Since the beginning of the Industrial Revolution, every economic boom has been followed by an economic bust. The bigger the boom, the bigger the bust. Over the past 20 years, China has experienced the greatest economic boom in history. It is only a matter of time before the great Chinese bubble pops.
China’s economic model is based on export-led growth. That model is now even more bankrupt than the American model of debt-fuelled consumption, since Chinese exports are dependent on US consumption. In 1990, China’s economy was only twice the size of Belgium’s. It is now the second largest economy in the world. That economic transformation was due entirely to China’s trade surplus with the US, which soared from $10 billion in 1990 to $268 billion, or the equivalent of 6% of China’s GDP, in 2008, the year the global economic crisis began.
One way of gauging the importance of that trade surplus with the US is simply to subtract it from China’s GDP. Doing so shows that without that surplus, China’s economic output would have been 6% lower than it actually was in 2008. That approach would radically understate the importance of that surplus to China, however. In reality, a large multiplier should be applied to that figure, since there are three other less direct ways in which the trade surplus with the US drives Chinese growth. First, tens of millions of Chinese workers are employed in factories producing goods for sale to the United States. The wages they earn and spend boost consumption in China, and therefore appear in China’s GDP accounts under the heading of personal consumption expenditure rather than exports. Moreover, there is a multiplier on this consumption figure as well. When those workers buy from merchants, that boosts the merchants’ purchasing power, too. Therefore, the wages earned by Chinese factory workers making products for the US market make a significant contribution to personal consumption throughout the Chinese economy.
Second, much of the gross fixed capital formation (i.e. investment) in China has gone into the construction of factories that make goods for export to the US. This includes investment not only from domestic Chinese investors but also from abroad (i.e. direct foreign investment). During 2008, $148 billion of direct foreign investment entered China. A significant amount of that would have been directly or indirectly related to investments aimed at producing goods to sell to the United States. Therefore, much of the gross fixed capital formation in China’s GDP accounts is tied to US demand for Chinese exports.
A further route by which China’s trade surplus with the US drives China’s economy is the banking system. When Chinese exporters bring back their earnings from selling goods in the United States, that money goes into the Chinese banking system and leads to rapid growth in deposits. This in turn leads to rapid growth of loans, since to pay interest on those deposits, Chinese banks need to earn interest on loans. Chinese bank loans have expanded at an extraordinary pace for 20 years, and rapid loan growth has been a major driver of the country’s economic growth. Such rapid loan growth would not have been possible without China’s large trade surplus with the US.
So even though China’s $268 billion trade surplus with the US directly accounted for an already astounding 6% of China’s GDP in 2008, it had an even larger impact through its indirect effects on personal consumption expenditure, gross fixed capital formation and credit expansion. It would not be unreasonable to estimate that as much as 40% of China’s economy must be attributed to its dependence on exporting to the United States.
Seen in this light, it should be clear why the breakdown of the American economic model of debt-fuelled consumption has thrown China into a terrible crisis of its own. Whereas the United States’ problem is that it cannot make as much as it consumes, China’s problem is even worse. China can’t consume as much as it makes. Chinese factory workers do not earn enough to buy the products they make. If China can’t export those products, there is no domestic market for them. Then production must stop, and the workers lose their jobs.
Since the economic crisis in the United States began, China has averted disaster through an explosion of domestic credit creation. Over the last 24 months alone, China’s state-owned banks have expanded outstanding loans by 60%. There could be no more certain way to destroy a banking system that to permit 60% loan growth over a two-year period.
The rise of China’s economy over the past 20 years has changed the world. It is generally believed that China will continue to grow rapidly for decades to come. It won’t. Every boom busts. China’s boom will be no exception.
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