China and the US both desperately want consumer spending to grow. Instead, the Chinese economy has grown even more unbalanced.

China is increasingly reliant on fixed investment, yet there are few economically viable projects. Worse yet, China is in the midst of gigantic property bubbles that will soon pop.

Please consider Consumer Spending Fades in China Economy

At the Haiyang Zhuangshi Co. hardware store in Beijing, sales of paint and aluminum window frames are slowing, one sign of a diminished role for consumer spending in China that’s foiling government objectives.

“It seems the peak days are gone,” said owner Hu Mengbin, 42, whose daily revenue has dropped to about 3,000 yuan ($463) from as much as 4,000 yuan last year after China stepped up efforts to rein in home prices. “Between 2006 and 2008 when the property market was red hot, we could make quick money.”

Hu’s loss underlines the dilemma for Premier Wen Jiabao: his campaign to control inflation is undermining attempts to make consumers a bigger driver of the world’s second-largest economy. Failure to lessen dependence on exports and investment spending leaves the nation more vulnerable to swings in external demand and subject to asset booms and busts.

Government data this week showed retail sales growth slowed to 16.9 percent in May, less than the average of the past five years and a figure that’s inflated by soaring prices for food. By contrast, spending on fixed assets such as factories and property climbed 26 percent, excluding rural households, in the first five months, the fastest pace in almost a year.

Analysts at Capital Economics, a London-based research group, estimate that private consumption may have fallen to 34 percent of gross domestic product last year, the lowest level since China began opening its economy to market mechanisms more than three decades ago. Just 10 years ago, the share was 46 percent, Capital Economics calculates.

“Just at a time when the government in China and a lot of people elsewhere are hoping to see Chinese consumers step up to the plate, actually they’ve been staying away from shops,” said Mark Williams, an economist in London with Capital Economics and a former adviser on China to the U.K. Treasury. “The trend over the past couple of years has been relentlessly downward.”

Consumption would have to grow three percentage points faster than GDP to reach 40 percent of the economy within five years, according to Michael Pettis, a finance professor at Peking University in Beijing.

“We would need the highest consumption growth ever recorded,” Pettis said. “In the short term we’re not going to see a lot of change.”

Beijing store owner Hu isn’t expecting any quick turnaround either. “Making money is getting harder this year,” he said as he stood in his 20-square-meter shop. “Business is slack.”

China Can Fail Like Japan

Please consider How China could yet fail like Japan by Martin Wolf

Until 1990, Japan was the most successful large economy in the world. Almost nobody predicted what would happen to it in the succeeding decades. Today, people are yet more in awe of the achievements of China. Is it conceivable that this colossus could learn that spectacular success is a precursor of surprising failure? The answer is: yes.

Premier Wen Jiabao has himself described the economy as “unstable, unbalanced, unco-ordinated and ultimately unsustainable”. The nature of the challenge was made evident to me during discussions of the 12th five year plan at the China Development Forum 2011 in Beijing in March. This new plan calls for a sharp change in the pace and structure of economic growth. In particular, growth is forecast to decline to just 7 per cent a year. More important, the economy is expected to rebalance from investment, towards consumption and, partly as a result, from manufacturing towards services.

The question is whether these shifts can be managed smoothly. Michael Pettis of Peking University’s Guanghua School of Management has argued that they cannot be. His argument rests on the view that in the investment-led growth model, repression of household incomes plays a central role by subsidising that investment. Removing that repression – a necessary condition for faster growth of consumption – risks causing a sharp slowdown in output and a still bigger slowdown in investment. Growth is driven as much by subsidised expansion of capacity as by the profitable matching of supply to final demand. This will end with a bump.

Investment has indeed grown far faster than GDP. From 2000 to 2010, growth of gross fixed investment averaged 13.3 per cent, while growth of private consumption averaged 7.8 per cent. Over the same period the share of private consumption in GDP collapsed from 46 per cent to a mere 34 per cent, while the share of fixed investment rose from 34 per cent to 46 per cent.

If this pattern of growth is to reverse, as the government wishes, the growth of investment must fall well below that of GDP. This is what happened in Japan in the 1990s, with dire results. The thesis advanced by Prof Pettis is that a forced investment strategy will normally end with such a bump. The question is when.

That is an excellent article by Martin Wolf. Inquiring minds will want to take a closer look.

Bearish on China

Fixed investment in China is going to collapse at some point. When it does, it will take China’s massive property bubble with it. Losses at Chinese banks will be staggering.

The ripple effect will hit commodity prices which in turn will hit Australia and Canada.

Expect more unrest.

Interestingly, China is in the midst of a surge in unrest already. Please see Wave of Violent Protests, Rioting, Bombings Hits China; Expect More Riots When China’s Credit Bubble Pops, Exposing Mountains of Fraud for details.

I see no reason to be bullish on China or the Yuan either.

Mike “Mish” Shedlock
Click Here To Scroll Thru My Recent Post List