The debate over whether China is going to experience a hard or soft landing is likely to last for a few more years as the country transitions away from a growth model driven by cheap credit and major exports (unless the hard landing thesis suddenly becomes true, of course), but Guanghua School of Management, Peking University professor of finance and author of The Volatility Machine: Emerging Economics and the Threat of Financial Collapse Michael Pettis thinks that this dichotomy misses the point.
“I’ve never been very impressed with the hard landing/soft landing debate because I think it misunderstands the Chinese economy and the growth model that we’re following. What I really expect is a long landing,” said Pettis in an interview with Chris Sheridan at Financial Sense. “There is simply no way that growth rates can be maintained at this point, but it’s unlikely to have a crisis.”
China’s growth will fall by 100 – 150 bp per year, says Pettis
According to Pettis, the rapid growth that we’re seeing isn’t as unprecedented as we may have been led to believe and “the miracle is the easy part.” Any country with access to so much cheap financing can buy growth, but the question is what happens afterward. He contrasts the 1982 Brazil debt crisis when external funding was suddenly cut off with Japan’s more gradual slide that evaded crisis and argues that Japan is the better comparison because so much investment in China is domestically financed by a system that is heavily controlled by the government.
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That doesn’t mean Pettis is painting a particularly pleasant picture for the next few years, he says that an annual 100 – 150 basis point drop in growth through the end of the decade is the best case scenario. The worst case scenario is that China never really gets its arms around the credit situation and growth falls gradually while debt continues to soar, leading to an eventual collapse and brutal adjustment, though Pettis doesn’t expect that to happen.
Shifting wealth back to households
As for what the rebalancing might actually look like, Pettis points to three pillars of China’s export competitiveness and says that all three will have to be gradually rolled back. An undervalued exchange rate, wages that haven’t kept pace with productivity gains, and low interest rates have all had the effect of shifting wealth from households to industry. As these factors change it will undermines China’s export competitiveness but it will also increase domestic demand, hopefully replacing the lost international demand. The process is likely to be messy, but Pettis sounds confident that China will manage the transition without falling into a crisis.