By Ruchir Sharma

The New York Times

June 03-2016

Sunday Review | OPINION

A vendor waits for customers at a market in an urban village

under demolition in Zhengzhou, Henan province, in May.

Credit China Stringer Network/Reuters

FOR years now, Donald J. Trump has been sounding the alarm on China, calling it an economic bully that has been “eating our lunch.” The crux of Mr. Trump’s attack is that Beijing manipulates its currency to keep it cheap and give Chinese exports an unfair advantage. But that narrative is so last decade. China is now a threat to the United States not because it is strong but because it is fragile.

Four key forces have been shaping the rise and fall of nations since the 2008 financial crisis, and none of them bode well for China. Debts have risen dangerously fast in the emerging world, especially in China. Trade growth has collapsed everywhere, a sharp blow to leading exporters, again led by China. Many countries are reverting to autocratic rule in an effort to fight the global slowdown, none more self-destructively than China. And, for reasons unrelated to the 2008 collapse, growth in the world’s working-age population is slowing, and turned negative last year in China, depleting the work force.

Soaring Debt

China’s total debt as a percent of G.D.P. — public and

private debt, including both commercial and household —

has risen sharply. Total U.S. debt has stabilized.

Source: Bank for International Settlements

Charts by Bill Marsh/The New York Times

It will be difficult for any country to grow as rapidly as 6 percent, and all but impossible for China. Nevertheless, in an effort to exceed that target, Beijing is pumping debt into wasteful projects, and digging itself into a hole. The economy is now slowing and will decelerate further when the country is forced to reduce its debt burden, as inevitably it will be. The next step could be a deeper slowdown or even a financial crisis, which will have global repercussions because seven years of heavy stimulus have turned the world’s second largest economy into a bloated giant.

In Beijing, confidence has given way to a case of nerves. Local residents often sense trouble coming before foreign investors and are the first to flee before a crisis. Chinese moved a record $675 billion out of the country in 2015, some of it for purchases of foreign real estate. If China were eating America’s lunch, its people would not be rushing to buy safe-haven apartments in New York or San Francisco. Far from conspiring to cheapen its currency, as Mr. Trump charges, Beijing is struggling to keep the weakening renminbi from falling more, which would further erode local confidence and make a crisis more likely.

The seeds of China’s current problems were planted in the months after the global economic crisis of 2008. When I visited Beijing in September of that year, just before the Wall Street implosion, the country’s economy was slowing, but the city was calm. Beijing had hosted the Summer Olympics, and in preparation had temporarily shuttered smokestack industries and eased censorship. The skies were clear, the conversation much more candid than it is today.

The nation had good reason to feel confident. Like Japan, South Korea and other Asian “miracle” economies, China had generated a long run of double-digit growth by investing in export industries. But Wen Jiabao, then prime minister, was not complacent. He was warning that after three decades of heavy industrialization, China was “unstable” and “unbalanced,” with too many factories belching too much smog. Many prominent Chinese recognized that with per-capita income rising above $8,000, their nation would face a natural slowdown, as Japan and South Korea had when they reached a similar middle-income level. Meanwhile, among outsiders, there was hopeful talk of how China would evolve into a democracy as it grew richer — again following the path of earlier Asian miracles.

Then, two weeks after I left, Lehman Brothers filed for bankruptcy in the United States, tipping the global economy into recession. Demand collapsed across the world, crushing export growth in China. The leadership in Beijing panicked, apparently fearing that if the recession reached its shores, social unrest would follow. Mr. Wen reversed course and doubled down on the old industrial model — fueling investment in factories with trillions in state lending and spending.

At first, the bet appeared to work. In 2009, China managed once again to beat its longstanding growth target of 8 percent, as the West struggled to recover from its deep recession. The rapid spending unleashed by Beijing contrasted sharply with the relative gridlock in Washington and the global elite, gathering for their annual confab in Davos, Switzerland, in 2011, marveled at the benefits of state capitalism. China, they said, was proving that unchecked autocracies had an advantage in managing the economy, particularly in a crisis.

But looking back, we can see that this was the moment China began to fall off the miracle path.

A Rising Currency, a Less Competitive China

As the renminbi becomes more valuable, China’s exports get more

expensive. Percent change in the real effective exchange rate since 2003.

2016 figures through April 30.

