the leading role in the world’s regions of final demand.

So we actually have two scenarios from Daiwa: a steady worsening of the Chinese economy as domestic demand and investment falls, or a debt deflationary collapse. The first of these would be unpleasant for China but have little effect on the global economy. The second, according to Daiwa, would have disastrous global consequences.

As Daiwa points out, which scenario plays out depends on Chinese policymakers:

China does not have a truly Capitalist system, but what is called a socialist market economy, and this fact may provide underlying support for the time being. Since economic problems could cause political instability, China’s political leaders would of course prefer to avoid the bottom falling out of the economy as much as possible. Since China is not a truly capitalist society, they could delay having to deal directly with the problems for 1-2 years, and would likely do everything they can to delay the problems for as long as possible. Since political decision-making is by a collective leadership working under a philosophy of gradualism, the Chinese economy can probably avoid seeing the bottom fall out in the short-term. Even the worst case scenario doesn’t mean immediate collapse then. Phew.

Provided, that is, Chinese officials kick the can down the road. Which they are already doing, of course.`

If the Eurozone is anything to go by, can-kicking can continue for years on end with no meltdown. As long as officials keep promising that growth will return “any day now” – and people believe them – the economy can worsen beyond the point of depression without a debt deflationary collapse. The question is, at what point do people stop believing officials, pull their money out of banks and transfer it to safe havens, and the house of cards collapses into an unholy mess of defaulted loans, bankrupt banks and insolvent corporations?

Well, it might come sooner than Daiwa think.
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