China Hype Part 1 (Jan 2010):
When an economy grows as fast as that of China, the growth can mask problems beneath the surface. From time to time, the financial press will play up these problems but the lack of transparency and information makes things very unclear. Even when there are credible assessments, the issue of timing and final day of reckoning is hard to pin-point. Take the example of Jim Chanos in my earlier article who warned about an "impending Chinese real estate collapse" in Jan 2010. Nothing much has happened since ...the action if any is in Europe and USA where economies have been weak.
Lets recap what has happened in China:
In 2009 facing the threat of recession, the Chinese govt implemented a stimulus package to avert a sharp slowdown. This money went mostly into infrastructure development and the private sector saw a boom in real estate. State govts and real estate companies borrowed massively from the big banks to invest.
"The manic and chaotic development of infrastructure projects after the 2008
financial crisis, costing more than 20 trillion yuan, has driven the economy at
a booming pace, but at the cost of speculation and inflation. Most local
governments have borrowed massively from banks to support their own plans, but
this has occurred without even the limited level of public scrutiny and openness
that exists in ‘democratic’ capitalist countries.
This has also led to serious debt problems for the Chinese economy. The Railway Ministry has come to
symbolise this problem. While a total of 2.35 trillion yaun has been invested in
the rail system since 2008, it has accumulated debts of 2.09 trillion yuan (USD
308bn), which accounts for nearly 60 percent of the total assets of the
ministry. The ministry’s loss in the first quarter 2011 is over 3.76 billion
yuan (USD 578 million). Its debt accounts for almost 5 percent of China’s GDP,
which is forecast to increase to 7 percent by 2015. This is also why the central
government intervened and removed former minister Liu and his team."
- Report on the recent Railway Crash in China[Link]
While the Central Chinese govt is a net creditor, regional govts and various ministries have borrow heavily to fund these infrastructure projects. These debts are guaranteed by the Central Chinese govt and effectively makes the Chinese govt an indirect debtor. That is not a problem if the amount is small as the Chinese govt has massive reserves. But the total amount of debt is estimated at 200% of China's GDP.
There is a large potential risk," said Zhu Min, the deputy managing director of
the International Monetary Fund and a former Chinese official. Mr Zhu said China
had doubled the loan ratio from below 100pc of GDP before the Lehman crisis to
roughly 200pc today. The danger is that this excess could start to unwind just
as the West goes into a sharp downturn, and possibly a double-dip recession.
China and emerging Asia are fundamentally in weaker shape this time, having used
up their "fiscal cushions", leaving them with little leeway to cope with a fresh
global shock - Link
The canary in the mine for potential problems in the debt market is the CDS (Credit Default Swap) market where investors insure themselves against debt default. This has started rising sharply last week.
The third act is happening in China. In the three years since the first act started, credit in China has mushroomed from 100% of gross domestic product (GDP) to 200%, at a time when GDP itself has been growing at a fast lick.Property prices as a ratio to incomes are more than 22 in many of the coastal regions, a bubble far, far more precipitous than that which engulfed the US. There are very clear warning signs that the asset bubble in China is going to burst with considerably more venom than it did in the West.
China is not immune to economic cycles; the same economic principles apply there as anywhere else.
China has not magically found a miracle panacea that enables it to dodge economic bullets and realities - Link
The Chinese govt has US$3.2B in foreign reserves and had the foresight to tighten and control the real estate market to prevent the real estate bubble from becoming bigger. China has been tightening credit for past 2 years to ward off inflation which is very high. All these give the Chinese govt policy tools to do something when need arises, however, it is it has far less firepower than in 2008 when Lehman collapsed vs the current situation which is potentially more serious and longer lasting than in 2008.
There is an uncanny resemblance to what occurred in in Japan and USA. In 1980s, Japan was the miracle economy of the world and about to top US as the world's number one economy. The Japanese has 2 bubbles than mark the end of its time on top, first a stock market bubble from which it never recovered and later a housing bubble that burse in 1989. The US economy made a remarkable comeback in the 90s under President Clinton and that boom ended with 2 bubbles - a stock market bubble (dot.com bubble) in 2000 and a housing bubble than peaked in 2007. The Chinese had a stock market bubble in 2006 that took the Shanghai Composite to 6000 (today 2350). That bubble burst and a property bubble took its place. This twin bubble phenomena looks like a pattern that recurred around the world when economic participants become very optimistic and think that the country is destined for never-ending secular GDP growth...proceed to borrow too much and saddle themselves with a debt problem that takes years to solve. The product of these bubbles in Japan, US, Europe and now China is this cumulative mountain of debt and this debt will stall the global economy. That is the reason I posted the "Debt as Money" video earlier this week. Negative factors are starting to converge rapidly in a situation when you have slower growth but a debt mountain that has expanded - as this dynamic situation unfold it will become very apparent that as govts try to eliminate this debt with austerity or printing money - deflation (falling asset prices) or inflation (cost of living rises). I think we might have reached a point of intractability - where there is no economic path ahead without some amount of pain. If you still haven't read it, I strongly recommend this 1999 book by Peter Warburton called "Debt and Delusion" (Amazon Link) that foresaw the sovereign debt crisis and predicted every method that central bankers will use to fix it including printing money.
I would like to add one more point. China's form of authoritarian capitalism has led to great social inequality - far higher than, say, in Japan when the Japanese emerged as a global powerhouse from the ashes of World War 2. The rampant corruption and the constant need to repress, censor and control the people means that there is plenty of social forces building up beneath the surface. Given this system fundamentals in place, the China Premier and top leadership has done an outstanding job to contain all these problems. But we know from the Asian Crisis, this superficial stability under authoritarian rule can breakdown quickly when the economy falters. That is one reason for such govts to accumulate vast amounts of reserves in case something happens. During the Arab Spring, as social turmoil threaten to spread to Saudi Arabia, the Saudi king announced an economic package worth US$400B funded by its reserves to take care of every man, woman and child with any cause to be unhappy. The Chinese govt has the reserves to keep the country going for some time should the economy falter and unemployment rises. However, the poor economy might persist given Europe is China's largest market and would be in the doldrums for a long time might result in the demands for change in China growing louder. Very often we get unusually shocking news from China ranging from reports of fraud, food scares, hopeless poverty, extreme immorality, rampant corruption and human rights abuses. All these don't matter and goes on year after year when the economy is booming, but when the economy falters - that's when real changes come. What happens to one party authoritarian rule when the economy no longer does well? We only have to look at Indonesia, S. Korea and Thailand to know the answer. Even in Japan where the people are culturally reluctant to go for change. They eventually threw out the LDP - the party that engineered its economic miracle. It is hard for a one party system because one-party rule concentrates the power and control in a small number of people and when serious problems occur these people have to shoulder the blame, lose credibility and the masses quickly reject their leadership.