Why China’s Heading for a Hard Landing, Part 5: A. Gary Shilling - Bloomberg

 

The hard landing that I foresee for China will probably prick the global commodity bubble, which is already showing signs of topping out.

Agricultural product prices have jumped, the result of robust demand, bad weather last year in Russia, recent floods in Australia, and dry and hot La Nina conditions in Argentina.

Industrial metals such as copper were on a tear. So were precious metals, such as silver.

But much of the leap in commodity prices was due to investors and other speculators. Exchange-traded funds had already tied up much of the physical supplies of gold and other precious metals. Futures contracts held by speculators were up 12 percent in 2010 through October, with sharp increases in bullish bets on crude oil, copper and silver. Volatility forced futures exchanges to raise margin requirements on a number of commodities.

The confidence that China would continue to buy huge quantities of almost all commodities has been the bedrock belief of speculators. For example, there were rumors that China was again building its emergency petroleum reserve in the first half of this year.

I’ve studied many bubbles over the years, and concentrated on predicting their demises. Commodities show every sign of being in one.

Rare-Earth Exports

China added to the commodity frenzy last year by slashing exports of rare-earth metals used in high-tech batteries, TV sets, mobile phones and defense products. China supplies 95 percent of these elements, and consumes 60 percent, exporting the rest. Its exports of rare earths fell 9 percent in 2010, but still exceeded the government’s quota by a third.

Chinese authorities cut the export quota for the first half of this year by 35 percent from a year earlier. Japanese manufacturers of high-tech gear are seeking alternative supplies. Of course, China maintains that its ongoing trade and political spats with Japan have nothing to do with the tighter quotas. They were necessary, Chinese leaders say, to sustain rare-earth development and deal with environmental damage caused by mining.

Speculators are starting to take stock of the evidence of a hard landing in China, and industrial commodity prices, including copper, are swooning. As in the past, warnings about shortages in key industrial inputs are magically being contradicted as unaccounted-for stockpiles materialize.

Weather-Driven Supply

Agricultural producers are influenced by global demand and by weather-driven supply. I’ll leave it to others to forecast the weather. But note that ideal growing weather often follows the kind of bad weather we’ve seen lately, and bumper crops and surpluses often replace worrying shortages in a crop-year or two.

Furthermore, China imports (and might have stockpiled) soybeans and other agricultural products that would suffer from a slowing economy. Weakness in industrial commodities can easily spread to the agricultural area. Notice the close correlation among all commodity groups in recent years. The huge quantities of hot, highly leveraged money now sloshing around the world tend to end up on the same side of the same trade at the same time.

As speculators suffer setbacks in one area, they quickly bail out of other, fundamentally unrelated areas to preserve their capital.

Commodity Exporters

The bursting of the commodities bubble will be bad news for developing-country producers such as Brazil, which has thus far largely escaped recent global economic and financial woes but is a major exporter of iron ore and other commodities to China. Developed commodity exporters -- Canada, New Zealand and Australia -- as well as their currencies, may also suffer.

I’ve long believed that a hard landing in China would be preceded by a price collapse in copper and other industrial commodities. Copper prices peaked in February, and Barrick Gold Corp. (ABX)’s agreement on April 25 to acquire copper producer Equinox Minerals Ltd. to gain mineral resources outside its area of specialization is a classic sign of a peak.

Another classic sign of a speculative price peak was the sudden appearance of copper inventories where none were thought to exist. As prices start to break, hoarded commodities suddenly become available for sale by highly leveraged owners. Copper in China was so abundant that bonded warehouses were full. In January and February, extra copper was sold abroad as Chinese exports were eight times the year-earlier total.

Falling Copper Prices

London Metal Exchange bonded warehouses saw copper inventories leap 17 percent in the first quarter. Furthermore, to circumvent tight bank lending in China, borrowers are relying more on available letters of credit to finance copper arbitrage trading and otherwise have the use of the borrowed money with copper purchases as their collateral. If copper prices continue to fall, those borrowers will have to sell their copper on the market to prevent further losses, resulting in still-lower prices.

