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Morgan Stanley’s Roach warns on China slowdown next year

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teaching-english-in-chinaWidely followed analyst and chairman of Morgan Stanley Asia, Stephen Roach has warned that China may face an economic slowdown in the middle of next year because its growth model is unsustainable.

He sees the record growth rates of this year as leading to a complacency about the outlook for China: ‘China’s growth model is much more about supply than demand. It’s not a sustainable model for any nation.’

Not sustainable

Stated in simpler terms China has massive overcapacity from its previous export-led growth that is only being sustained by artificial spending from a government stimulus package equivalent to half of GDP in the first six months of 2009.

No country can continue spending at that rate for long, and Chinese foreign reserves of $2 trillion will run out by the middle of next year if it continues to do so. Perhaps then it is no coincidence that Dr. Roach says ‘China’s economy risks slowdown again around mid-2010’.

Of course the middle kingdom is gambling that the US economic motor will be firing on all eight cylinders by then. However, a US recovery may be at best anemic and at worst non existent.

China will therefore have to hack back its government spending and that will result in a domestic recession. There are also bubbles in the stock market and real estate that will deflate suddenly with consequent damage to the real economy and bad debt levels.

High risk, high reward

China has risked all on maintaining its high level of economic growth this year, and with 8.9 per cent GDP growth in the last quarter has pulled it off. But nothing goes up in a straight line forever in economics and a day of reckoning is close.

Dr. Roach is right to warn of the approaching economic crunch in China. It has wide implications for the rest of the world. The commodities complex, including oil, has benefited from Chinese over-spending. Without it commodity prices will revert to their long-term average or below.

For oil prices a major downturn in China could mean retesting the lows of last December before China rolled out its huge spending plans. And for the global economy as a whole this means a double-dip or W-shaped recession. The Great Wall of China can be breached.

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Written by Peter Cooper

October 25, 2009 at 8:15 am

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