Why China's Economy Will or Won't Collapse

First up we have Brookings’ Douglas J. Elliott for the Nays:

It is difficult to go a day without reading scary headlines about China’s economy. The reality is that it is going through major adjustments, and has some serious structural flaws, but that its even greater strengths will almost certainly prevent economic calamity…

One does not have to dig far in China to find examples of serious over-investment. Much of it represents the building of infrastructure now that is not really needed until well in the future, such as many of the high-speed train lines. These projects are often justified by the fact that they will eventually be put to good use, but in the meantime represent “dead money” that could be channeled into much more profitable uses. Other investments are just vainglorious or foolish and will never be worth much. Lower levels of total investment would tend to be considerably more efficient, because it is easier to get funding for smart projects than silly ones.

There are also real limits to the sustainability of large trade surpluses in a world where all nations are looking to increase exports, and the sheer size of China’s economy has grown to the level where other nations will not long accept such an approach.

I can’t say that I’m moved all that much by an argument that relies on the wisdom of leaders who got China building ghost cities and an unsustainable export model. And while they might have guided China to soft landings after the last two bubbles, that’s no guarantee of future success. Besides, the nature of bubble economies is that each bubble must grow bigger than the last one (paging Ben Bernanke and Janet Yellen), so that the “wise” leaders can mask the failures of the previous bubble.

On the other hand, China does have five trillion dollars in the bank, and that’s enough money to paper over a lot of economic trouble.

But is it enough to hide a real estate collapse? That’s Gordon Chang’s fear:

Nothing is going right for Hangzhou at this moment. Walmart will be closing its Zhaohui store in that city on April 23 as a part of its overall plan to dump marginal locations—about 9% of the total—in China.

Thanks to the world’s largest retailer, another large block of space in Hangzhou, the capital of Zhejiang province, will go on the market at a time when there is generally too much supply. The problem is especially pronounced in the city’s premium office market. Hangzhou’s Grade A office buildings at the end of 2013 had, according to Jones Lang LaSalle, an average occupancy rate of 30%.

The real weakness, however, is Hangzhou’s residential sector. The cause is simple: massive overbuilding. Sara Hsu of the State University of New York at New Paltz writes that Hangzhou faces “burgeoning swaths of empty apartment units.”

It’s true that Chang has successfully predicted (if memory serves) three of the last zero economic collapses in China. He made his name around the turn of the century predicting a banking collapse — and I still have that book on my shelf although I can’t remember the last time I was tempted to pick it up.

That’s a mighty big bubble for Beijing to re-inflate, and the fact remains that every inflation simply masks the fact that the underlying value is not there.

So Chang has been wrong before. And he might be wrong this time. But the day of reckoning — the reconciliation of China’s asset prices to their actual value — must come eventually.

And that bell tolls for Washington every bit as loudly as it tolls for Beijing.