Meanwhile, sugar topped out in February, and cotton in March. I pointed this out in a speech to an investor conference in April, and several people in the audience questioned my facts. I compared those who hadn’t noticed this peak to Wile E. Coyote of the “Road Runner” cartoons, who runs off the cliff and finds himself suspended in air before dropping to the valley floor.

Further confirmation came May 2, when silver prices, which had skyrocketed earlier, started to collapse and virtually all other commodities followed: crude oil, cotton, copper, grains and even gold.

Moving in Lockstep

As I noted earlier, there is so much leverage money floating around the world that regardless of how it’s managed --by fundamental, momentum or technical strategies -- it tends to end up on the same side of the same trades at the same time. So, when one of these positions reverses, the effects spread rapidly as speculators bail out of their positions to reduce risk and preserve their capital. Keep in mind that the prices of the wide variety of commodities continue to move in lockstep.

Many commodity bulls see this trend as a short-lived midcourse price correction and have maintained their long positions in copper, crude oil, corn and even silver. But markets anticipate, and it now appears the declines in commodities are foreshadowing a hard landing in China, with the effects spreading globally.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the last of a five-part series.)

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Why China’s Heading for a Hard Landing, Part 5: A. Gary Shilling - Bloomberg

Shilling: China Heading for a Hard Landing, Pt. 4 - Bloomberg

 

Past performance, in China’s case, may be indicative of future results.

In late 2007, the Chinese government was scrambling to control a capital-spending boom. The central bank was concerned about 11 percent growth in gross domestic product, far above its official target of 8 percent, and about money flooding in from exports and direct foreign investment.

By Nov. 1, the People’s Bank of China had raised its one-year lending rate five times and reserve requirements eight times to soak up excess liquidity.

My firm’s research predicted then that the government would curb capital spending and excess liquidity just as exports weakened. Then, as excess capacity mounted, direct foreign investment would disappear and deflation would reign.

That’s essentially what happened in 2008 and 2009, as the effects of China’s fiscal and monetary restraint coincided with the worldwide economic slump. The growth rate dropped to 6 percent, which in China constituted a major recession.

Don’t be surprised if history repeats itself in the next few years.

This time around, some signs of cooling are already apparent. Besides dampened housing demand, the HSBC Flash China Manufacturing Purchasing Managers Index in June fell to 50.1, its lowest level in 11 months. Passenger-vehicle sales grew 33 percent in 2010, when the government subsidized small-car purchases, but only 3 percent this April over a year earlier.

Money, Banks, Stocks

Growth in the broadest measure of China’s money supply has declined from 30 percent year-over-year in December 2009 to 15 percent year-over-year at the end of May. Bank loans fell 25 percent in May from April. Excavator sales fell 10 percent in May from a year earlier, possibly foreshadowing a construction bust. The 14.3 percent decline in the Shanghai Composite Index last year and the 10 percent drop since mid-April also don’t bode well for growth.

Despite all these negatives, with recent data showing first-quarter GDP expanding by a still-healthy 9.7 percent, and consumer inflation at its highest levels since July 2008, China has continued to tighten its economic policy. The government raised banks’ reserve requirements to 21.5 percent in June, the ninth such increase since November. And it will probably continue to tighten until it sees decisive results -- that is, ahard landing.

What will happen next?

No Floating Yuan

For one thing, even though a hard landing could cause hot money to flee the country and weaken the yuan, China will not float its currency. Many Western governments argue that if China allowed the tightly controlled yuan to float freely, it would rise against the dollar and other major currencies. That, the thinking goes, would discourage exports, encourage imports and quickly eliminate China’s chronic trade surplus.

The Chinese have repeatedly told Western officials that they will not be pushed into floating the yuan. They worry that a jump in the currency’s value would wreak havoc on Chinese exporters and force them to move production to cheaper venues. A stronger yuan would also reduce the value of China’s foreign- currency reserves.

Furthermore, exchange rates have only limited effects on import or export prices and, therefore, imports and exports themselves. The key determinant of a country’s exports is the economic health of its trading partners. If their economies are robust, they buy more of everything, including imports.