Source: Morgan Stanley Investment Management analysis

of data from the Bank for International Settlements

and the International Monetary Fund

As its debt mania progressed, more of the lending was diverted into wasteful speculation. Normally, frenzied borrowing occurs amid excitement about a new innovation like the internet. But this spree spread on conviction that Beijing, obsessed with hitting its growth target, would not let lenders or borrowers fail. More and more unqualified players got in the game. The state banks soon had to compete with “shadow banks,” including crowdfunding websites that offered ordinary people a chance to invest in debt for as little as one renminbi (15 cents), promising fantastic returns.

Try as the Chinese authorities might to steer the money into industry, they could never fully commit to stopping shadow banks from financing an increasingly questionable array of borrowers speculating in real estate. When I visited Shanghai in August 2010, I was stunned to see apartment blocks rising two to three rows deep all along the 110-mile route to Hangzhou. Many of the biggest debtors are front companies set up by local governments to evade national regulators. Small cities are borrowing to build futuristic museums, aquatic centers and apartment blocks that exceed local demand and are often as empty as ghost towns.

My research shows that during the 30 worst debt manias of the past 50 years, private debt — which in China is often held by local governments — rose over five years by at least 40 percentage points as a share of gross domestic product. In all 30 cases, the economy slowed sharply, typically by more than half, in the next five years.

China’s mania is now the largest ever in the postwar emerging world. After holding steady at around 150 percent of G.D.P. for much of the boom, China’s public and private debts surged after Mr. Wen’s about face in 2008, rising to 230 percent of G.D.P. by 2014. That 80-percentage-point increase is also more than three times the increase in the United States before its bubble collapsed in 2008. Since then, United States debt has held steady as a share of its economy. Though many Americans still think the nation is drowning in debt, its burden is much less worrisome than China’s because it is not growing.

Paradoxically, the authoritarian form of government that helped guide China to those years of economic growth may now be undermining its economic stability. My research suggests that compared with democracies, autocracies generate far more unstable growth, and that’s the risk in China now. Looking at the available records going back to 1950 shows that extreme swings between fast and slow growth are much more common under autocratic regimes. On a list of 36 countries that have been whipsawed between rapid growth and recession throughout the postwar era, three out of four were autocracies.

Because these governments face no check on their powers, they can force feed periods of strong growth. But they can also veer off in the wrong direction with no one to set them straight. In the early stages of China’s boom under Deng Xiaoping, Beijing did what authoritarian governments do best, suppressing opposition to breakneck development, steering the people’s savings toward building export factories and commandeering land to build the roads and bridges to bring the manufactured goods to market. But the same decision-making process, centralized in a small circle in Beijing, allowed the government to impulsively shift course in 2008 and push through the lending campaign that put China on the increasingly unstable path of more debt, and less growth.

A Future Labor Shortage

Year-over-year percent change in the working-age population (ages 15-64).

ON my recent trips to China, I keep looking for Beijing to snap back to reality, but in vain. As the economy grows more unstable, the authorities have tried to control the business cycle with an increasingly heavy hand that extends into its financial markets. In late 2014, hoping to give its struggling companies a new lift, Beijing began to praise buying stocks as a patriotic act. Millions of ordinary Chinese signed up to play the market for the first time, many unaided by a high school degree, and started borrowing to buy shares as prices rose. When the bubble burst last June, Beijing did not let it implode, as it had in 2008. It ordered people not to sell or even to speak critically of stocks. The market collapsed anyway.

Afterward the Davos crowd finally started to question whether Beijing could simply command its economy to grow. It looked as if the lesson might be learned in China, too, but when I visited this April, authorities had begun a new stimulus campaign, and debt was still growing three times faster than the economy. Against this backdrop, residents spoke of dizzying price rises in Shanghai and Beijing real estate and in obscure markets like steel rebar futures. Their intention was to keep dancing until the borrowed money stopped flowing.

The sputtering global economy is one shock away from slipping into recession. In the postwar period, every previous global recession started with a downturn in the United States, but the next one is likely to begin with a shock in China. Through heavy stimulus, China was the largest contributor to global growth this decade, but it is fragile. China’s miracle growth period is over, and it now faces the curse of debt.

Ruchir Sharma

Ruchir Sharma is the chief global strategist at Morgan Stanley Investment Management. This essay is adapted from the forthcoming “The Rise and Fall of Nations.” (From The New York Times).

Ruchir Sharma is an emerging market portfolio manager, and has written widely on global economics and politics. As head of the Emerging Markets Equity team at Morgan Stanley Investment Management, he manages over $25 billion in assets under management. A longtime columnist for newspapers and magazines around the world, Sharma is the author of The Rise and Fall of Nations: Forces of Change in a Post-Crisis World (Norton/Allen Lane, June 2016) andBreakout Nations: In Pursuit of the Next Economic Miracles (Norton/Allen Lane, April 2012).

