Thursday, May 26, 2016

China and the L-Shaped Recovery

Let's open this posting with a definition:

An L-shaped recovery involves a sharp decline in key metrics including GDP growth, industrial output and employment followed by a long period of flat or stagnant growth.  

A prime example of an L-shaped recovery can be found in Japan's economy over the past three and a half decades where there was strong economic growth until the late 1980s followed by decades of economic stagnation as shown in this graph:

This long period of low growth is widely known as Japan's lost decade (or decades depending on your point of view).  For those of you that were around during the 1980s, you will recall the Japanese invasion of North America.  During the eighties, particularly the later 1980s, Japanese companies were massive investors in North American businesses, a pattern that dropped sharply in the early 1990s as economic stagnation took hold of Japan.  In fact, after its collapse in 1992, it took until 2013 for Japan's foreign direct investment (FDI) in the United States to regain its position as the largest source of new inflows of foreign direct investment.  For your entertainment, here are a few newspaper articles from the 1980s showing how Japan was taking over America:

Now that we have that background, let's look at a recent interview that was published in China's People's Daily, the state media news publication, with an "authoritative insider" (another word for a Chinese Communist Party high-level insider):

"China's economy will follow an L-shaped path as downward pressures weigh and new growth momentum has yet to pick up, the People's Daily on Monday quoted an "authoritative figure" as saying in an exclusive interview.

The country's economic growth, which slowed to its lowest level after the global financial crisis, will not see a U-shaped or a V-shaped rebound, but follow an L-shaped path going forward, the source said...

The source said China's economic growth has been stable and "within expectations," but warned of emerging problems such as a real estate bubble, industrial overcapacity, rising non-performing loans, local government debt and financial market risks.

High leverage is the "original sin" that leads to risks in the market for foreign exchange, stocks, bonds, real estate and bank credit, the person was cited as saying.

According to the authoritative figure, the country should make deleveraging a priority, and the "fantasy" of stimulating the economy through monetary easing should be dropped. The country needs to be proactive in dealing with rising bad loans, rather than hiding them." (my bold) 

Here is a graph showing China's year-over-year growth in GDP since 2011, keeping in mind that official economic growth data for the nation is often overstated:

While the graph shows a much shorter timeframe than the graph for Japan and its lost decade, it looks like China could be in the early stages of a long period of relatively low growth aka an "L-shaped recovery".

With China being the world's second largest economy and its largest consumer of many of the world's raw and partially finished materials as shown on this graph which shows how China's consumption of metals has outstripped the rest of the world:

...a prolonged L-shaped recovery in China's former economic miracle could prove to be a nightmare scenario for the rest of the already weak global economy.

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