Comparing China with Japan and Other Stories

Is it possible or relevant to compare China with Japan and if so which Japan? Should it be 1970s Japan or late 1980s Japan? While many commentators argue that China is better compared to 1970s Japan, Michael Pettis argues that China resembles 1980s Japan because of the unbalanced nature of its economy.

Japan in the late 1960s and early 1970s may share many developmental characteristics with China today, but the Japanese economy in that earlier period never achieved, as far as I can see, the kinds of imbalances that it did much later in the 1980s, and so it is not really comparable to an extremely unbalanced China today.

These imbalances are well documented. The important characteristics of Japan in the late 1980s would almost certainly include the following:

• Japan in the late 1980s grew at extraordinary rates fueled by a credit-backed investment boom funded at artificially low interest rates.

• Although for many decades much of the investment may have been viable and necessary, by the 1980s investment was increasingly misallocated into expanding unnecessary manufacturing capacity, as well as fueling surges in real estate development and excess spending on infrastructure.

• Artificially low rates, set nominally by the central bank but in reality by the Ministry of Finance, and coming mainly at the expense of household savers also fueled a bubble in local assets.

• An artificially low currency fueled very rapid growth in the tradable goods sector while also constraining household income growth.

• Because the growth model constrained growth in household income and household consumption, it forced up the domestic savings rate to extraordinary levels.

• The combination of low consumption and excessive manufacturing capacity required a high trade surplus in order to balance production with demand.

• And finally, and most worryingly, debt levels across the economy began to soar as debt rose much faster than debt servicing capacity.

All of this is true of China today, and this is why it is much more important to understand how Japan rebalanced after 1990 if you want to understand the challenges and risks facing China today. China is not like Japan in the 1950s, 1960s or 1970s in any meaningful way even if its current development level is much closer to Japan during those decades. Because of the serious imbalances China is much more like Japan in the late 1980s, with the major difference being that Japan never took debt, investment, and consumption imbalances to anywhere near the levels that China has taken them.

Ouch ... How, then, will the imbalances be reversed.

For this reason what we really have to consider when thinking about China is how these imbalances tend to be reversed. Since they were reversed in Japan in the period following 1990, Japan provides at least one possible model for China’s rebalancing process and, perhaps much more importantly, it demonstrates the kinds of pressures that China will face as it is forced into rebalancing. ... 

What about Europe?

Economic growth in Europe over the next ten years ... will not be anything like economic growth in the last ten years adjusted for changes in demographics, taxes, or anything else. We will be dealing with a Europe in which the tremendous debt, currency, and labor cost imbalances of the past decade must be reversed, and since the most likely form of the reversal will entail the breaking up of the euro, any growth predictions that do not at least acknowledge this chaotic rebalancing process are likely to be flimsy at best.

Currently Paddy Power is offering odds for both the end of the Euro and for individual countries leaving the Euro. Interestingly Greece is not included. Too short or what? My prediction is for an exit during the Xmas-New Year period, if if indeed happens. It's possible of course that European policy-makers will do whatever it takes to keep the currency going. (In other words I'm not suggesting you take a bet!)

The problem for the world economy is that the credit-fuelled growth strategy prevalent in most of the world has to at best stabilise or keep reversing.

Likewise with predictions of US consumption growth, which will have to deal with reversals in the savings and consumer credit trends of the past decade, and with sharp change in two decades of housing behavior.

For Australia there is, at best, volatility ahead.

Predictions about the prices of hard commodities, which have to consider a major dislocation in the source of commodity demand since the early part of the last decade, are also likely to be highly unstable.

As Pettis points out economic predictions are very difficult.

If you want to make economic predictions, in other words, whereas a long historical view will be very useful because it allows you to consider the dislocations created by a reversal of unsustainable imbalances, recent economic data are largely useless, as are predictions based on linear adjustments of recent economic data. Instead of projecting from past data you must model the various paths by which rebalancing can occur, and your prediction must be limited to those paths.

Pettis gives relatively short shrift to the view that insights from neuroscience could make a difference in predicting economic events.