The dammed-up zeal to own the Chinese currency would dissipate quickly if all barriers were removed and it became clear that a more expensive yuan was not ending China’s trade surplus. Pressure from foreign governments for a stronger yuan would then evaporate, as would interest in owning more Chinese currency in anticipation of higher values. And the removal of restrictions that prevent Chinese from diversifying their investments abroad might actually depress the yuan by encouraging money to flow out of China.

Holding Treasuries

China also won’t be selling its $1 trillion in reserves ofU.S. Treasuries in great amounts, as some have feared. The Chinese are well aware that doing so would be disastrous for their economy, because the resulting nosedive in Treasury prices and the dollar would decimate the value of China’s remaining holdings of U.S. debt and other assets. A global depression might well ensue, with China and other export-dependent countries as the biggest losers.

Excess Capacity

Instead, China’s most likely reaction -- to focus still more on exports -- will exacerbate its hard landing. Ifconsumer spending doesn’t increase substantially in the next few years, China will have a serious problem using all the industrial capacity it has built, partly to keep people employed. Capacity is mushrooming so rapidly that even in China’s booming economy, most manufacturers are still seeing flat or falling utilization rates.

This unused capacity portends weak profits and trouble for the loans that financed it. My judgment is that it will once again be used for exports aimed at the U.S. and Europe. And once again, this will add to global excess supply and put downward pressure on prices.

Then China, along with other export-dependent emerging economies, will be competing fiercely in a world of slow growth and deflation.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the fourth in a five-part series.)

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Shilling: China Heading for a Hard Landing, Pt. 4 - Bloomberg

Why China’s Heading for a Hard Landing, Part 3: A. Gary Shilling - Bloomberg

 

China is hoping to cool its white-hot economy without precipitating a recession. Doing so will be extremely difficult: Inflation fears are growing, the government’s ability to respond is quite limited, and China’s economic model, which leaves bureaucrats guessing about the market effects of their directives, is ultimately untenable.

Inflation worries start with housing. With Chinese exports curtailed by U.S. consumer retrenchment, capital spendingthreatened by government restraints and excess capacity, and domestic spending less than robust, housing has been China’s big generator of economic growth in recent years. By some estimates, half of Chinese GDP is linked to real-estate activity.

The government is fearful of rising prices, and has moved to prevent speculation. Buyers must now put down 60 percent of the purchase price on second homes, and 30 percent on first homes. The government is pressing banks to contain mortgages, and some have raised interest rates. In January, the mayor ofShanghai announced a new tax on property transactions that may be copied nationwide as other officials attempt to cool prices.

With these restraints in place, and with supply starting to catch up with demand, housing sales have slowed. But this has not fully curtailed China’s real-estate bubble: Housing starts rose about 40 percent last year. Developers are rushing to build while they try to support faltering prices by delaying completions and creating artificial shortages. Of course, these efforts are difficult to maintain because they tie up capital in uncompleted houses. Houses are now being built at about twice the rate they’re being sold, well above earlier norms.

Huge Loans

A report this week by China’s National Audit Office found that a significant chunk of bank loans made to provincial-government financing vehicles were improperly funneled into property investments, contributing to a debt load equal to some 27 percent of GDP. Other huge loans to state-owned enterprises, intended to finance infrastructure, also reportedly went into real estate and may be at risk.

With inventories soaring while demand softens, and the government clamping down on speculation, a collapse of the housing bubble seems increasingly likely.

Prices Rising

Housing isn’t the only area where signs of inflation are popping up. In May, consumer prices increased 5.5 percent versus a year earlier. In December, Chinese leaders agreed to “put stabilizing the overall price level in a more prominent position” in their ranking of economic priorities. In a country where many live at or below the poverty level, food costs are obviously a major concern, and they jumped 11.7 percent in May from a year earlier.

The government appears increasingly worried about social unrest. In November, it said it was ready to impose price controls to reduce inflation, especially on food and energy, and said it would help the poor with higher welfare payments. The unrest continues and, significantly, has moved from rural areas to the cities.

