China: Still A Phantom Expansion?

China’s manufacturing sector expanded again in July, according to the central government. The official Purchasing Managers’ Index rose to a seasonally adjusted 53.3 in July from 53.2 in June, the Federation of Logistics and Purchasing said, according to Bloomberg. Exports moved up by a small fraction.

The question that almost every analyst engaged in watching the Chinese economy asks is whether the expansion can be sustained once the nation’s $585 billion stimulus package is exhausted. The answer is almost certainly that it can be because the Chinese have the ability to put a second package in place without the funding problems that a similar move would create in the US. The Chinese have sufficient reserves to keep their economy “self funding” for another year or more, if the “self” is the Chinese central government.

The Chinese know what everyone else knows but perhaps know it more intimately. China’s GDP will not have rapid unassisted GDP growth while the West suffers through a recession and high levels of unemployment. China has little control over that, but it can do a great deal to supply its own consumers and businesses with capital. This may cause inflation, but the underlying Chinese economy is weak enough due to low export rates that inflation is not the government’s major enemy. China experts are concerned that liquidity provided by the current stimulus package is causing bubbles in real estate and the stock market.  The Shanghai Composite stock index is up more than 70% in 2009. Chinese banks may try to prevent those bubbles by keeping credit out of the hands of real estate speculators. That restriction may not be adequate to prevent problems, but a bubble situation in one sector of the economy is not enough to keep the government from going full throttle with its stimulus programs.

The Chinese central bank is faced with the same dual problems which are part of any economy in the midst of being artificially shocked. But, the government in this case has only one option. A withdrawal of stimulus funds and a restriction on liquidity, if extreme, will slow the economy to a crawl, and put a brake on GDP from which it might take years to recover. That could cripple the momentum of the Chinese economy; the momentum that the government believes will make it the premier economy in the world.

China’s political system is frail enough and the country is large enough geographically and diverse enough ethnically that shortages of jobs or food and other essentials could still cause a level of unrest that could also cause the economy to become unhinged. The population of China is pacified to a very great extent by fairly broad prosperity particularly in the large population centers. The current stimulus package and any new one that might follow could have the effect of keeping employment among the burgeoning middle class fairly high and their access to credit easy. China can handle political disruption in remote regions, which it gets from time to time, but broad unrest in the large cities built up in the nation’s interior to house massive factory complexes could shake Beijing to its foundations.

China will have a new stimulus package, perhaps this year. It could be another $500 billion, which would mean that the entire investment in keeping the economy going forward would be 25% of GDP. That is a stimulus program that no other nation, large or small, can match. It gives China an advantage over any other country in the world that needs help with GDP improvement. While the current program could cause inflation if it is expanded, the risk is almost certainly worth taking. The reward from these investments by the government is too large for them to resist.

Douglas A. McIntyre