Flash! Ah-Ahh!

By S.C. | HONG KONG

AS BUTTONWOOD has already noted, HSBC yesterday published its "flash" (ie, preliminary) purchasing managers' index for Chinese manufacturing (compiled by Markit). The PMI reading fell to 51.1, its lowest since July 2010. The release contributed to stockmarket declines in Japan, Australia, South Korea and Hong Kong as well as mainland China itself. The Shanghai Composite fell again today, for the fourth session in a row.

In the face of all this consternation, can I humbly point out that a reading of 51.1 is consistent with growth of 13% in Chinese industrial production and 9% in Chinese GDP. Settle down people.

Since late 2009, once it became clear China had pulled through the global financial crisis, I've despaired of keeping track of the pendulum swings of sentiment towards the country. I never know whether people want the economy to grow faster or slower. In the spring of 2010 people were worried about a property bubble, suggesting things were a bit hot. But when the government imposed curbs on mortgage borrowing and speculative homebuying in April of that year, people quickly began to fear a hard landing. Likewise in the past few months, China-watchers have documented the government's struggles to rein in its banks. But now that it seems to be succeeding, people are once again raising the alarm about a severe slowdown.

It is as if China-watchers are possessed by the 70-year old Harrod-Domar model of growth, in which the economy is always poised on a knife-edge. If growth is faster than warranted, the overheated economy will only get hotter. If growth is slower, demand will fall ever further short of capacity.

Tao Wang of UBS Securities suggests one explanation: "Outside China most people's exposure to the country is through the commodities market," she points out. "In that market, things tend to get accentuated." Speculation is followed by capitulation. "Any change in Chinese demand, or in the rate of change of Chinese demand, gets amplified. Things are either great or they are a disaster."

Hard landings come in a number of varieties. They can follow the bursting of an asset bubble, for example. It is not actually all that clear why: just because a nation's stock of assets falls in value does not mean its flow of activity should slow. But in America in the past decade and in Japan in the 1990s, a run-up in asset prices was matched by a build-up of liabilities. The assets fell in value; the liabilities did not. Efforts to pay down those debts, rather than writing them off, took a toll on spending, resulting in a grinding recession.

There is reason to hope China's property bubble will do less damage. In America, property was a vehicle for borrowing. But in China it is a vehicle for saving--a place to put your money if you are fed up with volatile stockmarkets and niggardly interest rates. Households are not yet up to their necks in mortgage debt (although it is rising quickly to somewhere near knee height). No one knows quite how much debt developers have taken on, or how exposed banks will be should they falter. But we can take some comfort from the depth of the government's pockets. If push came to shove, it could afford to recapitalise any overstretched lenders. (It wouldn't be the first time.) As Stephen Green of Standard Chartered puts it, "small NPLs (non-performing loans) are the banks' problem; big NPLs are the government's problem." The government is also planning to build 10m affordable homes this year and the same again in 2012. So even if property prices fall, residential construction might slow less than people suppose.

Bursting bubbles are not the only, or most common, cause of hard landings however. They can also arise because policymakers let ordinary, consumer-price inflation get out of hand and then find it necessary to hammer the economy to quash it. The Volcker shock is the most famous American case. I suppose the best Chinese example is the brutally effective slowdown orchestrated by Zhu Rongji in the mid-1990s. But Premier Zhu was responding to inflation rates of 25%. China today, let's remember, has headline inflation of about 5%. If any other emerging economy reported that kind of inflation no one would bat an eyelid.

A hard landing can also ensue because the authorities do too much. In a piece last July I alluded to "painting legs on a snake", a Chinese expression for "overegging the pudding" or "gilding the lily", ie spoiling something by overdoing it. I confidently predicted that China's authorities would not overdo their efforts to slow the economy, by tightening more than was necessary. As it turns out, I was so right I was wrong. The economy subsequently sped up again, thanks to what Yu Song and Helen Qiao of Goldman Sachs called a "stealth stimulus". Even as I wrote my piece, the National Development and Reform Commission was apparently speeding up its infrastructure investments to perk up growth.

My impression is that the government is better at propping the economy up than at pulling it back. The small band of Beijing policymakers who worry about overheating (people like Zhou Xiaochuan, head of the central bank, and Liu Mingkang, who oversees the banks) struggle to prevail against the go-go governors in the provinces and the steamin' captains of state-owned industry. They may have a collective interest in slower, more sustainable growth. But each would rather everyone else's fiefdom did the slowing, leaving them more room to expand.

Given these difficulties, I am glad that the government's efforts to slow the economy finally seem to be working. That helps ease my doubts about its willingness and ability to slow the economy. And unlike the disciples of Harrod and Domar, I'm not now going to flip over to the opposite worry: that the government will lack the willingness or ability to prop up growth should things turn out badly.

If China's government could handle the global financial crisis of 2008; it can handle a Flash PMI of 51.1.