Income inequality also remains a problem. The flow of Chinese to more prosperous urban areas has increased averageliving standards, but the difference between the rich and the rest continues to widen. In 2010, annual per-capita income was about $2,900 in cities and about $900 in rural areas. (Adjusting for lower costs in rural areas reduces this gap.)

Limited Response

China’s ability to respond to these worries is extremely limited. The central bank relies on adjusting reserve requirements and limits on bank lending to implement monetary policy. Since January 2010, it has raised reserve requirements 12 times (to 21.5 percent), while only increasing the one-year lending rate four times (to 6.31 percent), to accommodate inefficient state-enterprise borrowers, which provide a lot of jobs.

Finally, implementing any policy in an economy that is partly government-controlled, partly market-driven is very difficult. In a completely controlled economy, as China’s used to be, government leaders might have made economically inefficient decisions, but their authority wasn’t disputed. In an open economy, as in Singapore, the markets make the decisions, and politicians have little involvement.

But under China’s current arrangement, officials making major decisions have to guess what market reactions will result, then try to mitigate the unintended consequences of their actions.

Unintended Consequences

With a managed floating exchange rate, for example, officials have to estimate how much hot money will enter China in anticipation of a stronger currency, and then determine how to neutralize the undesired effects of this flow. Government policies that encourage exports and trade surpluses have pushed China’s foreign-currency reserves to more than $3 trillion. Until recently, all the foreign-currency earnings of Chinese exporters had to be traded in for yuan, but then the central bank was forced to issue securities to sop up that money to avoid depreciation.

Similarly, the Chinese government sets yearly limits on bank loans in advance, but leaves it up to the banks and demand to determine the monthly lending pattern. So the banks rush to make loans early in the year for fear that the government will reduce the limit in a midcourse correction.

I suspect that such a hybrid market system is too unwieldy to allow the Chinese government to manage a soft landing for its economy. By my reckoning, the Federal Reserve has tried 12 times in the post-World War II era to cool an overheating economy without precipitating a recession. It succeeded only once. Can the politically controlled Chinese central bank, and the government leaders who really call the shots, be more successful than the independent Fed?

That seems unlikely. And the consequences, for China and the world economy, could be unfortunate.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the third in a five-part series.)

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Why China’s Heading for a Hard Landing, Part 3: A. Gary Shilling - Bloomberg

Why China’s Heading for a Hard Landing, Part 2: A. Gary Shilling - Bloomberg

 

China has become an economic giant because it has so many people who are producing moderate amounts. In most ways, however, China remains an underdeveloped country with political and economic policy tools that are crude by Western standards. Those tools can spur impressive growth --but they also mask some deep structural weaknesses in China’s economy.

It’s relatively easy for developing countries to grow by emulating the technology of advanced nations or, in China’s case, by forcing them to share it as the price of doing business or by simply stealing it.

And a tightly controlled economy can get results quickly. That’s what happened with China’s $586 billion stimulus program introduced in 2009. Growth in gross domestic product leaped from a 6 percent rate in early 2009 back to double digits. Most of the money was channeled through government-controlled banks, whose lending increased by $1.4 trillion, or 32 percent, over the course of 2009 after being flat since early 2006. The money supply increased by 29 percent.

Those loans financed public and industrial infrastructure and real estate. Property prices in January 2010 were up 9.5 percent from a year earlier, according to government numbers, and much more by private realistic estimates. Employment gained along with economic activity, and in the third quarter of 2009, there were 94 job openings for every 100 applicants, up from 85 in depressed 2008, and close to the pre-crisis average of 97.

Unsustainable Growth

Here’s what we should remember: This kind of growth is unsustainable, and it won’t be able to cover up China’s underlying vulnerabilities forever.

China’s reliance on exports and a controlled currency for growth, for instance, will no longer work if U.S. consumers are engaged in a chronic saving spree, as I believe they will be. Chinese export growth, which averaged 21 percent per year in the last decade, is bound to suffer.

