China Economic Outlook Short and Medium Term

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This analysis of China's economic outlook finds a contradiction between its short-term and medium-term prospects. China's short-term problem is inflation but the analyst is concerned about the potential for deflation after 2013. The economy has been based on a relatively cheap currency and strong export led growth. Investment spending on public housing and infrastructure has been high as well. It increased from 45% to 50% of GDP when there was a 5% decline in net exports. This raises questions about the potential for over-investment in capacity that might fuel future deflation. The analyst bases some of his concerns on his observations on a recent trip to China. He observed under utilized transportation infrastructure and wondered how China could increase its train infrastructure without harming its investments in new airports. He also believes that investments in auto manufacture may be outpacing its rapid growth in auto sales.

The alternative for China is to grow household consumption at the expense of net exports. This would require structural changes that interfere with that alternative. The currency would be allowed to appreciate which would make imports cheaper and exports more expensive. It would also require growth in wages to support consumption. Consumption is less than 50% of GDP today. This would impact China's large savings rate which is the basis for low interest rates that support investment in China's State Operated Enterprises. They might suffer as well. The analyst believes that taxes should be increased on the SOE's or some should be privatized.

The author of this report was one of the few who predicted that the US financial system was headed for crisis. We will have to see whether his analysis of China's outlook holds up over time.