Fears of a slowing Chinese economy added to the woes of global sharemarkets overnight, as investors fretted that the juggernaut of global economic growth could finally be faltering.

Chinese share prices tumbled after the HSBC preliminary PMI for China — a leading indicator of Chinese manufacturing activity — fell to 51.1 in May, from 51.8 in April. A result above 50 shows continued growth, but the drop in the index points to a slowdown in the pace of growth.

The drop in the index heralds a “further cool-down of the world’s second largest economy, as both domestic tightening and external supply disruptions kick in”, Qu Hongbin, HSBC chief economist for China, said in a research note. But, he added, “cooling growth is not all bad news as it also helps to tame inflation”.

Qu also dismissed fears that the Chinese economy was set for a hard landing, saying the current level of the index was consistent with Chinese GDP growth rates of about 9%. He predicted that inflation, rather than growth, would remain Beijing’s top priority in coming months, especially since China’s consumer price index was likely to climb until around the middle of the year. (China’s CPI rose 5.3% from a year earlier in April, down slightly from March’s 5.4% rise but still well above the official full-year target of about 4%.)

“As such, current tightening measures must be kept in place for a while longer to manage inflationary expectations. We continue to expect more hikes in the coming months.”

But other analysts argue that China’s growth is about to slow sharply as a result of the Chinese central bank’s inflation-fighting measures. The central bank has hiked interest rates twice this year, following two similar moves in 2010. It has also lifted banks’ required reserve ratio five times this year, following six increases in 2010.

Mark Lapolla, head of strategic research at Knight Capital, provides an even more pessimistic assessment of the Chinese economy.

In a recent interview with Kathryn Welling at [email protected], he argues that the Chinese economy at present bears an uncanny resemblance to the US economy in 1929, just before the onset of the Great Depression.

He points to eight key similarities — the massive disparity of wealth, income and education; the rapid industrialisation and displacement of labour; opaque and misleading economic and financial data; a massive build-up of leverage across the “rising” class; bubbles in residential real estate and fixed asset/infrastructure development; an accelerating and uncontrolled growth in disintermediated credit; the expected transfer of economic growth to domestic demand; and, finally, an accelerating price/wage spiral.

At present, he says, China has lost control of its economy. “Essentially, in its own zeal to placate its masses with rapid growth, China has created a tide of inflation that threatens it with widespread social unrest. But if it crushes speculation and clamps down on credit, it risks a deflationary collapse that would also threaten social harmony. The upshot is that China no longer controls its own destiny. The free markets do.”

Lapolla, who in 2007 predicted a collapse in US credit markets, argues that China, along with a growing number of emerging countries, is now caught in a price/wage spiral that it won’t be able to tame through traditional monetary, fiscal and legislative controls.

The price/wage spiral, he says, is not only the result of the country’s massive credit boom, but also of surging wage inflation. “We’ve seen 20% to 30% wage increases by the government on the low end, and by contract manufacturers such as Foxconn, which does the Apple iPhone, on the high end. It has raised wage rates almost 30%.” China, he says, has probably reached a tipping point where the movement of workers from agriculture to manufacturing hits a peak, and then begins to taper off.

Eventually, he says, investors will lose faith that the global economic recovery “will be driven by this juggernaut in China, and the other emerging markets in Asia”.

When those hopes are nipped, he says, “the world will be left with the dominoes — which are the deflationary adjustments starting in the US and then moving across Europe and then finally, into the emerging markets”.

*This article first appeared on Business Spectator.

Peter Fray

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