The country’s seemingly inexhaustible pool of cheap labor is expected to peak in 2014, in part due to its rigid one-child policy. By some estimates, ample labor has boosted GDP growth by 1.8 percentage points annually since the late 1970s, but the contraction of the working-age population will reduce growth by 0.7 percentage points by 2030.

Wages and Ages

Wages are already rising, and even Chinese manufacturers are moving production to Vietnam and Pakistan, where pay levels are a third of China’s. Some factory workers have seen wage increases of 20 percent to 30 percent in the last year or so, with those producing goods for foreign companies seeing especially large boosts. At the same time, better conditions in rural areas have reduced the flow of cheap labor into coastal cities.

As the Chinese population ages, the ratio of retirees to working-age people is forecast to rise from 39 percent last year to 46 percent in 2025.

This does not bode well for China’s future growth. When Communist Party leaders transitioned China’s economy from a cradle-to-grave nanny state to a progressively free-market one starting in 1978, no meaningful unemployment, retirement or state health systems were instituted. (Although President Hu Jintao said in October that China will “institute a social safety net that covers all,” and the government has set a goal of providing basic medical care for all Chinese by 2020.)

Prodigious Saving

So the Chinese must save prodigiously to provide for their welfare and retirement. This has contributed mightily to China’s high rate of saving and low rate of spending, and its consequent reliance on exports. Chinese households save close to 30 percent of income on average, in large part to cover old age and medical costs.

Yes, the Chinese saving rate will be pushed down in time by aging Chinese who still consume but no longer work, much as it has in Japan. Nevertheless, less saving and more Chinese consumption won’t substitute for weakening exports any time soon. Chinese consumers buy only about one-tenth of those in Europeand the U.S. combined. As the euro zone remains troubled, and the U.K. slashes government stimulus and U.S. consumers continue to retrench, it’s unlikely that a drop in Chinese saving could offset the negative effects of reduced exports.

Inflation Looming

Finally, China’s state-controlled economic boom may soon lead to crippling inflation. In February 2010, the director of the National Bureau of Statistics said that “asset-price increases pose a challenge for macroeconomic policy.”

The housing boom has pushed up prices to the point that apartments in Beijing are affordable to only the top 20 percent of earners -- they’re selling at about 22 times average income (average U.S. house prices peaked at six times average income). A square meter of property in China costs an estimated 164 times per-capita income, compared with 33 times in high-priced Japan.

The 2009 stimulus package also spurred consumer price inflation to a year-over-year acceleration of 5.5 percent in May. Food prices are very sensitive politically because so many Chinese are at subsistence incomes, and they rose 11.7 percent in May from a year earlier.

Chinese leaders are not amused, and are taking stringent restraining actions. But with only blunt-force economic tools available, it’s not clear that they’ll be capable of managing a controlled slowdown without significant pain.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the second in a five-part series.)

Read Part 1. Read more Bloomberg View op-eds.

To contact the author of this column: A. Gary Shilling at insight@agaryshilling.com.

To contact the editor responsible for this column: Timothy Lavin at tlavin1@bloomberg.net.

Why China’s Heading for a Hard Landing, Part 2: A. Gary Shilling - Bloomberg

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling - Bloomberg

 