This suggests that we don’t really need a radically new understanding of economics. To understand the global rebalancing, or the European debt crisis, or the upcoming Chinese economic adjustment, we need only to read the works of John Maynard Keynes, Hyman Minsky, Charles Kindelberger, Friedrich Hayek, or dozens of other economists of the 19th and 20th centuries. In every case they fully understood how economies can beetle along in one direction and then suddenly, as imbalances become unsustainable, reverse course and follow a dramatically different path.

This is simply a logical outcome of disequilibria, and doesn’t require anything quite so mysterious as brainwave patterns or irrational behavior mechanisms to explain the process. I think it was Herb Stein, President Nixon’s economic advisor, who reminded us that "If something cannot go on forever, it will stop."

In other words, as Keynes was reputed to have said: the unsustainable cannot be sustained.

It would have been much more powerful, I guess, if Stein had expressed this idea in a way somewhat more mathematical and abstruse, but anyway it seems like a pretty good explanation of what has happened in the US and in Europe in the past few years and what will happen in China in the next few. Just because many economists fail to see the point doesn’t require an overhaul of the discipline – perhaps it only requires an overhaul of the way the discipline is taught.

Pettis then goes on to quote a number of news sources outlining some very bad news for Australia.

From Bloomberg

Copper inventories at bonded warehouses in Shanghai probably climbed to a record as import premiums dropped to a four-month low, signaling demand in China may not be improving as much as expected after a summer lull.

Reserves were 650,000 metric tons, according to the median of nine estimates from traders, analysts and warehouse managers, compiled by Bloomberg. Five said that this was a record. The amount compared with an estimate of 550,000 tons by Macquarie Group Ltd. on Aug. 20. Fees paid by importers over the London Metal Exchange cash price are about $40 to $60 a ton on a cost, insurance and freight basis, the lowest since May.

Or this Financial Times article:

The southern Chinese province of Yunnan has launched a subsidy programme for metals producers, in a sign of the pain hitting the Chinese metals sector as demand growth remains low. Slowing economic growth in China, the world’s biggest consumer of commodities, has meant falling profits at Chinese raw materials producers, including copper smelters, steel mills and zinc smelters.

An official at the Yunnan Provincial Industry and Information Technology Commission confirmed that a small “stockpiling” programme, which has not been publicly announced yet, was launched in September and would continue until the end of the year. The programme targets copper, zinc, aluminium and other small metals, the official said.

Under the programme, which covers 300,000 tonnes of metals, producers will be able to draw subsidised loans from banks using their material as collateral. Banks will give the companies loans based on preset “purchase” prices for the commodity, and the Yunnan government will subsidise the process by paying for the interest on the bank loans. The system is designed to help smelters by providing them with more liquidity as financing gets more difficult. “The targets of this stockpiling system are the companies,” the government official explained.

But perhaps the inevitable pain could be delayed by more stimulus.

In Saturday’s South China Morning Post there was another article on roughly the same topic:

A group of state-owned Chinese shipping companies has placed a US$4.5 billion order for 50 supertankers, throwing a financial lifeline to struggling shipbuilders.

The order adds to a flurry of infrastructure investments by state companies in recent weeks - a key element in Beijing's effort to reverse a painful slowdown in economic growth. The government has approved a wave of spending on new steel mills, subway lines and other corporate and public works projects.

…Chinese shipbuilders, the world's biggest by tonnage, have been among the industries hit hardest in the slowdown. Orders have fallen by more than half, and shipyards are cutting jobs.

"Small and medium-size shipbuilding companies are either out of business or near bankruptcy," said Xia Xiaowen, an analyst for the China Shipbuilding Economy Research Centre, a think tank in Beijing. If the reports of new orders are accurate, "it will definitely be good news for those large manufacturers, and they don't need to worry about survival any more", Xia said.

But eventually, Pettis argues, rebalancing will have to occur.

no matter what analysts or policymakers may say, there is absolutely no way to resolve the problem of growing excess inventory except by abandoning the development model. Until China rebalances, in other words, it cannot resolve the problem of excess inventory because excess inventory is one of the inevitable consequences of the process that created the imbalances.

