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What would happen if China had an economic crisis, like the one in Argentina?

Thank you for A2A.

What would happen if China had an economic crisis, just like Argentina?

The simple answer to a question like that is that there will be massive repercussions worldwide if China or America has an economic crisis. Just look at the Great financial Crisis of 2008. This is because their economies are so large that invariably almost every country will be affected because global demand will be much lower and recession will be the order of the day. However, since you mentioned Argentina, I have added a short synopsis of the Argentina story and then compare it with the present Chinese economic story. The main problem is obviously a story of politics and poor management.

Argentina.

In the early 20th century, the South American country was one of the world’s richest, thanks to its production of beef, wheat and other farm goods, plus an educated workforce made up mostly of European immigrants and their descendants. But the constant crises, often attributable to government mismanagement and fluctuating commodities prices, have plunged millions into poverty and put the country off-limits to all but the most daring investors today.

Here are some of Argentina’s crises through history:

1930 —The Great Depression hit Argentina especially hard, as demand in Europe and United States for its farm exports suddenly dried up. As customs revenues plunged, the government had trouble paying public workers, causing unrest to grow. Fed up with the crisis, the military staged a coup in 1930 against democratically elected President Hipolito Yrigoyen, setting a precedent for throwing out governments in times of economic trouble. For the remainder of the 20th century, more generals (14) than civilians (11) would run the country.

1955— President Juan Peron, a populist who drew his support from Argentina’s poor and working class, oversaw a period of relative prosperity following World War Two. Factory workers received paid vacations and unions gained unprecedented power as the economy grew at an annual pace of nearly 6 percent. However, by the early 1950s, the good times came to an end as commodity prices fell once again. Peron’s nationalizations of British-owned railroads and other property antagonized business leaders and caused investment to dry up. Inflation soared to 40 percent, and real wages plunged. The death in 1952 of Peron’s wildly popular first lady, Eva, known as “Evita,” weakened him further. Three years later, as labor strikes paralyzed the country, Argentina’s military intervened again and sent Peron into exile.

1976 — Argentina’s economy failed to stabilize under a succession of military and democratic governments that implemented wildly different policies. Between 1930 and 1983, presidents averaged only two years in office, while the lead minister for economic affairs was replaced at a pace of once a year. By the 1970s, many Argentines with warm memories of postwar prosperity were clamoring for the military to allow Peron to return home. The generals relented, and Peron assumed the presidency once again. But he was unable to heal either the economy or the increasingly violent fissures in Argentine society, and Peron died of heart failure just a year later.

Various armed factions struggled for control under Peron’s successor: his third wife, a former nightclub dancer he had met in Panama. In early 1976, as annual inflation surpassed 600 percent, the generals staged yet another coup. Ensuing years would see rising inequality and an explosion in Argentina’s foreign debt, as well as the deaths of up to 30,000 suspected leftists as the military tried to snuff out dissent in the so-called “Dirty War.” In 1982, the military launched an invasion of the Falkland Islands, a British colony claimed by Argentina and called the Malvinas by the South American country. Britain retaliated, and Argentina lost the ensuing brief, but bitter war. Many believed the military was using the conflict to distract from economic woes fueling political discontent.

1989 — Democracy returned to Argentina in 1983 – this time to stay. With the armed forces disgraced by widespread human rights abuses, the loss of the Falklands War and poor economic management, a vast majority of Argentines deemed the armed forces unfit for power, an opinion that still prevails today. However, that did not mean stability. Under President Raul Alfonsin, public payrolls swelled while government revenues remained stagnant. In 1989, only 30,000 out of 30 million Argentines paid any income taxes. That year, inflation reached an unprecedented 5,000 percent, rising so fast that some supermarkets read prices out over intercoms rather than bothering to update price tags. As strikes swept the country and rioters looted supermarkets for food, Alfonsin decided to hand over power five months early to his elected successor, Carlos Menem.

2001 — Menem spent the 1990s cultivating foreign investment, slashing import tariffs, and privatizing money-losing state enterprises. Inflation fell to single digits, and Argentina was for a time hailed as a poster child for free-market reforms by the International Monetary Fund and others. By the time Menem left office in 1999, however, rampant corruption was scaring off many investors. Contagion from financial crises in East Asia and Russia caused capital to rush out of Argentina almost as quickly as it had come in. The currency peg that Menem used to tame inflation became untenable as the government, unable to print money, borrowed it instead. Unemployment soared beyond 20 percent, and reports surfaced of widespread hunger and malnutrition in a country that had long prided itself as being one of the world’s breadbaskets. When another wave of riots and looting reached the capital, Menem’s successor, Fernando de la Rua, resigned. It was a period that would see five presidents in just two weeks. Before the crisis ended, the economy had shrunk by a fifth and thousands of young, educated Argentines had emigrated to their grandparents’ ancestral homes in Europe. The government also stopped payment on more than $100 billion in debt, the world’s biggest-ever sovereign default.

