When will China overtake the United States as the world’s largest economy? That’s the question that’s getting most of the attention right now. At current growth rates the Chinese economy—at a GDP of $5.7 trillion at the official exchange rate or $10.1 trillion at purchasing power parity, which corrects for the differences for prices among different economies—will catch the $14.7 trillion U.S. economy sometime around 2016 on purchasing power parity (according to the International Monetary Fund), or in 2020 at the official exchange rate (according to The Economist.)

But the really important question for China and the global economy is when, or actually “if,” China will catch South Korea. Not in size of GDP, of course. China’s GDP has long since passed Korea’s $1.5 trillion (purchasing power parity) economy on that scale.

However in terms of per capita GDP China lags well behind with GDP per person of $7,600. Korea’s GDP of $30,000 is actually closer to the $47,200 per capita U.S. GDP than China is to Korea.

Why is this important? Because of something that economists call the “middle income trap.” Developing economies showing fast rates of growth have a tendency to slow down once they hit per capita GDP of $7,000 or about where China is now. Over 40 economies have reached that $7,000 per capita GDP level over the last 100 years or so, according to economic historian Angus Maddison. Of those, 31, or more than 75%, have shown a drop in their economic growth rate over the decade after they’re hit $7,000. The average drop in growth was 2.8 percentage points.

For some countries this drop in growth is temporary. Growth reaccelerates once the economy works through the transition from the export-driven, manufacturing-heavy model that typically fuels fast early growth. Korea, for example, hit the $7,000 mark in 1988, nearly defaulted on its debts in 1997 as a result of the Asian currency crisis, and then took off again in years after the crisis after reforming it economy. Since the end of 1997, the Korean economy has grown at more than twice the speed of the average developed economy in the Organization for Cooperation and Development.

On the other hand some economies that have reached the ranks of middle-income countries have stagnated for a decade or two. That was the fate of many of the Latin American economies that boomed in the 1960s and 1970s only to stagnate for the 1970s and 1980s. Only recently have countries such as Peru, Chile, and Brazil reaccelerated.

China’s economy has, on all evidence, hit this crux. Read more

Now this could slow the economy: China gets tough–maybe–with local government lending

A government report due at the end of June will sharply curtail the borrowing platforms that local governments have used to finance property development and infrastructure, according to a story by Caixin today http://english.caing.com/2011-06-22/100272075.html

The decision–if enforced with reasonable speed—would do more to slow the growth of new loans in China and to slow the Chinese economy that any of the increases in bank reserve requirements or benchmark interest rates announced by the People’s Bank of China.

According to a report from the People’s Bank more than 10,000 of these local government financing platforms were in business as of December 2010. That’s an increase from 7,500 in 2008. The platforms work by borrowing money from China’s banks and then relending it to finance everything from local real estate projects to roads to factories. These loans themselves, of course, don’t show up on bank balance sheets. The total debt at these local government platforms was 14 trillion yuan or about $2 trillion as of the end of December. Many of those loans have no hope of ever being repaid since they went to projects unlikely to ever turn a profit, Fitch Ratings has warned repeatedly. Older loans through the platforms to these projects have been paid off with new loans that themselves are unlikely to be repaid.

Even before the report is final, Caixin reports, the China Banking Regulatory Commission told banks in April to start curbing platform loans. And banks have been told to end the practice of transferring platform loans and collateral among themselves to manage their balance sheets.

If the new policy has any teeth, expect it to show up first in monthly figures on investment in fixed assets such as real estate and commercial and industrial buildings.

Beware China’s reports on growth and inflation tomorrow–they certainly have the power to move stocks

Don’t get buried by this week’s data dump from China. The numbers certainly have the potential to move financial markets around the world.

China weighs in on Tuesday June 14 with its monthly inflation and industrial production update. In April China’s annual inflation rate ticked down to 5.3% from 5.4% in March. With food prices still climbing economists are predicting that inflation will edge back up to 5.5% for May, according to Bloomberg. That will keep inflation above the People’s Bank of China’s target of 4% and feed into fears that the central bank will have to keep raising bank reserve requirements and benchmark interest rates to slow the economy and fight inflation.

Worry that the bank will slow the economy too much got an unpleasant boost from figures released today showing that both bank lending and China’s money supply grew at a slower pace in May. New bank loans fell to 552 billion yuan ($85 billion) from 639 billion yuan for May 2010. (There may be less to this decline than meets the eye. Faced with pressure to reduce bank lending, borrowing has shifted to non-bank sources. It’s not clear whether or not actual lending is falling or if what the numbers show is simply a shift in the sources of lending.) Even with the deceleration, however, yuan-denominated loans outstanding were 17% higher than a year ago. As measured by M2, money supply grew by 15.1%. That was down from 15.3% growth in April and marked a third consecutive monthly drop in the rate of growth.

Tomorrow will show whether this slowdown in the rate of bank lending and in growth in the money supply is reflected in the growth rate for industrial production in China. Read more

Can China’s biggest companies become true global players?

The next six months will test the power—and the limits of that power—of China’s global champions.

First, sometime in early 2011 California will decide what company will build the high-speed rail link between Los Angeles and San Francisco. The Japanese companies that built that country’s pioneering Shinkansen bullet trains and France’s Alstom (ALSMY), which built Amtrak’s disappointing high-speed Acela, will go head to head with Chinese rivals that nobody in this market ever heard of ten years ago.

The ability of Japanese and European companies to beat Chinese upstarts on the relatively neutral ground of California will speak volumes about China’s ability to win dominant positions in new global markets.

Second, the success—or lack of success—of Huawei, China’s champion in the telecommunications gear market, in breaking into the U.S. market will tell investors exactly how big a handicap the ties between China’s biggest companies and the Chinese government in general and the People’s Liberation Army in specific will be as these companies try to break out onto the global stage.

Between them, what happens with California’s bullet trains and Huawei’s attempts to break into the U.S. market will show investors the lay of the competitive terrain as the next generation of corporate and government spending speeds up as the global economy returns to whatever “normal” is after the Great Recession. Read more

China’s banks on the hook for $260 billion in local-government bad loans

That’s one huge bad loan problem.

23% of the $1.1 trillion that Chinese banks have lent to infrastructure projects backed by local governments are likely to go bad, an unnamed source with access to government data has told Bloomberg.

The works out to about $260 billion in potential bad loans or about five times the $50 billion that China’s five biggest banks plan to raise this year in new capital.

About half of the projects can’t generate sufficient revenue to cover their debt service. The interest on these loans will have to be paid by other sources including the local governments that guaranteed the loans.

The problem isn’t likely to show up all at once. Many of the loans to the investment vehicles set up by local governments (since China’s local governments aren’t allowed to borrow themselves) are long-term debt. Borrowers will probably manage to scrape up interest payments for the next year or two in the hope that something will happen to bail them out before running out of cash. That means that loan problems will start to show up in large numbers in two or three years.

But show up they will. This same insider said that government data show that only 27% of the loans to local government-affiliated investment vehicles will generate enough cash to repay their loans.

The central government is ultimately on the hook for this bad debt—well at least as much on the hook as Beijing can be given its history of simply burying bad debt in special purpose vehicles. Read more