Jim Jubak

Is China's economy headed for a hard landing in 2011 or 2012?

I don't think so. I'd go so far as to say, not a chance.

That answer, and most definitely its certainty, will surprise you if you think the question is about economics. After all, growth in China's manufacturing sector seems to be slowing but with no discernable effect on inflation. Investment in assets such as factories and real estate is exactly what we'd expect in a bubble. And the latest interest-rate increase by the People's Bank to 6.56% is a tiny adjustment that won't nip the problem in the bud. We've seen this movie before, and it ends with the central bank having to crack down hard after waiting too long to take meaningful action.

But this isn't a question about economics. It's about politics. If anybody thinks that Beijing's leaders are going to let anything like inflation targets, asset bubbles or bad loans spoil the 90th anniversary celebration of the founding of the Chinese Communist Party or the coronation of a new generation of leaders in 2012, they're confusing China with a free market economy. China's government will do whatever it takes to prevent a hard landing this year or next.

That said, China's economy has the numbers of an overheated engine ready to blow all its gaskets.

  • Inflation is continuing to go up despite three interest-rate increases from the People's Bank of China in 2011. Economists project that inflation hit 6.2% in June, up from 5.5% in May.
  • Fixed asset investment -- that's money going into real estate, commercial space, and factories -- climbed by 25.8% in the first five months of 2011 from the same period in 2010. That's a disappointing increase from the 23.8% rate of growth in 2010 and a clear sign that the economy is still putting excess cash to work in assets that won't pay off. For example, even though China's steel industry earned a net profit of just 2.91% in the first five months of 2011, plans are to expand production by 25% over the next five years.
  • Money supply (as measured by M2), slowed its growth to 15.1% year-over-year in May from 16.6% in April. But the gap between growth in the money supply and in the economy is still inflationary.
  • Bank lending is down. New loans fell to 552 billion yuan ($85.4 billion) in May from 740 billion in April. But evidence suggests bank loans are falling because lending has shifted to non-bank lenders. And if you include loans made by local government lending platforms, China has the kind of growing bad-loan problem that precedes a hard landing. Moody's recently estimated that if you include all local government lending, China's banks could be looking at 8% to 12% of loans going bad.

Anecdotally, there are more ways that China looks like an overheating economy headed for a quick dip in ice-cold water.

High-speed trains to where?
Take the boom that's occurring around railroad stations on China's new high-speed train lines.

For example, in Qufu, the birthplace of Confucius, the town government has built a bus terminal near its station on the just-opened Beijing-to-Shanghai line and then connected it to the downtown with the new Confucius Avenue. The bus station and Confucius Avenue cost the town 755 million yuan, or about 70% of the city's 2010 revenue. Nearby, the Shangri-La Asia chain is building the city's first luxury hotel, with 491 rooms. Qufu will be the smallest city in China to host a Shangri-La hotel.

Qufu isn't alone in investing to exploit the potential of the new high-speed rail system. Xuzhou, a city near the midpoint of the line, is developing a 5.2-square-kilometer (nearly 1,300-acre) business district near its train station that will include offices and a four-star hotel. Bengbu, in Anhui province, is developing a satellite town around its train station, with government offices and a residential complex.

It reminds me of one of the first stories I covered during the U.S. technology boom of the 1980s. The first venture capitalist I talked to said that the disk drive company he had funded "only needed 10% of the market." So did the second venture capitalist and the third and the fourth. By the time I got to the 20th disk drive company that needed just 10% of the market, I knew this investing boom wasn't going to end well.

And it didn't. Atasi went bankrupt. Cogito Systems went bankrupt. Data Storage International, ditto. Integral Peripherals. JT Storage. Ministor Peripherals. Tulin. Microscience International. During the product's history, about 200 companies made disk drives. Today the industry is down to just three major players.

It's unlikely -- extremely unlikely -- that all the Chinese cities and towns that have invested so much in projects linked to the high-speed rail system will recoup their investments. It's also unlikely that the additional 25% capacity planned for the steel industry will be profitable. Or that all the loans made by China's local government lending platforms will be repaid.

But don't expect the Chinese economy to be left littered with the smoldering hulks of the crashed and burned. This system doesn't work like that.