One of the most underestimated risks facing the global economy is an outright recession in China. Almost nobody in the world of economics or finance believes that it is possible, let alone likely. However, is it really that unlikely? The CLSA purchasing managers index has already topped out in April 2010, so while China’s economy is still expanding, the rate of expansion has likely peaked. The decline in the PMI in late 2008, coupled with similar falls at the time in freight transport, electricity production, and imports, suggests to me that the economy was in recession in Q109, despite the officially reported GDP growth figure of 6.1% y-o-y. Given the precarious state of the housing market and external demand, an outright decline in economic activity once again is a major risk. However, the chances of Beijing reporting such a scenario in the official statistics are very slim.

China Purchasing Managers

I would like to remind readers that Beijing’s CNY7.5bn loan quota for 2010 is already 45% accounted for with data only out up to April, which means much tighter monetary conditions over the coming months. Should the property bubble burst aggressively as a result, sending house prices in the major cities down 30%, it is not difficult to imagine a situation where construction spending falls by a similar amount. Construction spending in the US is currently down 30% from its peak after a similar decline in home prices, and the ‘house prices never fall’ mentality that drove the construction boom in the US appears every bit as visible in China today, which I take as a worrying signal.

Regional Investment Booms

The accompanying chart shows how China’s current investment boom compares with others we have seen throughout the region, namely Thailand and Malaysia in the 1990s and Japan in the 1980s. While the true rate of expansion may be exaggerated by Beijing’s unique accounting methods, the boom is clear for all to see, and the historical precedents are a cause of major concern.