F.ORECASTS CAN haunt their authors, especially when they appear in headlines or book titles. Most experts play it safe and give “a number or a date, but not both,” as an old wise man once advised. Bloomberg’s Thomas Orlik is bolder. His most recent book, China: The Bubble That Never Pops, provides an unusually balanced account of China’s economic resilience that is both closely watched and analytically interesting. But its title offers quite a hostage of luck. After all, “never” is a lot of data.
Fortunately for Mr. Orlik, his definition of China’s bubble gives him some leeway. It doesn’t refer to any particular market or mania (like the tech frenzy this year, bike sharing in 2017, or the caterpillar fungus in 2012). The title instead refers to China’s resilient economic dynamism that has weathered countless predictions of collapse. Even now, this unstoppable force is recovering from the Covid-19 pandemic (which came after this book was written) at an impressive rate. Will Mr Orlik ever wish he never said never?
Although Mr. Orlik does not rely heavily on economic theory to justify his trust, it does take comfort. A bubble that never bursts sounds like something the laws of business should rule out, like a free lunch or an out-of-pocket dollar bill. Indeed, theorists have long considered the possibility of sustainable bubbles, inspired by the work of two Nobel Prize winners Paul Samuelson (1958) and Jean Tirole (1985).
They showed that bubbles can persist when an economy’s rate of growth consistently exceeds its interest rate. In these circumstances, a bubble can remain both attractive and affordable, enticing shoppers to feed themselves without dwarfing the economy. For example, suppose that workers of each generation are putting a portion of their income into an inherently useless asset, such as an empty apartment, that they want to sell in retirement. Since each cohort has the same plan, each of their descendants will find buyers for the asset they bought from their ancestors. Since another generation “always comes along”, as Samuelson put it, this chain never has to break.
As the economy grows, each generation can spend more income on the asset than the previous one. This allows the seller to achieve a positive return. And when the rate of growth of the economy exceeds the interest rate, that rate of return is higher than what other austerity measures like bank deposits can offer. This condition, known as “dynamic inefficiency,” was once considered rare. But at a time when interest rates are close to zero, it seems almost familiar. China’s dynamic inefficiency was documented by economists at the Hong Kong Monetary Authority in 2006 and confirmed by subsequent studies.
China’s interest rate may underestimate the country’s true return on investment due to ongoing financial repression. Even so, according to a 2014 article by Kaiji Chen of Emory University and Yi Wen of the Federal Reserve Bank of St. Louis, a long-lasting bubble could emerge. In their model, private capital produces impressive returns as long as it can benefit from cheap labor migrating from fields to factories and from state-owned companies to private companies. This gives entrepreneurs the financial means to make huge sums of money in the real estate market. At the same time, they know that when their workforce becomes scarce, their company’s profitability will eventually decline. This gives them the motive to diversify their assets into other stores of value such as real estate.
In this scenario, house prices will keep pace with the return on business capital, which is even higher than the growth rate of the entire economy. Then, when it becomes more difficult to find workers, the returns on capital and property fall steadily at the same time. The later chapters of Mr. Orlik’s book explain how China coped with this slowdown. It entered in a shaky state in 2016. Real estate developers had discouraging inventories of unsold homes and owed shadow lenders similarly discouraging amounts. China also suffered from overcapacity in related industries like steel, which threatened to plunge the economy into deflation.
How did China deal with it? The answer is what you could call the five: reflating and remixing the economy, and refinancing, rotating, and depreciating assets and liabilities. China has reshuffled the mix of activities without slowing down. It has spent less on new mines and steel mills and more on infrastructure. Projects financed with short-term high-interest bank loans were refinanced with low-interest bonds from the provincial governments. Some debt shifted from overworked developers to cleaner household balance sheets with easier access to mortgages.
China has also written off bad loans (including shadow loans) and many physical assets. Old mines were closed. Slums were cleared. Displaced households were given money to buy newer homes. These efforts have often been funded by targeted central bank loans. The releases, closings, and write-offs reduced the prosperity of the economy but did not interrupt the flow of new activity. Indeed, the combination of new money injected into the economy and old capacity removed from it has raised prices and accelerated nominal growth GDP. This restored the gap between growth and interest rates and made it easier to maintain debt.
This purge capitalized on some of China’s unusual strengths, including the reach of its regulators and the flexibility of its workforce. When the mix of activities changed, workers followed suit. But it also conformed to some economic principles that could apply anywhere. The deflationary pressures China faced during this dangerous time showed that there was room to stimulate the economy. And because interest rates were lower than growth rates, it could afford to renew any debt that it dared not write off.
Will China never pop? Safer to say, there is little that it cannot wipe.■
This article appeared in the Finance & Economics section of the print edition under the heading “The Mop That Never Stops”.