Hold onto your hats.

Graphs that Show a Little Pain: Mining, Manufacturing and Services

In my last post I included a graph showing the high level of mining investment past, current and prospective. The graph was from a speech the other day by Deputy Governor of the RBA Philip Lowe elegantly titled "The Changing Structure of the Australian Economy and Monetary Policy" 

The happy graph is this one. 

Mining investment is as high as its ever been in Australia, but this doesn't necessarily mean that all is fine in the Australian economy.

Lowe also discusses a range of other graphs that show how some parts of the economy are struggling.

The first graph below uses 2000 as its starting point and considers outcomes since that time.  Manufactured exports were growing substantially until the GFC, with the parts of the sector clearly becoming more export oriented (consider exports in ratio to output). Part of the cost of this transition was a gradual decline in employment. Since the GFC, exports and outputs have recovered somewhat although still well below the pre-crisis peak and well below the general recovery in world manufacturing trade, which has exceeded pre-crisis highs. Unemployment in the sector, meanwhile, has fallen in a hole.

It's harsh to say it, but the survival of the manufacturing sector (and remember that it's a remarkably varied sector) is probably dependent on more job losses as firms restructure and focus on higher value-added activities. Steel production, for example, is not going to survive in its current form. Car production is also probably dead in the water over the longer-term unless the government does something more than simply providing regular gifts to American and Japanese car companies to keep producing cars in Australia.

Just imagine the potential results for Australia's hi-tech manufacturing future if just 10 per cent of that largess delivered to American and Japanese investors had been put into research on new engine technology. Instead we paid the car companies to keep producing cars that fewer and fewer people wanted.

There is some indication that the manufacturing sector is restructuring in a good way in that a greater percentage of firms are embracing new operational processes than in other industries. Once again this means higher productivity and clearly fewer employees as a percentage of output. Currently manufacturing employs about 950,000 people and accounts for about 9% of output. As Lowe argues:

Realistically, Australia cannot hope to be a large-scale producer of relatively standardised, plain-vanilla, manufactured goods for the world market. But what we can be is a supplier of manufactured goods that build on our comparative advantages: our educated workforce; our ability to design and manufacture specialised equipment; our reputation for high-quality food; our research and development skills; and our expertise in mining-related equipment.

Inevitably, the high exchange rate means that the manufacturing industry has little choice but to move up the value-added chain in order to compete. This is, of course, a lot easier to say than to do. It means difficult changes for many firms and those who work for them. It also means ongoing investment in human capital and the latest machinery and equipment and constant attention to improving productivity. One piece of evidence that things are moving in this direction is in the ABS business characteristics survey, which asks firms a series of questions about innovation. In this survey the manufacturing sector clearly stands out as one where firms are actively reviewing their business practices and, over recent times, they have been doing this more frequently.

Two significant sub-sectors that have been growing are "professional and scientific" and "specialised machinery", while cars and metals and construction manufactures are in a dangerous decline. The problem for the car industry is that there is overproduction throughout the world and especially in Europe.

Another sector that has been doing poorly is tourism, although some sectors of the accommodation sector have not been doing so badly, highlighting that there is restructuring going on within sectors, not just between them (as in manufacturing above).

As those of us who live in Queensland will have noticed, tourism is in deep trouble. Sydney, however, is doing well as business travel remains high and as tourists seek city-based experiences rather than coast-based experiences. The floods and La Nina have probably not helped Queensland tourism.

Another sector that is going through a tough time is the real estate industry. Not only are prices in decline, but turnover rates have more than halved from their peak in the early 2000s. The fall over the last few years has also been significant. The trend is clear despite a couple of rises before and after the GFC. I live near a high street that must contain at least 6 real estate agencies on one side of the road over a distance of no longer than 200m. Might be difficult to maintain that sort of penetration of Logan Rd Holland Park if the turnover trend charted below continues.