Jesse McKay 3 days ago 6 comments collapsed CollapseExpand

I tend to agree with the author on China's future from an economic standpoint.
China presents today as a primarily agrarian country of 1300 million people.  Claims that it manufactures most of America's goods, or is the principal manufacturing country of the world, are false: that title rests with the United States and her heavily mechanized factories.
Fearmongers in the USA point to China and in shrill tones proclaim she is sweatshopping us to death; but, in reality, this is nonsense.  Such a plot needs two acts -- in Act I, the country sells so many goods so cheaply as to wreck the production and capacity of its buyers (check the books: this is not happening.  The USA produces more goods today than it did in the heyday of 1970 but with far fewer workers).  In Act II, the country breaks off exports and turns against its former customer.
My friends, there is no such Act II on the horizon.  China's industrial rise of the past 40 years has lifted it from Afghanistan-poverty into Mexico-poverty, and there it shall stay.  Assembly workers building plastic toys or steel tools do not generate USA-style wealth and they never will. 
Americans make toys, but they are more than manufacturers.  Americans are designers.  In this category, China lags far, far behind and their pitiful gains are not enough.  "Hello Kitty" is not going to eclipse Disney or even Ronald McDonald.
Ladies and gentlemen, China saw a world where she was too big to fail and has simply become too big to succeed.
China's military buildup is cause for concern, yes, but they are pushing a bamboo ceiling they won't be able to crack.  Could China invade its neighbors -- India, Russia, Japan, steal their wealth, and become the new superpower?  No.  Any such plan is foolish, self-defeating, and insufficient.  China can field millions of soldiers but it cannot feed them.  To war with her customers is to lose them, and she certainly cannot afford to do that.  America doesn't relish a war with China but it will not shrink from one and it is prepared for one.
We should worry about China joining with Muslim terror groups.  We should worry about China trading nuclear technology with less visible actors who believe in national suicide (China doesn't).  We should worry about Chinese spies.
We shouldn't worry about 21st century capitalism breaking down before 19th century communism, because that is not going to happen.  Everything they steal, we'll make 10 times better in the next generation.
To sum-up, China makes 10 percent of our stuff.  We buy it because it's cheap.  That, my friends, is an arrangement made in hell.  They'll never get rich from it, and their power over us is centered on the idea that Americans need more and more cheap stuff... but the dynamic is, people who have cheap stuff want good stuff, and those goods are not Chinese.  So.. bamboo ceiling.

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling - Bloomberg

Plaza Accord and Japan’s “lost decade”

 

jamesin reply to Teik Min Lim 2 days ago 1 comment collapsed CollapseExpand

The Plaza accord was signed in 1985 and was a multilateral agreement between France, German, Japan, the US, and the UK.
Japan didn't ruin their economy by allowing currency appreciation. It had a minimal (almost no) effect on the Japanese trade surplus. The "lost decade" was the result of rapidly aging demographics and relying too heavily on fixed asset investment for growth. Japan is a trade surplus country and has been for a long time but they now have, by far, the largest proportion of debt in the world and weaker purchasing power than their nominal GDP would otherwise indicate. Currency manipulation bring short-mid term benefits while fueling unsustainable debt in other parts of the world; however it will catch up with the currency manipulator later on big time via big hits to ROI and lagging "real" competitiveness. Foreign currency reserves parked in treasuries making less in interest than the rate of inflation are a very poor investment policy.
Japan was hit with heavy social security costs that were captured by the government. China with its weaker social security net will put more burden on working class children to support the elderly subtracting from productivity. So it's not like the costs can be avoided by simply ignoring the problem.
The myth that avoiding calls for ending currency manipulation and keeping trade protectionism in place will ensure China avoids a Japan-like crisis seems to be alive and well. Unfortunately it's dead wrong, China is facing Japan's greatest problem (a rapidly aging population) and making the same big mistakes (amassing unsustainably large poorly invested foreign currency reserves while relying too heavily on fixed asset investment to drive growth). What China doesn't have that Japan had are friendly growing markets in the US and EU; both regions will see weak growth and are likely to become more protectionist when fiscal stimulus proves ineffective. The "Asian export model" will almost certainly fall apart this decade.

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling - Bloomberg

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling - Bloomberg

 

Few countries are more important to the global economy than China. But its reputation as an unstoppable giant -- as a country with an unending supply of cheap labor and limitless capacity for growth -- masks some serious and worsening economic problems.

China’s labor force is aging. Its consumers save too much and spend too little. Its political and economic policy tools remain crude. Its state bureaucracy seems likely to curb spending just as exports weaken, and thus risks deflation. As U.S. consumers retrench, and as the global commodity bubble begins to dissipate, these fundamental weaknesses will combine in a way that’s unlikely to end well for China -- or for the rest of the world.

To start, China is much more vulnerable to an international slowdown than is generally understood. In late 2007, my firm’s research found that too few people in China had the discretionary spending capability to support its economy domestically. Our analysis showed that it took a per-capita gross domestic product of about $5,000 to have meaningful discretionary spending power in China.