2014 —Since the default, Argentina has remained cut off from foreign capital markets and is considered a pariah by most investors. But the economy has also defied doomsday predictions by Wall Street analysts and others, and has by some measures experienced its best run of growth since the 1940s. Most economists credit high prices for Argentina’s soy and other commodities, due largely to demand from China. However, the economy is now paying the price for President Cristina Fernandez’s populist and interventionist policies, economists say, and is set to contract for the first time on an annual basis since 2002. High government spending on social welfare programs, printing of new money and an ailing currency have fueled one of the world’s highest inflation rates. In January, the government was forced to devalue the peso. If Argentina defaults once again, economists forecast an outflow of dollars that will pile more pressure on dwindling central bank reserves if it cannot extricate itself from the mess swiftly. So far, no one expects a recession anywhere near as deep as in 2002. Current interest rate as at August 20th, 2018 is 60%!

China

Nearly 70 years ago, China was embargoed and maintained policies that kept the economy centrally controlled, vastly inefficient, and relatively isolated from the global economy. Since opening up to foreign trade and investment and implementing free-market reforms in 1979, China has been among the world’s fastest-growing economies, with real annual gross domestic product (GDP) growth averaging 9.5% through 2017, a pace described by the World Bank as “the fastest sustained expansion by a major economy in history.” Such growth has enabled China, on average, to double its GDP every eight years and helped raise an estimated 800 million people out of poverty. China has become the world’s largest economy (on a purchasing power parity basis), manufacturer, merchandise trader, and holder of foreign exchange reserves. This in turn has made China a major commercial partner of the United States. China is the largest U.S. merchandise trading partner, biggest source of imports, and third-largest U.S. export market. China is also the largest foreign holder of U.S. Treasury securities, which help fund the federal debt and keep U.S. interest rates low.

Its real GDP growth has slowed significantly, from 14.2% in 2007 to 6.9% in 2017, and that growth is projected by the International Monetary Fund (IMF) to fall to 5.8% by 2022. The Chinese government has embraced slower economic growth, referring to it as the “new normal” and acknowledging the need for China to embrace a new growth model that relies less on fixed investment and exporting, and more on private consumption, services, and innovation to drive economic growth. China has been migrating from an agricultural base (primary sector) to an industrial base (secondary sector), to a service base (tertiary sector). And obviously even the Japanese feel that China is getting more innovative. China’s government has been actively rebalancing the economy, and that is no mean feat for an economy of >1 billion population.

From 1979 to 2016, China’s annual real GDP averaged 9.6% .This has meant that on average China has been able to more than double the size of its economy in real terms every eight years. The global economic slowdown, which began in 2008, had a significant impact on the Chinese economy. China’s media reported in early 2009 that 20 million migrant workers had returned home after losing their jobs because of the financial crisis and that real GDP growth in the fourth quarter of 2008 had fallen to 6.8% year-on-year. The Chinese government responded by implementing a $586 billion economic stimulus package (approved in November 2008), aimed largely at funding infrastructure and loosening monetary policies to increase bank lending. Such policies enabled China to effectively weather the effects of the sharp global fall in demand for Chinese products. From 2008 to 2010, China’s real GDP growth averaged 9.7%. However, the rate of GDP growth slowed for the next six consecutive years, declining from 10.6% in 2010 to 6.7% in 2016 (although it rose to 6.8% in 2017). China’s rapid economic growth is due to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand.

China has historically maintained a high rate of savings which has enabled China to substantially boost domestic investment. In fact, China’s gross domestic savings levels far exceed its domestic investment levels, which have made China a large net global lender.