As with accommodation, retail is a sector with varying fortunes. Clothing, footwear and accessories are doing poorly as are Department stores, but other retailers are doing quite well.

As I argued in The Internet and the Death of Retail the problem for the bricks and mortar part of the sector is not yet because of Internet sales, which are less than 5 per cent of overall sales, with o/s sales even smaller at about 25 per cent of total Internet sales.

Nevertheless, a recent study by the NAB reported that online retail had been growing rapidly, although the rate of growth slowed in the second half of 2011.

Australian retailers are not, therefore, powerless to take advantage of the Internet. Australian businesses, even those with stores, can sell online as well. But a little hint here to Rebel Sports and Super Amart, things have to be cheaper online.

After trying to find some running shoes in the US, I found that many of the cheaper retailers wouldn't sell directly to Australia, although there were companies that would provide you with a US address and then send the goods to your Australian address. This seemed more trouble than it was worth after I found an Australian site - myfootyboots.com - that sold shoes much more cheaply than the bricks and mortar retailers.

Undoubtedly we live in interesting times and clearly some sectors (and sub-sectors) are doing much better than others.

The Australian Economy in 2012

When the world economy recovered strongly in 2010, many commentators believed that the great recession was over. In Australia, we still have commentators who fully dismiss that there was any need for action to bolster the Australian economy during 2008 and 2009. This is despite the fact that government guarantees kept the banks afloat (no thanks from the banks for that now), the Reserve bank's monetary stimulus bolstered mortgagees' spending power and Treasury's fiscal stimulus bolstered confidence just at the right time.If you have a look at the graph below you will see that the world economy contracted during this period - an unusual event - and the Australian economy did not.

Successful fiscal stimulus is a bit like averting a terrorist attack. People don't really appreciate what might have been if the action to avert the problem had not been taken.

The subsequent reinvigoration of the Chinese economy through government action also acted to bolster the economy further in 2010, making many people argue that there was no value in the building of school facilities that followed. Anyone who has a child at school or goes to a university will realise that there have been some marvellous facilities built that will benefit students far into the future. The Building the Education Program may have been rushed and it may not have been an effective form of fiscal policy, but it was in the main an effective piece of infrastructure development in Australia.

One building company owner in South Australia made it clear to me that without the prospective work, layoffs would have been significant in his company. So we've been doing fairly well, despite some real and significant problems associated with structural change in the Australian economy.

The Reserve Bank is a prolific publisher of research and its key figures regularly give speeches on the state of the Australian and world economies. Phillip Lowe, the Deputy Governor, gave a speech this morning on "The Forces Shaping the Economy Over 2012.

The first thing to note is that the world economy is expected to do worse than thought in September 2011. Most forecasts have been revised downwards in recent times.

But compared to 2009, this is still a good performance. Europe remains the major problem. According to Lowe:

Working through the various challenges is taking the Europeans time. The process has been frustratingly slow and we have witnessed some missteps along the way. But for all of that, we should not lose sight of the fact that progress is being made. Late last year there was a palpable sense that something might go badly wrong over our summer. Clearly, that has not happened. Instead, government bond yields for some of the troubled countries in Europe have declined a little (Graph 2). Equity markets have picked up and confidence has improved a bit. And significantly, bank debt markets are functioning again, although the cost of issuing bank debt, relative to government yields, is higher than it was in the middle of last year.



Lowe notes that one of the problems for 2012-13 is the fact that many countries are undergoing fiscal consolidation at the same time, providing a significant drag on growth, although he doesn't want to sound too much like a booster.  

Over 2012 and 2013, fiscal policy is set to be quite contractionary in both Europe and the United States as governments attempt to put their public finances on a sounder footing. Indeed, the aggregate fiscal contraction across the advanced economies is likely to be the largest seen for many decades. This is not because the size of the fiscal consolidations in individual countries is unprecedented, but rather because the consolidations are occurring simultaneously in a large number of countries. Unusually, they are also taking place in an environment where output in the affected countries is considerably below potential.

