China’s Economy: Bank Lending Restrictions to Slow Growth?

China’s regulators are asking banks not to grow their loan outstandings between October 31 and December 31.  This is a ham-handed way to slow the pace of economic growth and tame inflation, which is running 6.5 percent in China’s official statistics.  That 6.5 percent is an average; foodstuffs are rising by 17 percent, which has to make everyday Chinese people feel like they are experiencing runaway inflation.

Economic growth in each of the first three quarters of this year exceeded 11 percent.  Not too long ago we had been thinking that China’s long-run average growth potential was about nine percent.  We can’t be too sure about much in this regard, neither the official historic statistics or the estimated growth potential.  But the evidence from accelerating inflation is that the economy is growing too fast.

Our worry now: that blunt instruments will cause trauma. It’s quite likely that the new policy will not work gently.  I guess it will seem to not be working, possibly get dialed up, then all the time lags run out and China slows very sharply.  But the exact timing of this process is hard to nail down.

Will China go into recession?  Not in the sense that we know recessions, with real GDP falling for a couple of quarters.  But China’s growth will decelerate sharply at some time in 2008 or 2009.  After that, look for a sharp re-acceleration.  In the big picture, it will be a little blip in a long spell of growth.

What impact would a Chinese recession have on the United States? Don’t expect too much.  Our exports to China amount to about half of one percent of our GDP.  And a Chinese recession probably would not reduce U.S. exports to China, just slow the growth rate.  So don’t worry.

Some basic economic lessons can be taught from this policy.  Some doofus will calculate the change in bank lending from this policy, and compare it the change in bank lending from a developed country’s change in monetary policy.  Not apples to apples here.  China’s approach will lead to credit rationing, because there will be more demand for credit, at the going rate, than banks are allowed to supply.  The banks will pick and choose among their customers, kowtowing to the well connected.  In a market economy, borrowers sort themselves out based on who is most willing to pay higher interest rates.  So a market-based policy keeps credit flowing to the companies that can best use credit.  Efficiency of the economy is much greater that way.

This is just another example of stupid policy in China.  However, don’t get too pessimistic about this country.  They have so much room to grow, that they can survive a lot of stupid policy.  But some day, their advantage over the West in labor costs will be diminished.  If they have not yet adopted world class economic policymaking at that time, they will stagnate at a fraction of U.S. GDP per capita.