Central Bank of China probably meets regularly (annually or quarterly?) with its local provincial HQs and agrees target growth of investment credit in each province. The total credit created is about 25% of Chinese GDP a year and this amount, together with the 25% of GDP funds available to local Provinces and their businesses, produces the total Chinese c50% of GDP of “equipment investment” which, with a current capital-output ratio of 7, produces an economic growth rate of c7% pa. Extra credit in the central PBoC is loaned to large national projects by rediscounting these loans up to the desired “window guidance” target of the pre-discussed target rate of investment in these central projects. The no-cost created credit is converted into long-term loans at low interest rates. Some money provided centrally for major Chinese investments in R&D and perhaps as military expenditure is written off annually, as happens in many countries. The no-cost investment credit is therefore converted into a huge list of interest-bearing assets. The construction of new cities creates massive assets and high incomes to the provinces through the sale to developers of land and the higher level of economic activity each city creates. The average use of the new flow of investment funds is about 20% additions to liquidity, 5% to raw materials and work in progress and finished goods and the rest to new plant and equipment (which may include OBOR projects). The extra money in Chinese companies improves their liquidity and makes them less risky and more enterprising, the funds provided for more raw materials, Work In Progress and finished goods avoids the over-trading route to bankruptcy, and the extra funds for productive equipment investment (including robotics- my input) improves labour productivity and high quality output. The expenditure of the extra funds creates additional tax returns to the Chinese Government of about 10% to 15% of GDP a year. The above explanation is the result of George E Tait’s mapping of Japanese Shimomuran procedures into the Chinese context. The worth of the wealth created is greatly in excess of the debt incurred. And these debts are not owed to foreigners and could be written off if the Chinese Government so decided (and as the Bank of Japan sometimes has, eg in the case of Mazda).

Of all the national debts in the world, China’s is the most sustainable. China’s debt to GDP is far below Japan’s. It is below the USA’s, too, yet its economy is growing 3-4 times faster. Its corporate assets offset most of its corporate debt (Beijing is the home to the largest number of Global 500 headquarters on earth, incidentally) and it has annual trading profit of $300 billion, ample savings and a GDP that’s 15-30% bigger than the official figure. While local governments borrowed a lot over the past eight years, an audit focusing on their indebtedness concluded that this was not a pervasive problem. And as for the localities which do have issues, either the provincial governments or the central government will have to bail them out. The key question is whether the central government has the resources to handle the debt problems of some of these corporations and local governments. And the answer is yes. Beijing has almost three to four trillion USD of reserves and its overall government debt level as a share of GDP is low. China actually saves more than it invests; it is one of the few countries where the savings rate is higher than the investment rate. Moreover, the country is still generating substantial balance of payments surpluses. China therefore doesn’t fit into a stereotype of a country in a financial crisis.

Poverty alleviation.

The Chinese government has probably read Minsky as well and adopted quite a few of his insights. Policy includes trying to make sure that anyone who wants to work has access to a job and because the private sector, although invaluable and a dynamic force in providing jobs, may not by itself ensure full employment, the government has to be an employer of last resort through its infrastructure programs or education policy or research or wherever their job training, expertise or education will allow. Even re-afforestation programs and so on. This generates skill development, poverty alleviation, community building, social networking, political and economic stability and social multipliers in a variety of socioeconomic benefits. As the mid and lower segments of society tend to spend more of their income on consumption, this elevates aggregate demand and improves the consumption portion of the GDP which tends to be more stable.

Household Debt

Over the years, Chinese consumers and clients have become increasingly connected to their banks through digital platforms, thereby resulting in the exponential growth of China’s online lenders. The P Bank of China has licensed Baihang Credit Bureau Co. as a credit information business through which banks and structured finance sponsors can improve the quality of their consumer loan portfolio with more refined underwriting, structuring, and monitoring. Baihang will complement the government’s existing consumer credit database of banking transactions by using big data digital technology to process behaviour data of activities such as mobile phone usage, travel and location reference, and shopping events. The complementary value of the non-bank behaviour data will allow banks to make more informed loan decisions for consumers that lack a credit history, such as the 171.9 million migrant rural workers in China.” Furthermore, Moodys Investment analysts suggested that this is cross-referencing various sources of information to improve traditional credit scoring based on static demographic and banking information. According to them, this would enable early detection of overleveraged consumers across bank and non-bank borrowing, thus deterring unscrupulous or overextended borrowers and this would also help address the risk of China’s rapidly rising household leverage since 2015. “Regarding household debt levels, China doesn’t rank that high on a global scale, but the pace of growth has picked up in the last few years,” People’s Bank of China governor Zhou Xiaochuan said. Mortgage loans for buying property are the largest driver of that household debt growth, because the returns on property investment were much higher than interest rates on savings and loans. However, the State has been monitoring the growth in household debt as it is potentially destabilising if there is too much speculation. If you look at graph 1, China’s household debt is certainly a lot lower than many western countries.

