The 4 Trillion RMB Mistake

PUBLISHED : Monday, 25 April, 2016, 11:09 p.m.

Link to article here.

At the dusk of the 2008 U.S. subprime mortgage crisis, a total of $10.2 trillion disappeared seemingly overnight. $3.3 trillion was cumulatively lost by U.S. homeowners, and $6.9 trillion in stocks and investments was wiped out.[1]

The consequences of the greed and shortsightedness of this nation’s wealthy elites manifested themselves as harrowing, real-life costs. In the United States alone, 1.2 million homes were lost as a direct result of what we now call “The Great Recession.”[2] The recession is still being felt globally. The Greek economy is free falling so rapidly that people are selling their bodies on the street for the price of a sandwich.[3] Countries like Iceland, Italy, Spain, and Portugal are still desperately trying to claw themselves out of their financial gutters, while Germany stretches to miraculously balance the gigantic burden on its shoulders.[4] The effects of the recession do not just stop at the West; Japan, Taiwan, and Hong Kong — three of the four Asian Tigers — all saw their GDPs shrink in 2008’s second quarter as a result of the Great Recession.[5]

In the midst of 2008’s chaos and pandemonium, somehow, China trudged along.

Seemingly unaffected by the financial meltdown, China’s GDP in 2008 and 2009 sustained a consistent growth of 9.6% and 9.2% respectively.[6] Chinese tourists were still traveling around the world, making monthly headlines with their unsophisticated behavior and driving up the prices of local goods and property with their incessant spending.[7][8][9] To the outside world, it looked as if the Chinese were living in their own bubble, completely unaffected by the 2008 financial crash.

Fast forward to 2016. The Shanghai Stock Market took a dive just last year.[10] The Communist State’s economic growth is at its lowest in 25 years, with a mere 6.8% increase in GDP in 2015.[11] Foreign investors are leaving, while the media reports on the final chapter of the “Chinese Miracle.”[12] China’s cheap labor-driven economy is finally coming to an end; the exodus of Chinese workers from urban to rural areas has been dubbed “the largest migration of any known mammal.”[13] Are the Chinese finally feeling the shockwave of the Great Recession?

That’s one way to look at it. Another way is to understand that China has been digging its own grave since 2008. Now is finally the time to decide whether to jump in or keep digging.

The 4 Trillion RMB Nightmare

China was originally supposed to suffer greatly from the 2008 financial meltdown. The Great Recession was expected to take an enormous toll on China’s economy; exports, imports, and exchange rates dipped significantly in the immediate wake of the financial crash.[14] In an attempt to combat impending doom, Chinese leaders simply tried to push the problem into the future; by introducing a 4 trillion RMB ($570 billion) stimulus package that invested in local infrastructure, healthcare, and industries that urgently need government aid in order to maintain their level of growth.[15] The scale of China’s current housing and credit bubbles and its failing raw materials and manufacturing industries were blown to their current proportions due to this gargantuan stimulus package.

In order to further understand China’s current financial turmoils, the 2008 stimulus package itself must be closely examined. The 4 trillion RMB stimulus accounted for 12.5% of China’s GDP in 2008, and was allocated roughly into six different sectors: transport and power infrastructure, rural village infrastructure, environmental investment, affordable housing, technology innovation and structural adjustment, and, lastly, health and education. Along with that, the central government issued instructions to loosen up monetary policy and to provide bank credit to large lenders (usually backed by government approval).[16]

This stimulus package was just fancy duct tape — it temporarily plugged the holes in the  ship but did not keep it from sinking in the long run.

