Opinion | Chinas wobbly economic recovery unlikely to become full-blown Japanification

02:07 Japans small-sized firms struggle to offer higher pay to keep up with inflation Japans small-sized firms struggle to offer higher pay to keep up with inflation Koo revived these fears last month when he warned that China was likely to enter a balance sheet recession and needed to take urgent action to head off

For an indication of how quickly investor sentiment can deteriorate, look no further than China. The MSCI China index, which tracks Chinese stocks listed at home and abroad, was in the midst of a blistering rally at the start of the year, triggered by the unexpectedly rapid reopening of the country’s economy following three years of self-imposed isolation.By early June, however, shorting Chinese equities was the second-most popular trade in markets, according to the results of Bank of America’s latest global fund manager survey published on June 13. Since peaking in late January, the MSCI China index has plunged more than 18 per cent, compared with a 4 per cent rise in the FTSE All-World Index, a gauge of global shares.Concerns about the unevenness of China’s recovery have turned into deep misgivings about the underpinnings of growth and the timeliness and effectiveness of stronger monetary and fiscal stimulus. Morgan Stanley, one of a dwindling number of China bulls, said in a report published on June 20 that “we think it is fair to say without exaggeration that in our years of tracking China, investor sentiment has never been as bearish as it is now.”This is partly because of mounting fears that China’s economy is suffering from the same malaise that plagued Japan following the bursting of its epic asset bubble in the early 1990s. To this day, that financial shock prevents the world’s third-largest economy from experiencing strong and sustained growth.One of the most compelling analyses of what happened to Japan is the “balance sheet recession” concept pioneered by Richard Koo, chief economist at the Nomura Research Institute. This is when monetary policy becomes ineffective because highly indebted households and companies are focused on paying down debt and are reluctant to consume and invest, even when interest rates fall sharply.Not only is there strong evidence that this phenomenon was responsible for Japan’s post-bubble stagnation and deflation, signs of such a slump were also apparent in the euro zone and the United States following the 2008 financial crash.

02:07

Japan’s small-sized firms struggle to offer higher pay to keep up with inflation

Japan’s small-sized firms struggle to offer higher pay to keep up with inflation

In the past decade, there were suggestions that China – whose non-financial corporate debt has surged since the 2008 crisis, whose economic model is characterised by overinvestment, a high savings rate and suppressed consumption and whose property bubble has begun to deflate – could be turning Japanese.

Koo revived these fears last month when he warned that China was likely to enter a balance sheet recession and needed to take urgent action to head off a protracted, Japanese-style downturn.

He is not the only economist sounding the alarm over “Japanification”. Citigroup, which warned earlier this year that today’s China looks “strikingly similar” to post-bubble Japan, said last week that China was on the brink of a “confidence trap as the reopening impulse starts to fade”.What is particularly worrying is that China appears to be stuck in a liquidity trap, whereby a dearth of willing and solvent borrowers renders cuts in interest rates ineffective. Only more forceful fiscal stimulus – mainly to boost consumption by restoring confidence in a property market where developers have yet to complete unfinished projects – can avert a downward spiral.

Given how bleak sentiment towards China is right now, these fears risk becoming self-fulfilling. Yet, the differences between China and Japan are far more consequential than the similarities.

First, because Chinese policymakers are sensitive to the mistakes made by Japan, it is unlikely they would allow a full-blown balance sheet recession to take hold. Beijing has had plenty of time to learn from Tokyo’s costly policy blunders.

China can’t afford to wait and see about economic stimulus

Second, comparisons between China and Japan are inapt in several crucial areas. Not only did Japan allow the yen to strengthen sharply in the years preceding and following the bursting of its bubble, it kept real interest rates above the rate of economic growth and maintained an overly restrictive fiscal stance in the 1990s.

By contrast, China carefully manages its currency, ensuring the yuan trades in a tight range versus other major currencies. More importantly, China benefits from its state-owned financial system that makes a systemic crisis in the banking sector highly unlikely. Furthermore, strict controls on the country’s capital account significantly reduce the risk of major capital flight.Third, the declines in asset prices in China, particularly in the property market, have been nowhere near as catastrophic as the falls in Japan in 1990 and the US in 2008. Beijing’s penchant for control – as opposed to Japan’s more market-driven system – not only provides a financial backstop, it helps buy China time to shift to a consumption-driven growth model, a conceivable prospect given that it still has plenty of economic catching-up to do.To be sure, worrying demographic trends, acute geopolitical tensions and much deeper global economic integration than in the 1990s make China more vulnerable in some respects.

Yet, the bigger the vulnerabilities, the stronger the likelihood that Beijing will deliver the necessary fiscal stimulus to kick-start growth. Renewed fears of a balance sheet recession in China could be the necessary catalyst to force Beijing’s hand.

Nicholas Spiro is a partner at Lauressa Advisory

ncG1vNJzZmivp6x7tK%2FMqWWcp51ksLC5zJ6lrWefpbavtc6nZpqqpJ6wrbGObGlrbmdrgHCvx6KlmqtdrLyjrsuyZJ6bn6O8rrXCZqmem5%2BrsrPFjK6lpaGbmrm6ecGemqillWKztrjLZpmlp6ejequtz5qlop6ZmK61tc6n

 Share!