Carrer:

Sharma has told interviewers he spent his early school years in Mumbai, Delhi, and Singapore. He did his undergraduate studies at the Shri Ram College of Commerce in New Delhi, and afterward joined a securities trading company, and in 1991 he launched a column called For Ex, first for The Observer, later for The Economic Times of India. His writings attracted the attention of Morgan Stanley, which hired him in its Mumbai office in 1996. In 2002 he moved to the New York office, which remains his base today. In 2003 he became cohead of the emerging markets team at Morgan Stanley Investment Management. In 2006 he became head of the team.

Breakout Nations: In Pursuit of the next Economic Miracles is a 2012 book written by Sharma. The book discusses his views on Emerging Markets and his travel through these countries. Sales of the book has broken records and has become an international best seller. Breakout Nations has received extensive global media coverage, including The Economist, The Washington Post, and The Wall Street Journal.[10]

In Breakout Nations, Sharma writes that he travels in emerging markets for roughly one week out of every month, in order to understand what is happening in the economy up close. He used those travels as the basis for his monthly columns in The Economic Times, and later became a regular columnist for Newsweek International, as well a contributor to the Wall Street Journal and other global publications. More recently, Sharma’s articles and columns have appeared in Foreign Affairs, The New York Times, The Washington Post, The Wall Street Journal, the Financial Times, Time, Foreign Policy, Forbes, The Bloomberg View, and other publications.

W. W. Norton & Company has announced that Sharma's next book, The The Rise and Fall of Nations: Forces of Change in the Post-Crisis World will be released in June 2016.

Economic Views:

Sharma has argued in his book and articles that the rise of emerging nations as a group is a “myth” that came to seize the global imagination in the unprecedented boom of the 2000s, when emerging nations actually did grow as a group. Typically, when an emerging economy gets hot, it will grow fast for a decade, maybe two, then backslide when its leaders grow complacent. The result is that most emerging nations remain emerging nations and very few (including Japan, Korea, Taiwan, and Singapore) have grown fast enough for long enough to emerge into the ranks of developed nations. One of Sharma’s fundamental messages is that analysts need to study nations as individual cases, not as part of faceless groupings, in order to understand which ones have a chance to excel. Sharma refers to those with the brightest prospects as “Breakout Nations,” which he defines as an economy that can sustain faster growth than peers in the same per capita income category for the foreseeable future, which he considers no more than five to ten years. Sharma has been a sharp critic of forecasters who attempt to make predictions for the coming century.

This nation-focused approach underpins Sharma’s skeptical view of the hype surrounding the “BRIC” nations, the catch-all acronym for the big emerging markets, Brazil, Russia, India and China. In a cover story for the November/December 2012 issue of Foreign Affairs, “Broken BRICs, Why the Rest Stopped Rising’, Sharma argued that if you look at the individual storylines in these nations, each faces serious challenges to sustaining rapid growth. For example, China has reached a stage in development, with a per capita income of around $6,000, at which the growth of even the most successful economies in history (including Japan, Korea and Taiwan) began to slow markedly. And as China slows, nations like Brazil and Russia that thrived mainly by selling raw materials to China will slow as well. Many commentators have juxtaposed Sharma’s view against that of Goldman Sachs' economist Jim O’Neill, who coined the term “BRIC” to capture the hot economies of the future.

China:

As early as 2010, Sharma was arguing that China is “running out of growth drivers.” He contends that China has little scope left to expand the heavy investment that has driven the double digit growth of recent years, a declining pool of surplus rural labor leading to rising factory wages, and the basic challenge of growing fast from a high-income base all conspiring to slow growth – gradually, not catastrophically—in the future.

In early 2012, Sharma argued in an oped for the New York Times that while the China bulls are too optimistic about its ability to sustain 8 percent growth indefinitely, the bears are too quick to forecast disaster. The greater likelihood is that China “is slowing to a rate that is ideal for the interests of the United States: fast enough to remain an important pillar of global economic growth, but not fast enough for China to remain a disruptive threat to American power.

More recently, Sharma has focused on China’s “own debt bomb,” writing that the money supply and private debts are growing dangerously fast. Sharma notes that, according to studies by the International Monetary Fund and the Bank for International Settlements, such rapid accumulation of debt normally presages a major crisis or, more likely he argues in China’s case, a sharp deceleration in growth.

