The coming collapse of China’s savings surplus

China’s massive investment surge since last year to prop up economic growth is drawing down the country’s famed savings surplus into a deficit, with implications for the US’s ability to fund its budget deficit and for the US dollar, says a CLSA economist.

The price of China ramping up its investment so rapidly is that savings are being used up faster, and extrapolation of current trends would see the savings surplus turn into a deficit by mid-2010, estimates CLSA head of economic research Eric Fishwick. “For the whole of 2010, we are forecasting a deficit of 0.8% of GDP.”

This has enormous implications for the rest of the world, reasons Fishwick. “China is turning from a net lender to a net borrower, which means that in 2010, the world’s current account deficit countries will find China competing for savings rather than be a source of them.”

China, he adds, “is too large an economy for this shift from saver to borrower not to have implications for all other borrower countries.” But in his estimation, a fall in Chinese reserves “is the worst case as far as the US is concerned —- because it’s happening at a time when the US government needs the money.”

In practical terms, a huge US government borrowing requirement colliding with China starting to compete for savings means two things: higher interest rates and a cheaper dollar.

“The yield curve is already steep, but we fear that it will be cheaper still during 2010,” says Fishwick. “We have increased our forecast for 10-year Treasury yields for end-2010 to 5% in recognition of these concerns.” In his estimation, dollar is likely to weaken in 2010, which also argues against an early economic upturn.

However, Fishwick reasons that China’s ‘directed investment’ strategy is not without risks for its own economy. “China’s stimulus policy,” he says, “is a move away from the market.” It’s because of China’s command economy that the investment surge has been so rapid and the policy has been so effective at promoting GDP growth.

“But by making it harder for the US to recover, Beijing is indirectly applying pressure on its own export sector. Unless handled carefully, China risks replacing one dependence with another.”  That risk, he adds, “is of making China’s economy dependent on government-directed investment.”