Infrastructural developments from the stimulus package actually contributed to the emergence of more ghost towns throughout the country. Wuhan, a city that currently owes China’s central bank upwards of 122 billion RMB as a result of poor development plans, serves as a perfect example of this phenomenon.[17] Massive developments in the city were made possible by China’s Central Bank’s all-out-landing strategies, but the non-existence demand for property means that the city cannot pay back its loans. The real estate market was tremendously overvalued, backed by the false pretense that China’s enormous population would cause demand to rise as soon as there was supply for it. The truly horrifying reality is that Wuhan is just one of the Chinese cities that found itself in a hundred-billion RMB debt; cities like Chongqing, Chengdu, and Ordos are suffering nearly identical ordeals.[18][19]

Poor development efforts in these less well-off cities actually incentivized more ill-conceived development projects. In order to provide an illusion of GDP growth, development, and employment, local officials retreated to the option of building just for the sake of building. For example, shopping malls and new streets spurred out of nowhere in the proposed economic center of Zhengzhou, with no one to occupy them. They have, however, already served their purpose by generating a temporary economic growth.[20] In cities like Chengdu and Chongqing, perfectly good roads have been dug up and rebuilt to provide a facade of employment to their communist leaders.[21]

Sunset industries such as steel, iron ore, and rubber are also on the receiving end of this stimulus package. These were industries that had been on the decline in China’s modernizing economy, and were hit especially hard as a result of the 2008 financial crisis. Chinese leaders were subsequently forced to pump money into these dying industries for the sole purpose of keeping them afloat.[22] In truth, the IT and tech industries that were listed as beneficiaries of the stimulus package received close to nothing; most of the funds were funneled into dying manufacturing and raw materials industries instead.[23]

The sudden boost of economic stimulant caused extreme overproduction in these manufacturing and raw material industries. After reaching their peak at over 5,500 RMB per metric ton, steel prices in 2016 sank below 2,000 RMB at the same volume. Similar drops in value due to overproduction can be seen in similar industries, like the iron ore and rubber sectors. The former lost almost four-fifths of its value since 2009, while the latter has shrunken by approximately 60% since 2011. Similar trends in manufacturing and raw material industries can be observed across the board in China. For a state with 42.7% of its economy dependent on such industries, this is extremely bad news.[24]

Why Is This Continuing to Happen?

The complicated nature of China’s political system has eluded Western observers ever since it opened up in the early 1980s. While economic growth is important in other states, it takes up a special significance under the Chinese Communist Party as a deciding factor of societal stability. As a result, poor economic decisions, ones that do not deliver true growth and only maintain a facade of it, are made in an attempt to keep order and maintain China’s image as the economic miracle of the 20th century.

The 4 trillion RMB problem and its seemingly blaring mistakes are just a mere symptom of China’s unique power structure. The country stood to lose too much in 2008 had its sustained economic growth halted. The temptation to fund its dying industries in order to maintain the facade of growth is understandable.

This is exactly where the problem lies. What the Chinese government did on the eve of the 2008 crash stabilized the country’s economy for the next couple of years, but the problems did not go away completely. In fact, it enlarged the root causes and created an even larger mess than existed eight years ago.

The downfall of the Chinese economy does not only spell doom for China, but for the entire world. China accounted for 21% of total U.S. imports ($481 billion) in 2015 alone.[25][26] In lesser developed parts of the world, China’s slowing economy has already had a deadly impact. Today, China consumes 50% of the world’s nickel supply, 53% of thermal coal, and 60% of iron ore.[27] A drastic drop in China’s ability to purchase these goods will be disastrous for countries with economies dependent on their raw materials industries.

Though the situation is dire, it isn’t time to run for the hills just yet. Even though the last large stimulus package was fueled by China’s own shortsightedness, the mere fact that China managed to maintain its economy for eight years after the most serious financial meltdown in recent history — albeit its short sightedness — is a strong indication that the country has its sleeves loaded with tricks. In order to combat recent financial slowdowns, the country laid off close to two million of its workers for the purpose of retraining.[28] The true extent of China’s ability to manipulate its economy remains a mystery. Still, scholars and speculators who are accustomed to studying free market economies need to exercise extreme caution while judging the unaccounted future of China’s state capitalist economy.

The conclusion to all of this is an unsatisfying one. There is no substantiated proof as to whether or not China can weather the upcoming financial storm. If it chooses to push its problems further into the future again, a more dismal situation — packed with even larger bubbles and more financial woes — waits at China’s doorstep in the next decade. If it chooses to cut its losses and brace for the storm, it must prepare for serious political and social turmoil in the face of a slowing economy. Either way, China is in for one hell of a rough landing.

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