The economic literature is mixed on the effects of fiscal consolidation on growth. There are certainly some examples where consolidation has been associated with fairly strong GDP growth. But in most of these examples, the countries undertaking the fiscal consolidation have benefited from some combination of robust growth in their trading partners, an easing of monetary policy and a depreciation of their exchange rate. Given the nature of the current situation, it is unlikely that the advanced economies, as a whole, can benefit from these factors. There is therefore a material risk that fiscal consolidation weakens growth in the short run, which leads to more fiscal consolidation in order to meet previously announced targets and, in turn, yet weaker growth. We are currently seeing this dynamic play out in a couple of the countries in southern Europe. If it is not to be repeated on a wider scale, the fiscal consolidation in the North Atlantic economies will need to be accompanied by reforms to the supply side that lift the underlying rate of growth of these economies.

In other words widespread fiscal contraction provides a big risk of a negative spiral and a long period of stagnation. All of which is going to be exacerbated by continuing household and wider private sector deleveraging.

The US is increasingly being seen more positively, but it might be too early to open up the champagne just yet.

The US is paying off debt more quickly than many other countries as a recent McKinsey report noted.

Household debt outstanding has fallen by $584 billion (4 percent) from the end of 2008 through the second quarter of 2011 in the United States. Defaults account for about 70 and 80 percent of the decrease in mortgage debt and consumer credit, respectively. A majority of the defaults reflect financial distress: overextended homeowners who lost jobs during the recession or faced medical emergencies found that they could not afford to keep up with debt payments. It is estimated that up to 35 percent of the defaults resulted from strategic decisions by households to walk away from their homes, since they owed far more than their properties were worth. This option is more available in the United States than in other countries, because in 11 of the 50 states—including hard-hit Arizona and California—mortgages are nonrecourse

The report argues that the US is further down the path of deleveraging than Spain or the UK, but the default part of the equation is perhaps no reason to be jumping for joy. McKinsey bases their assumption on a historical trend line of increasing debt and argue that the US may be half way through the deleveraging process.

But think about it this is a trend line from 1955. Eventually the trend line will reach 130% of GDP, perhaps by 2040, which would mean deleveraging during the 2050s could involve a decline from an above trend 140% of GDP ... or whatever. The point is the assumption of an ever-expanding trend line is a furphy. Credit really takes off in the early 1980s with financial liberalisation and the massive expansion of credit that followed. Believing the trend line would mean accepting that eventually. perhaps by 2100, that household debt at 200% of GDP was sustainable.

Comparison with deleveraging in Sweden after their severe financial crisis is quite illuminating. It also makes clear that the UK and Spain also have a long way to go before their episodes of deleveraging are finished.

But anyway the report is well worth a read, just to see why this period of economic stagnation may be a long one. For a look at some comparable figures on Australian household debt see here.

Lowe downplays the impact of China  in the speech:

The Chinese economy is also continuing to grow solidly. The pace of growth has slowed, but it has done so in line with the authorities’ intentions. Inflation in China has also moderated. Across the rest of east Asia, the recent data have been mixed. Nevertheless, for the region as a whole, growth in 2012 is expected to be around trend, with domestic demand likely to play a more important role in generating growth than it has for most of the past two decades.

Let's hope his anodyne assessment is correct.

Lowe then moves to the Australian economy and notes the significance of the once in a lifetime investment that is happening right now.

As you can see from the graph the projected level of investment is huge, belying the regular scare-mongering from the resources sector.

But as many of you will now know this investment has been heavily concentrated in the resource sector and is part of the equation leading to a higher exchange rate.

 

I used to amuse students with stories of the Australian dollar at around 1.50, which seemed rather ridiculous at the turn of the millennium when it hovered around 50%.

Given the importance of the RBA in managing the Australian economy it is worthwhile considering how they see these developments.

The effects of the high exchange rate are evident in the manufacturing, tourism and education sectors, as well as some parts of the agriculture sector and, more recently, in some business services sectors. With the exchange rate having been high for some time now, more businesses are re-evaluating their strategies, as well as their medium term prospects. In some cases, this is prompting renewed investment to improve firms’ international competitiveness. But in other cases, businesses are scaling back their operations in Australia and some are closing down. These changes are obviously very difficult for the firms and individuals involved.  

