A lot of people have trouble understanding the growth of the Chinese economy. They have grown so fast for so long that a lot people feel that they are due for a bust. Their currency is pegged to the US so their monetary policy has interest rates that seem unnaturally low relative to their natural rate. Even in 2004 and 2005 many observers labeled China as a bubble. While part of the reason they got China’s growth wrong was because they underestimated the force of convergence, it is also because China is an interesting case of the Austrian Business Cycle Theory.
Even the most casual observer of markets understands that many people believe the housing bubble and financial crisis was to some extent driven by unnaturally low interest rates during the post tech bubble years. Using the framework from Roger Garrison’s Time and Money: The Macroeconomics of Capital Structure, we can see that a lower than natural interest rate sends false signals to consumers and investors through the loanable-funds market, which causes the economy to move outside the production possibility frontier, leading to malinvestments and excess consumption. This process is explained in detail in a very good PowerPoint presentation at Roger Garrison’s website, but here is the big picture: (click to enlarge)
The process starts in the bottom right where the central bank sets the interest rates at a point lower than the natural rate of interest, where savings and investment would clear in a normal market. These false signals tell consumers to save less, which means consume more, and investors to invest more. Moving up on the chart we see that if the economy was near the production possibility frontier, the lower interest rate sends the economy outside of the frontier due to the increased investment and increased spending. Through the Hayekian triangle on the left, it can be seen why these increases are so disruptive. The increased saving and investment is not uniform, but is distributed towards the early and later stages of the process, leading to inflation when it is determined that certain parts of the economy are underinvested (This middle stage in the past has often been in things such as oil production), then a bust when it is determined that the investment is not in fact going to pay out.
However, China and other Asian countries have gotten around some of these problems with a policy of forced savings. This forced savings comes from policies that keep their currencies artificially weak, discourage imports by making it difficult for foreign companies to enter the market while subsidizing their exporting companies with cheap loans.
This has the effect of shifting the savings curve in the loanable funds market to the right, and it helps turn an unsustainable economy into more sustainable growth.
This isn’t to say that policies of forced savings make countries immune from business cycles. When the government allocates capital, there is more likely to be malinvestments that the market will eventually identify. A lot of recent spending in China has been focused on their real estate sector, in a way that does not seem sustainable. If the real estate market crashes, China’s economy will undergo a recalculation phase during which it’s GDP will be lower as they switch towards producing end products that their citizens actually want to consume.
The main point is that when we look at Asian economies that implement policies that force their citizens to save, they may actually be making their economies more immune to a typical boom/bust cycle. However, when these economies create a massively inefficient domestic sector as part of the way they are implicitly encouraging savings, as they do in Japan, it lowers the standard of living in the country to such an extent that it probably is not worth it once convergence has mostly occurred (because the are preventing convergence in the inefficient parts of the domestic economy).