Can China avoid a hard landing?

Article Highlights

  • Three reasons why China's economy is in for a hard landing

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  • China's growth remains vulnerable to a global slowdown

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  • The longer #Europe's crisis continues, the greater the risk that collateral damage will spread to #China

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This is part of an ongoing series preparing for the AEI/CNN/Heritage National Security & Foreign Policy GOP presidential debate on November 22.

China is heading for a hard landing in 2012 or 2013 for three reasons: Excess capacity tied to overstimulation of investment in export industries and weak domestic demand growth, a bursting speculative bubble in its real estate sector, and a sharp slowdown in global growth.

After the Lehman crisis, China engineered a massive—14 percent of GDP over two years—stimulus package aimed at boosting investment in export industries. Chinese households haven’t done much to boost demand for higher output because they continue to save a large portion of their incomes to cover health care, retirement, and education costs that are not provided for by the government. Consequently, China has more excess capacity in its export sector today than it had a few years ago.

The easy credit included in China’s stimulus package spilled over into the real estate sector, creating a real estate bubble. Inflation also began to rise, particularly for food and energy. Recently, China’s authorities have tightened credit to slow inflation. This has led to a sharp slowdown and some falling prices in China’s volatile property markets. The combination of excess capacity in its export sector and a bursting property market bubble has made Chinese growth vulnerable to a global slowdown.

The weakness of the U.S. economy in 2011 and, more important, the intensification of the European sovereign debt crisis since summer have sharply increased the risk of a Chinese hard landing. China’s response has been to mitigate its credit tightening policy. Meanwhile, Chinese resistance to further currency appreciation that continues to threaten export growth will grow. That said, the longer Europe’s debt crisis drags on with its depressing effect on growth, the greater the risk that collateral damage will spread to China. If China has been too slow in reversing its credit tightening, the weakness in domestic demand combined with falling demand for Chinese exports could mean that China’s inflation rapidly drops and deflation appears. The antidote—a weaker Chinese currency—could surprise everyone.

John H. Makin is a resident scholar at AEI

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