Both the investment boom and the very high level of the exchange rate are historically very unusual events. This makes it difficult to assess their net effect. It seems, however, that over the past year these forces have balanced out reasonably evenly. 

In other words, don't worry, be happy. While it was slightly cool to be a pessimist before the crash it's now much cooler to be an optimist as a range of recent articles and books have pointed out.

China and the Australian Dollar

The high Australian dollar is a source of joy for many Australians, especially those travelling overseas or buying goods overseas via the Internet. To be honest, I dig it in a big way. I get that lovely feeling of schadenfreude every time some British person complains about how expensive everything is here in Australia and I love buying books from the UK's Book Depository at reduced rates with no shipping costs and an inflated exchange rate.

(Nevertheless try as I might I couldn't buy the running shoes I wanted from the US either because the stores didn't ship to Australia or they did, but didn't have the size or style I wanted. I eventually found an Australian online store that sold shoes much cheaper [for Asic Kayano 18s about $70 cheaper than the retail outlets like Rebel and Super Amart]. For an analysis of the Internet and bricks and mortar retail see here)

But these pleasures just serve to highlight that a high dollar is a major problem for Australian (non-resource) exporting and import-competing businesses. Resource exporters aren't suffering yet, because demand remains high for the things that they export, especially coal, iron ore and gas.

As most educated Australians will understand, a high Australian dollar makes imports cheaper and exports dearer, which eventually causes many businesses, especially those with options to make things in other countries to reassess whether it is worthwhile continuing production in Australia. This is what has been happening in recent weeks with Toyota and Holden announcing job cuts and before that Bluescope Steel announcing that it was abandoning exports and cutting jobs.

Expect these announcements to become more frequent in coming months, especially given the fact that economic policy-makers in Australia seem to think that nothing can or should be done about the high dollar.

The exchange rate is a key enforcer of structural change in a resources boom. This phenomenon has been called variously 'Dutch disease", the two-, three- or multi-speed economy, and the patchwork economy.

Current concerns go beyond the banal fact that economies are always multi-speed. But right now the higher prices for Australian resources and the inflow of capital to fund investment and to take advantage of interest rate differentials between Australia and most countries with very low, zero, or effectively negative, interest rates is bolstering the Aussie. Borrowing at low interest rates and then investing in Australia with relatively high interest rates is rather attractive at the moment. Also a factor is growing foreign purchases of Australian bonds, especially by central banks and sovereign wealth funds.

According to another report in the FT, foreign ownership of Australian government securities has reached 80%.

While this makes some bond traders nervous, the real problem for Australian government bonds at the moment is a lack of supply. Still one trader argues:

this is worrying as heavy foreign ownership of government bonds can be very dangerous, particularly when this is combined with a country running a current account deficit (i.e. the country is reliant on capital inflows from abroad).

These concerns seem to be overdone - Australia's CAD is as low as it has been for some time, but I suppose things could change if China fell in a hole.

Right now, the worry is the high exchange rate's negative impact on key sectors of the economy, particularly those that employ large numbers of people and help to create a more diverse economic structure for Australia.

As I have noted many times before on this blog and elsewhere, exchange rate-induced structural economic change has a lot to do with whether the high Australian dollar is sustained over the medium term or whether it falls against our major trading partners and, especially, the US Dollar.

According to Hume in the FT, most economists expect a fall in the Aussie, but not back to its long term post float average of around 75 US cents. Instead the consensus view is that it will be supported at about the mid 90s. But at the moment Australians going overseas are doing pretty well compared to the early 2000s:

Australians planning to visit London for this summer’s Olympic Games will get bang for their buck. The Aussie, which recently hit a 27-year high of 67.96p against sterling, has appreciated by more than 80 per cent since Sydney hosted the Olympics in 2000.

