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The Austrian explanation of recessions is actually true – Evergrande Edition

An interesting proof of the Austrian contention on recessions:

The potential timebomb has been ticking for some years. China’s housing market has become hugely bloated by years of cheap credit and is reckoned by conservative estimates to account for 16% of GDP, although some estimates put that figure at 25% – far more than the proportion in western economies.

But the low-hanging fruit of debt-fuelled growth has long gone. In 2007-08, about 6.5tn yuan ($1tn) of new credit was needed to raise GDP by about 5tn yuan a year, according to the IMF. In 2015-16, it took more than 20tn yuan in new credit for the same growth.

This means it is becoming much more expensive to repeat the trick, as more credit is pumped into the system for an ever-decreasing impact. In the end there has to be a reckoning and the crisis at Evergrande suggests that the cycle has finally caught up with the poster child of China’s property-market miracle.

Just to remind of the nutshell of that theory. Folks throw free money around into such a plethora of malinvestments that the only possible cure is to let them all go bust and start again.

This does appear to be true here. And it’s as with ripping off a plaster, better t’were done quickly.

The error with the Austrian diagnosis is as with any and every macroeconomic theory. Which is that recessions come in different flavours. They are not all the same. Today in China may have similarities with 2008 in the US but neither are anything like 1981 in the US. We have, sadly so, too little an evidence base to be able to settle upon the one cause of recessions. We know the numbers for some handful – not even all the OECD – of economies back to WWII or so, 5 or 8 business cycles perhaps, this just isn’t enough data on enough incidences to be able to plump for just the one explanation.

That is, as with most macroeconomic theories, each one is right sometimes, wrong others, and knowing which is which is the trick.

At which point, yes, China does seem to be on the cusp of an Austrian recession. Bully for the Austrian definition of recessions then.

6 thoughts on “The Austrian explanation of recessions is actually true – Evergrande Edition”

  1. I wonder if the biggest loser out of this might be Taiwan. If things go seriously wrong for the CCP, a glorious small war might take some of the heat off.

  2. Here’s an easy way to tell whether war on Taiwan is intellectually serious or is just intended as a distraction for the Chinese masses. If they do it the sensible way – mine Taiwan’s harbours and wait – then they are serious. If they go for bombing raids and soldiers rushing up the beaches then it’s distraction.

  3. Austria is a nice place to visit. Vienna is beautiful.
    I hope there is no World recession. Would China having a recession hit the Western nations, or would it make no difference to the West?

  4. re: malinvestment versus “too early investment”

    This is about the 2008 housing bubble, but it might be relevant here.

    I agreed that there had been some excessive housing construction in the inland portion of the sand states, perhaps because builders expected the US population in 2050 to be 50 million higher than is now predicted. (Recall that 2006 was the year of the immigration crackdown.) But I argued that these cities were fast growing, and this problem was relatively mild. In my view the malinvestment is better termed “too early investment”—some houses were built a few years before they were needed. The Austrian counterargument was that these houses would remain empty for decades, and eventually depreciate sharply (in a physical sense.) It looks like I was closer to the truth. —Scott Sumner (About that “malinvestment”)
    [end quote]

    link to article:

  5. Plenty of CCP investment in African countries. It depends on your definition of malinvestment – they might have been good investments which should have turned out well with nice interest repayments. You could use a simpler definition of malinvestment, which is based on the outcome of not getting repaid e.g. due to bad KYC.

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