China's Two Most Likely Scenarios In 2011: Overheating Or Recession

Simple Views on China Economy today: from strength to strength

China economy has staged a strong and fast recovery since 2009, with strong figure of PMI in November, the economy is powered ahead.

chartSource: China Federation of Logistic and Purchasing

 However, I believe China Economy is on the verge of overheating as the super supportive monetary expansion and undervalued currency fuelled the excessive growth of money supply. 

chartThis is copyrighted material. Please use the following link to reference the original article, but do not copy & paste articles which is copyright infringement. Source: People’s Bank of China, St Louis Fed

The CPI figure, while doesn’t look like it has gone out of control, is very likely to break out on the up side

chart Source: National Bureau of Statistics

Home prices are still high.  Although some administrative measures (e.g. limiting mortgages approval, not allowing people buy second and third homes, etc) showed modest effect earlier this year, the uptrend seems to be intact.

chartSource: ehomeday

My very little thought on China Economy in 2011

The goal for Chinese is probably to maintain strong growth but at the same time lowering inflation and stop asset bubbles.  These are incompatible goals, and I have said that they have to choose only one.

On the monetary policy, I believe more tightening (interest rate hikes and reserve requirement ratio hikes) is possible given the strong monetary growth and inflationary pressure.  However, the government is also doing something which are completely opposite to tightening.  The undervalued currency and supportive monetary policy has fuelled inflation and asset bubbles.  As of now, the Chinese government has shown very little intention to allow the Chinese Yuan to appreciate faster.

Also, China announced that they will invest 1 trillion Chinese Yuan to build 10 million public housing.  I think this is not targeted directly at curbing home prices, rather, it is to ensure that low-income families have affordable places to live, with a side effect of giving fixed-asset investment a boost.  Together with the start of 12th five-year plan in 2011, where the state is probably investing some US$1.5 trillion in 7 strategic industries in the next 5 years, the fixed asset investments will still probably be the growth driver.  However, the progress in its transition into a consumption-led economy looks slow.

China is confronting a dilemma, where they have to slow inflation and prevent asset bubbles from going bigger.  At the same time, they fear that aggressive tightening would lead to a recession.  I am really not sure how the Chinese government can achieve their goals of simultaneously lowering inflation and support growth.  Putting another US$1.5 trillion into the economy does not sound like a very intelligent move if you know that your economy is overheating.

So in 2011, the Chinese government will tread a fine line between overheating and plunging itself into recession.  That, to me, would be a even bigger uncertainty than Euro crisis and the possibility of the US double-dip recession.

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