Housing Issues

A secret about Chinese real estate: China’s real estate markets are almost bubble-proof because there is no Chinese real estate market–there are only local and regional real estate markets. In 2013 the prime minister, an economist, warned that homes are for families, not speculators and, in 2017, the president warned that speculators bankrupted by policy changes have only themselves to blame because, ‘houses are built to be lived in, not traded’. Another bubble-damper is that there is no national real estate market, just hundreds of local markets, a de facto partition created by an ancient, discriminative tool, the hukou, an internal residents’ visa. Yet another damper is that Chinese housing debt per capita is only a fraction of America’s, so there’s still a long way to go. In order to prevent speculation from sending property prices even higher, local Chinese governments have implemented policies to restrict purchases such as limiting the number of apartment units someone can own and how soon they can resell them. Moreover, for a second property, the initial down payment is incredibly much higher, and even to obtain bank loans are a problem. Even for couples who ‘divorce’ in order to buy apartments, there are restrictions in place to prevent speculation.

Shadow Banking

Evidently having taken a page from Minsky, the P B of China has been keeping an eye on Shadow banking and the health of the banking sector because the financial sector places a structural risk to the economy. Modern investment is expensive and has to be financed but if not appropriately constrained, it generates structural fragility because during upswings, profit seeking firms and banks become more optimistic, take on riskier financial structures, do not check credit worthiness as thoroughly as before, and firms commit larger portions of expected revenue to debt service whilst lenders accept smaller down payments and lower quality collateral. Of note is that quiescence changes behaviour, policy making and business opportunities, so the more stable the economy, the more the internal dynamics will seek to displace this equilibrium. Which means that shadow banking, which is a method by which profit seeking firms including banks seek to find a way to get around restraints on lending practices will increasingly rise. These para financial institutions like pension funds, money market mutual funds, mortgage companies, wealth management products and various kinds of securitization vehicles such as derivatives become part of the playbook. Together with more relaxed regulations and supervision of financial institutions, it sets up a scenario for what happened during the Lehman Crisis. So now, it is likely that China has adopted Minsky in using two very important constraining institutions i.e “ Big Government”-(National Treasury) and “Big Bank” (Central Bank – PB o C), which helps to stabilise the economy through countercyclical budget – spending falls and taxes rise in a boom, while spending rises and taxes fall in a bust. Budget surpluses in expansion and budget deficits in recession constrain the cycle. In addition, its supervisory function has indeed been tightened.

As far as shadow banking is concerned, the government has taken firm steps to address the problem since 2017 and the tide has turned.

ING Asia Pacific (Feb 2018):

China’s loan data shows that shadow banking is shrinking, this could be the result of financial deleveraging reform. We expect the reform to continue for the rest of 2018. Loans going to standard channels, namely, new yuan loans grew 40% year-on-year to CNY2.69 trillion and contributed 87.9% of total social financing. Even though banks are usually eager to book loans at the beginning of the year in order to enjoy a full year of interest income, it seems that financial regulators, including the central bank, the banking regulator, insurance regulator and the securities regulator, have gained some success in limiting shadow banking activities. New trust loans fell to CNY45.5 billion, and new entrusted loans contracted by CNY71.4 billion, which resulted in a 17%YoY reduction of total social financing. Over the past year, the growth of banks’ funds extended to NBFIs, including through WMPs, has slowed sharply. This is because regulations on banks’ shadow banking activities (including channel investing and interbank financing) have been tightened to address the build-up of systemic risks that have accompanied the rapid growth in this sector.

Stock Market

Some commentators on Quora have already commented on the assumption that just because the Shanghai Composite Index has fallen 26% from 3,587 points to 2,650 points it marks the serious effect of tariffs on the Chinese economy and that the country will soon capitulate. But if you look at the chart below, in the past quarter century, China has experienced six bear markets in total and yet its economy has been doing well. In china, the stock market is quite dissociated with the real economy, because Chinese regulators know that the average stock picker is more of a punter than a well-disciplined value investor and treats the stock exchange more like a casino! However, trade wars are economically punishing for all parties all over the world, and should China really enter a recession, you can bet that USA will have just as bad a recession, and probably quite a few other countries as well.

So in summary I would say that on the evidence of the current government’s ability to manage the economy of China, it is unlikely to collapse as badly as in Argentina. However, be careful what you pray for. Any economy the size of either USA, China or European Union were it to collapse, will send tidal waves across the world.