Commodities and Oil:

Sharma has been a sharp critic of those who argued, in the last decade, that increasing demand from China would lead to a commodity supercycle—a rise in prices for commodities such as oil, lasting indefinitely. He contends that the inevitable slowdown of China, as its economy matures, would restore the normal global commodity cycle, in which prices rise for a decade and fall for two decades.

He applauds this likely turn, arguing that rising prices for commodities, particularly oil, led to the rise of “bad billionaires” who make money by “digging stuff out of the ground,” at the expense of “good billionaires”, who work in productive industries like technology.

Recently he has written that the “China-commodity connection” is breaking, and that the retreat of commodity prices will undercut commodity economies that thrived in the last decade based on spiking prices. Those include Russia, Brazil and “nasty petro states”, and their retreat will greatly help commodity importers such as the United States. He says that, if anything, Americans underestimate the negative impact of high oil prices, noting that a sharp increase in oil prices has laid the stage for virtually every postwar recession.

Brazil:

Sharma, who has argued that other nations like South Korea are spending too little on welfare given their income level, says that Brazil is spending too much. He argues that in focusing investment on welfare rather than infrastructure, Brazil has created an economy with too little capacity—too few roads, schools—which means that when the economy starts to grow fast, demand for these facilities quickly outstrips supply, triggering inflation at a relatively slow rate of growth of only 4 percent. Sharma’s May/June 2012 article in “Foreign Affairs,” “Bearish on Brazil,” provoked a number of critical responses arguing that he had either failed to appreciate how much Brazil had done to encourage the rise of the middle class within a democratic system, or had failed to criticize the shortfalls in Brazil’s economic reform efforts harshly enough. Sharma responded that the bottom line is weak growth compared to the competition: Brazil’s long-term growth rate has averaged just 2.5 percent, well below emerging nations in its per capita income class, including Turkey and Russia.

India:

Sharma is best known in his home country, India, where “Breakout Nations” broke sales records for a serious non-fiction book and provoked widespread discussion over his view that India has at best a 50-50 chance to be a Breakout Nation. Sharma has argued for some time that India’s growth shows a clear pattern, rising and falling with the tides of the global economy, even when its leaders take personal credit for the periods of strong growth. He has argued that India needs to develop a stronger, more sustained will to reform, as East Asian success stories have in the past.

Recently, Sharma made the case that India is starting to evolve along a federal model, similar to the European Union, with each state pursuing its own economic strategy, and those states with competent leaders growing much faster than others do. Sharma contends that this federal structure fits the diverse “natural fabric” of India, and should be encouraged by the national leadership.

Other Emerging Markets:

Sharma has argued that his view of the BRICS should not be misconstrued as a negative view of emerging markets as a whole, just recognition of the historic reality. Over time, it is very unusual for all the emerging markets to boom at once, the way did between 2000 and 2010.

In 2012 Foreign Policy magazine cited Sharma as one its top 100 Global Thinkers “for dusting the gold off the term ‘emerging markets’, and refocusing the global discussion on “the real breakout nations to watch.” In an accompanying article, Sharma described seven of his top candidates, including the Philippines, Turkey, Indonesia, Thailand, Poland, Sri Lanka and Nigeria. FT emerging markets editor Stefan Wagstyl wrote that emerging market investors are bullish by definition, otherwise they would be investing elsewhere, and found it “refreshing” to read an emerging markets book that was “mercifully light on blue sky predictions” and “that has little truck with the relentless Bric-led rising of the emerging world.”

United States:

Sharma emphasizes in Breakout Nations that success has to be defined in relative terms. As the global economy slows, money and satisfaction will flow to nations that grow faster than peers, even if their own growth rate is slower than it was during the boom of the last decade. Analysts need to compare nations against rivals in the same per capita income class, because the challenges of growth change rapidly as a nation gets richer. So India should be compared to rivals in the class of emerging nations with average per capita income below $2500, Brazil should be compared to those with per capita incomes between $10,000 and $15,000, and so on.

In 2012, Sharma began applying this basic framework to analyzing the position of the United States, and concluded that – despite the growing camp of American declinists—the United States is in position to be a “Comeback Nation.” He cites five key factors, all related to the superior flexibility of the US system, compared to its peers. The US is paying down its private debts faster than European rivals or Japan. The dollar is at its most competitive level in three decades (in real terms). The US remains the hub of technological innovation. The revolution in US shale oil and gas is greatly lowering energy costs. All these factors are helping to spur a US renaissance in manufacturing, putting the US in position to be the “breakout nation of the developed world,” if it can address its Achilles heel: rising government debt.

 (From Wikipedia, the free encyclopedia).

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