Chinese threats of failure… and success

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Угрозы китайских неудач… и успехов

World financial leaders gather in Washington for the annual spring meeting of the International monetary Fund. Their hopes — and fears — associated with China. China is the country that was able to push forward exhale the recovery of the world economy. However, its own economic growth rests on the Foundation, in which there are increasing signs of overload. The dilemma is that not only failures but also the successes of China pose risks to the global economy.

The negative scenario might be unique in the entire post-war history. China’s economy is so large that the consequences of this scenario will feel in the world. But unlike the situation in 2008, when the US dollar strengthened, contributing to the rapid recovery of emerging economies, the yuan, is likely to start losing its value in the event of a serious downturn of the Chinese economy, causing widespread and deep deflation.

Other currencies can also begin to devalue, some deliberately. Thus, Chinese negative scenario may be similar to the events of the 1930s, with competitive devaluations and rapidly falling real economic activity.

But what if China will succeed in begun the transition to an economic model based on consumption? When in 2007 the surplus on the current account of China has reached 10% of GDP, the savings rate in the country exceeded 50% of GDP, and investment volumes were more than 40% of GDP. These figures seemed too high from the point of view of dynamic efficiency and growth of wealth. As a result, quickly emerged a consensus: the level of savings and investment should be reduced so that they become more balanced. Investments expected to curb the introduction of more stringent financial discipline for state-owned enterprises too independent. At the same time it was supposed to strengthen the system of social support that households should not have to save so much funds to meet the expenses on children and old age.

Ten years have passed and what do we see? The government has established a system of social protection, and the surplus on the current account declined, as expected. Last year the surplus has not reached 3% of GDP, far below the level of 2007.

However, these results do not confirm the correctness of the used economic theory. About half of the reduction in the surplus of the current account is explained by the fact that investments actually rose relative to GDP. However, there has been some reduction in the level of national savings, perhaps by 3.5 percentage points of GDP compared with 2007 (according to IMF estimates, as official statistics at end 2013). However, this decline looks modest compared with an increase of 15 percentage points in the period 2000-2007.

More importantly, this moderate decline in saving rates occurred, apparently, at the expense of the corporate sector. Household savings remained roughly at the same level relative to GDP as in 2007. In other words, something that grew during the economic boom, has not yet declined back again. It’s a real puzzle, and its solution is important not only for the future of China but also the world’s future.

In General, there are two options. It is possible that the theory is correct in principle, but need more time to see the results. In this case (and if the Chinese authorities will continue to strengthen the social security system) reducing the level of savings compensates for the expected reduction in the level of investment that will allow you to keep the surplus of the current account at a low level.

But what happens if this theory is incorrect (or imperfect)? For example, the impact of the social protection system on savings, perhaps, overrated. Or this effect will be offset by the negative impact of population ageing. In the next 15 years the number of Chinese over 60 will increase by two-thirds. These aging workers may now save all that we can to create a financial cushion before approaching retirement.

If some version of this scenario will be realized, the household saving rate may continue to decline, but only gradually. Meanwhile, the government will be to close unprofitable plants, which can lead to an increase in corporate savings. As a result, aggregate saving rates will remain high, while investment will drop sharply, which again will increase the surplus of the current account.

It is not the most pleasant prospect for the world economy. As the slowing growth of China’s economy, the same thing will happen with global economic growth, but the remaining demand will be redistributed in favor of China, exacerbating already serious deficit in other countries. This will be a story quite different from previous episodes of global imbalances, when a large surplus of current account of China, at least in some degree compensated by the rapid growth of the Chinese economy.

In other words, if a hard landing of China’s economy is able to trigger global deflation, the prevention means a return to global imbalances. This is a very troubling options, on which to reflect world leaders when in gloomy mood, they will begin to gather at the headquarters of the IMF in Washington.

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