Is China’s Seeming Recovery Sustainable?

China has garnered much interest during the current financial crisis for several reasons. Among them, China is one of the largest creditor nations. On the surface, China seems to be rebounding quickly. Many media outlets report that the Chinese economy is recovering, citing their rising GDP (up 7.9% in Q2 from a year earlier), booming stock market (up around 60% this year) and soaring car sales (up 70%).

In order to answer whether the China’s recovery is sustainable (or their economy is really recovering to begin with), one might have to look at how they got where they are in historical contexts.

China watched the devastating impact of financial Tsunami during the Asian financial crisis. They learned the importance of foreign reserve and political ties with the U.S. It was their strategic choice to peg the yuan. China has depended on their exports to the U.S. to earn the hard currency, becoming the largest holder of U.S. treasuries. In other words, The Chinese has developed a complex interlocked relationship with the U.S.

China had grown fast until the U.S. financial crisis hit by pursuing export-driven economic development to build the industrial base, following the footsteps of Japan and Korea. They have accumulated their technological capacity by employing several modes: for instance, acquiring financially-distressed Korean high-tech companies and car maker.

China’s recent rebound has stirred some concerns. For one, the Chinese government’s stimulus measures and overseas capital inflows have been the major drivers for real estate and stock speculations, raising concerns for equities and asset bubbles. The Chinese government has tried to boost domestic consumption; China’s private consumption takes up only 35% of GDP. As a result, retail sales rose 15.4% year on year. However, according to Asia Times, retailers’ profits don’t look rosy: for instance, Chinese electronics retailer, “Gome’s first half net profit plunged just short of 50% from a year earlier”. In addition, China’s exports dropped 23.4% in August year on year.

The Chinese seem to be fully aware of what the U.S. government has been doing to keep the U.S. banking system from collapsing. Yes, their financial sector is controlled by the central government and has a problem of non-performing assets, but most of economies are in the same boat in terms of bad debt. It is also true that they have employed the stimulus interventions similar to that of the U.S. to induce the ordinary citizens consuming. Of course, the government’s stimulus package will dry up at some point. And yet, some argue that China is the creditor nation, not the debtor nation, although they are in a dollar trap. Accordingly, they are in the process of decoupling from the Dollar Zone, converting their USD into physical assets.

Even if the Chinese government may argue that maintaining employment and social stability is extremely important from political perspective, if they follow the West’s boom and bust cycles, their seemingly recovery would not be sustainable. For any economy, if there are private sector job growth and corporate profit increase with public and private debts descending, then one could say its economy is recovering in a genuine sense.

China has a huge domestic market potential. After all, they have 1.2 billion people yearning for better standard of living. Hence, they’ve got a lot of building and goods producing to do domestically, which can offset sluggish spending around the globe. They should also take away the right lessons from the U.S. financial crisis and Japan’s last 18 years of deflation: In the U.S. case, asset inflation has instigated the appetite for debt; in Japan’s case, they have also tried to reinflate the economy, but still mired in economic difficulties. History is no short of the dangers of big government especially in the communist regime. The China’s real recovery may boils down to their political will to care about the real welfare of the common people.

One thing is for sure: we live in interesting times as we may witness shifts not only in the global economic order but also in geopolitics. We have not seen concerted governments’ interventions of this magnitude to fight off recessionary forces. We are in uncharted waters. China may suffer, but they may adjust like they have done so throughout their long history of civilization. As China is leading the Asia pack – For Korea and Japan, China is the largest trading partner out there - and could become the possible locomotive of the global economy, we don’t seem to take our eyes off China.