Given that he is a long-term bear about China's medium-term economic prospects (increasingly becoming more short-term) Michael Pettis questions whether the Aussie should be currently so strong:

I am actually much more pessimistic about Chinese growth prospects, commodity prices, and the pace of European recovery ... but even so we would have expected that the obvious prospective problems in Europe and China should have made themselves felt in the Australian dollar. So why has it remained so strong?

The answer he suggests might have something to do with the amount of capital flowing out of China as cashed up Chinese worry about the potential for wealth destruction in China in coming years.

I just had coffee earlier in the week with one of my PKU students. He told me that he and his business-owning father are trying to take money out of the country as quickly as possible. He says it has become harder recently (I don't know why) but everyone they know is setting up businesses abroad and trying to do the same, in part, he said, so that they can get foreign passports if they ever need it. On that topic there was an interesting article last week in the New York Times:

A recent survey of 980 Chinese millionaires found that 46 percent of them were considering leaving China and another 14 percent had already emigrated or were completing the paperwork for relocating. The survey by the Bank of China and the Hurun Report said 40 percent of the would-be émigrés — they’re known as “migratory birds” in China — would aim for the United States, followed by Canada (37 percent), Singapore (14 percent), Europe (11 percent), Hong Kong (5 percent) and Britain (2 percent). 

The leading reasons for taking flight: better educational opportunities for their children, advanced medical treatment, worsening pollution back home (especially urban air quality) and food safety concerns. But many potential émigrés, not surprisingly, are working on a Plan B in case China’s economic growth begins to slow, widespread social unrest takes hold or the political winds begin to blow against them.

We are seeing this process most vividly in Hong Kong. In spite of a recent video showing a fight between Hong Kongers and mainlanders in the Hong Kong subway, which went viral and inspired real anger and mutual recriminations among even some of my most laidback Beijing and Hong Kong friends, mainlanders are scooping up apartments in Hong Kong. This is from an article in Saturday’s South China Morning Post:

Data compiled by Midland Realty shows individual mainlanders spent HK$62.3 billion on residential properties in Hong Kong last year, or about 20 per cent of the value of all sales excluding those involving corporate buyers. That was almost double the 10.8 per cent in 2010. The agency expects the figure to jump to about 25 per cent this year.

Rich mainlanders are clearly eager to take money out of the country. And what is just as clear, the debate on the limits of state capitalism we have been hearing and reading about a lot recently is not just of academic interest to them. According to my student, it is becoming harder and harder for non-SOEs [state-owned enterprises] to do business in China, and more necessary than ever to have friends in high places.

As an aside, for those watching the real estate market, my student also mentioned that two very large real estate projects that his father runs are having trouble selling units. He said his father has decided to sell as quickly as he can, even at very low prices, rather than wait for prices to recover.

One of the places that Chinese capital could go is, of course, Australia. which may account for the continuing strength of the Aussie:

a lot of Chinese capital is flowing into Australia. He, for example, has traveled to Australia nine times in the past year, mainly looking after business for his father, who has also been to Australia many times. The family has large investments in food, real estate and construction, and my student tells me he often arranges to meet in Sydney or Melbourne school friends of his who also happen to be in Australia for similar purposes. My guess is that at least part of the reason for a strong dollar, in spite of weakening growth expectations, may be that a lot of Chinese capital is flowing into Australia.

What would happen if growth in China slows significantly? This would probably result in a sharp drop in non-food commodity prices, which should cause much slower growth in Australia. But if a Chinese slowdown coincided with an increase in private Chinese capital outflows, it might be difficult for the Australian dollar to adjust downward sufficiently to help absorb some of the cost of the slowdown. In that case Australia might suffer low growth and an expensive currency – not a very good combination.

Let's hope that this doesn't eventuate!

Let me finish this already long post by noting that this is not an argument against the floating exchange rate, which has been overwhelmingly beneficial for Australia since the early 1980s and has helped Australia to adjust to international shocks and keep inflation in check during the boom. But let's not pretend that it doesn't have some costs that the government and the RBA will need to manage.