About 110 million Chinese had that much or more, but they constituted only 8 percent of the population and accounted for just 35 percent of GDP in 2009, while exports accounted for 27 percent. Even China’s middle and upper classes had only 6 percent of Americans’ purchasing power.

Why Overconfidence Abounds

With such limited domestic spending, why do so many analysts predict that China can continue its robust growth?

In part because they believe in the misguided concept of global decoupling -- the idea that even if the U.S. economy suffers a setback, the rest of the world, especially developing countries such as China and India, will continue to flourish. Recently -- after China’s huge $586 billion stimulus program in 2009; massive imports of industrial materials such as iron oreand copper; booms in construction of cement, steel and power plants, and other industrial capacity; and a pickup in economic growth -- the decoupling argument has been back in vogue.

This concept is flawed for a simple reason: Almost all developing countries depend on exports for growth, a point underscored by their persistent trade surpluses and the huge size of Asian exports relative to GDP. Further, the majority of exports by Asian countries go directly or indirectly to the U.S. We saw the effects of this starting in 2008: As U.S. consumers retrenched and global recession reigned, China and most other developing Asian countries suffered keenly.

Overconfidence in China’s ability to keep its economy booming is also partly psychological. It reminds me of the admiration and envy (even fear) that many felt toward Japanduring its bubble days in the 1980s. As Japanese companies bought California’s Pebble Beach, Iowa farmland and Rockefeller Center in New York, what was safe from their zillions? Then the Japanese stock and real-estate bubbles collapsed, and Japan entered the deflationary depression in which it’s still mired.

Success and Complacency

What’s more, China’s recent successes have been so pronounced that they’ve led many to conclude that its economy is a juggernaut. And, indeed, the Chinese have much to be proud of: Last year, China passed Japan to become the world’s second largest economy, a huge achievement considering China started in the late 1970s with a tiny pre-industrialized economy.

But this success may have led to complacency. I suspect that the 2007-2009 global recession, and the dramatic transformation by U.S. consumers from gay-abandon borrowers-and-spenders to Scrooge-like savers, caught Chinese leaders flat-footed. They probably planned to encourage consumer spending and domestic-led growth, but later -- much later.

Growth Machine

They were enjoying a well-oiled growth machine. Growing exports, especially to American consumers, stimulated thecapital spending needed to produce yet more exports and jobs for the millions of Chinese streaming from farms to cities. Wages remained low, due to ample labor supplies, and held down consumer spending. So did the high Chinese consumer saving rate. Because Chinese could not invest offshore, much of that saving went into state banks at low interest rates. The money was then lent to the many inefficient government-owned enterprises at subsidized rates.

In a country where stability is almost worshipped, why would any leader want to disrupt such a smoothly running economy?

But before you worry about China’s becoming No. 1 any time soon, consider the remaining gap between its economy and theU.S. economy. In 2009, China’s GDP was $4.9 trillion, only 34 percent of the U.S.’s $14.3 trillion. Because China has 1.32 billion people, or 4.3 times as many as the U.S. has, the gap in per-capita GDP was even bigger: China’s $3,709 was only 8 percent of the U.S.’s $46,405.

A Wide Gap

Just to maintain this gap at current levels, Chinese GDP will need to grow at double-digit rates for four years before tapering off, or rise sixfold in three decades (assuming that U.S. real GDP increases 2 percent per year on average for the next 30 years, and using government population projections). To close the per-capita GDP gap in 30 years, Chinese GDP would need to grow about 10 percent per year for three decades, or expand to 17.8 times its current size in that period.

Such rates of growth seem close to impossible if the global economy slows.

As the announcer for the Cleveland Indians used to say when the Tribe was hopelessly behind, “They have their work cut out for them!”

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the first in a five-part series.)

Read more Bloomberg View op-eds.

To contact the author of this column: A. Gary Shilling at insight@agaryshilling.com.

To contact the editor responsible for this column: Timothy Lavin at tlavin1@bloomberg.net.

Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling - Bloomberg