China’s economic boom has been like nothing the world has ever seen, and that financial might will continue translating into political capital. But is the country headed for a painful correction similar to the one experienced by Japan in the 1990s? Perhaps, and that doesn’t even take into consideration a gigantic older population that will need to be supported as modernization increases lifespan. From Martin Wolf at Financial Times:

…why should anybody doubt China’s ability to grow quickly for years?

The first reason is that growing very quickly is rather like riding a bicycle: it goes well so long as speed is maintained. Once it slows, however, a bicycle starts to wobble. This is why managing deceleration is so hard. The second reason is crucial: the Chinese economy is highly unbalanced. Slowing an unbalanced economy is particularly hard.

A salient aspect of the unbalanced economy is the high savings rate and thus its reliance on investment as a source of demand. Yet, as the economy slows, the demand for investment is likely to fall more than proportionately. The reason is that past investment was done on the assumption of annual growth at 10 per cent. With growth substantially slower, excess capacity will be chronic. What do people do when they have excess capacity? They stop investing. That is also why China’s government needs to keep growth up: if it fails to do so, investment might collapse, with devastating effects.

That is not all. The combination of a debt overhang with a slowing economy is particularly damaging. Yet that is what the credit-fuelled, property-related investment boom has created. As growth slows so would the ability to service debt, even if underlying investments might ultimately be profitable. This decline in debt-servicing capacity would generate a “balance-sheet recession” in demand. That would add to the adjustment to investment outlined above. This combination is what laid the Japanese economy low in the 1990s.

If the Chinese economy is to shift into its new normal on a stable and sustainable basis, it has to avoid any such collapse.•