Sunday, October 02, 2011

The China Hype...Part 2 : Dangers ahead...

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 ( 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.


Anonymous said...

But China's economic growth also benefits Singapore, isn't it?

For instance there are so many super rich Chinese nationals buying high end Singapore properties, and the not so rich ones becoming PRs or even citizens and buying HDB resale flats.

And our private banking system and even our Casinos also benefited from these rich Chinese and other foreign nationals who likes to gamble big.

All these also help our economic growth and prosperity.

And even if other countries are in danger and trouble, their rich people may even flee to Singapore and bringing more of their wealth here with it.

So whatever it is, Singapore benefits. And I say Singapore, not necessarily ordinary Singapore folks. But anyway does it matter?

Lucky Tan said...

anon 10:24,

If we are dependent on China to hold up our banking sector, property sector and casino sector...what happens to Singapore when China falters?

Yes, it is great to have the Chinese economy growing...but even better if it can sustain the growth over the long term.

Capacity is key said...

Overcapacity is the bugbear.

In Singapore, this is well managed despite the fact that 3 wafer fabrication plants ( woodlands and Tampines) are under utilised.

We have managed many of our resources well. It is always undercapicity. Our Roads, our buses, our COEs, our schools, our ports, our train timmings, our police force

Undercapacity is good. It maximises use and allows control over wages, costs,etc.

In USA, the overcapacity exists in almost all manufacturing, caused by China offering faster & cheaper alternatives despite the distance and shipping costs. With excess capacity, workers get laid off and will need time and incentive to re-train, re- learn alternative skills.

In some small ways, this has happened here in Singapore ( PMETs)

Will we face overcapacity in homes and offices soon? not if the import of people continues.

China does not have overcapacity, and will not in the next 5-10 years. All the debt that you have written about is not an issue. This is evident in how debt is confronted in USA & Europe. Just print more money.

Will the "end of the road" be here next year? next 2 quaters? No.

This "end" will come about many more decades later.. after you and I have departed. The generations after us will deal with it when the time comes... at the moment they are concerned with WoW and facebook..

We will be fine here in Singapore.
The Bukom incident actually will help us keep jobs and the economy humming.. undercapacity has been created, supply drops, demand remains constant, price increases, workers required to repair.. jobs remain.

The financial industry here will face issues... too much capacity.. too many 25 year olds with Masaratis.. too many millianaires.

Lucky Tan said...

anon 10:37,

I too hope that everyone in Singapore is alright. We have the resources to pull through as we have so many recessions. This one may be longer that the garden variety.

It will give us time to reflect on our fundamentals and the true meaning of life provided the real estate debt level does not cause widespread pain.

Optimistically, a slower economy brings greater motivation to restructure, retool and reinvent ourselves. We cannot be chasing GDP growth as we have in the last 10 years. A slower global economy will force us to stop chasing. some reflection.

Plenty of good can come out of a slowdown but the PAP has to step in to protect the economically weak especially if this slump goes on and on. ...and there are reasons to believe this one will go on for quite long.

Anonymous said...

"...but the PAP has to step in to protect the economically weak..."
Lucky Tan 2/10/11 10:49

Hahahaha! Sure they will but I only got 2 questions to ask about this.

1. What is the PAP's priority on this?

2. And to what extent of protection?

My home is here... said...

We cannot measure our success using other countries yardsticks. Too many variables, too many factors unique to our circumstance.

What then, is success for us?
What does it mean?

More flats? how much more?
More babies? how many more?
More income? how much is enough?
More roads?
Less cars?
More Schools?
More subjects to choose?
Less haze?
Cheaper medical costs? how much cheaper?
More jobs? what jobs?
Less foreigners? none at all?
More opposition? how many more?
less PAP?

Success means different things to different people. Can we find a common idea?
To LKY, his measurement of success means higher GDP, one dominant party.
You and I are mere single votes.

So, what does success mean to you?

Anonymous said...

/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./

Lucky, I don't think this is all too bad not because the problem is small in respect to the massive reserves.

It has the mechanics of plowing back the spending internally benefitting the nation. However, the spending on the needed infrastructure (social good) must equitably go the deserving provinces or places and not spent on white elephants or just to pad the pockets of a few corrupt elements.

Anonymous said...

Although China's debt is closed to 200% of GDP, its foreign debt is only 700billion USD, less than 20% of GDP.

As sovereign country like China, It can always re-capitalized the banking system and local government with newly printed cash. Don't confuse China with those EU country, who can't print their own money.

Property bubble in China will be burst. It is matter of when. However, China government has prepared this scenario. Down payment on property purchase is increase to 40-50% of the purchase price. Banks will hardly be hurt even the price crash 50%. Middle class and rich man will be scarified. Their wealth has been transferred to gov for mass infrastructure building and "kopi money" for corrupted official.

China hype will be burst. But it won't be as ugly as you think.


Anonymous said...

//Middle class and rich man will be scarified.//

The poor are so poor that you can't tax them - nothing to tax. Sometimes, they need to be helped so that the social problems will be reduced.

The rich are so rich that whatever large tax they may have to pay, they are still rich assuming they do so reasonably even with their discretionary spending and not spend like Michael Jackson.

The middle class is getting the real squeeze, not so poor to qualify for handouts and not so rich to have their level of discretionary spending preserved as previous.

Anonymous said...

Anon above,

Middle class getting the real squeeze? So what, especially in Singapore?

As long as they voted PAP in elections.

If not, how could PAP got 60% votes if they didn't had the middle class votes?

Anonymous said...

/As long as they voted PAP in elections.

If not, how could PAP got 60% votes if they didn't had the middle class votes?/

Agreed. To simplify, two broad groups of middle class (or the rich or the poor)

1) People who really feel that PAP is good and mostly likely vote for PAP.
2) People who do not feel that PAP is good but voting for PAP out of fear for a myriad of reasons.

As long the second group stays fearful and willing to tolerate the squeeze, the 60% will not change much. It is like a masochist who will say 'one more time' each time after being whipped.

Anonymous said...

The difference between China and Japan is China has a huge gold reserve. this is why so many countries wanna invade China in the past.

Anonymous said...

We cannot predict the future, but we sure can prepare for it.

We can do what we have now, and what we have is our attitudes.
Do we have negative or positive attitudes?

What can we do now?

1st things:

- Spend less money
- Learn new things that you enjoy
- Smile!
- Say " Thank you!" and "Please"
- Save money for yourself
- Walk often
- Appreciate sunshine

2nd things:

- Avoid Sentosa for 3 years
- Avoid Marina Bay for 3 years
- Avoid the Zoo for 3 years

3rd things:

- Visit Bandung, Indonesia
- Visit Yangon, Myama
- Visit Jordan


- Read 3 fiction books

Then, share your experience with others. You will be richer in knowledge and more confident to face the future... and the past too.

Anonymous said...

I agreed with your view and I think Singapore will be affected. I believe that the local stock index will decline to 2000 by end of December and 1500 by end of June next year. What is youe view?

Anonymous said...

You forgot to visit geyland. Your legs will feel stronger.

I wannabe an elite!! said...

If ST index ever falls to 2000 and below..

I will buy up shares that are too big to fail:


Bet my asshole they will not go belly up.. and I will earn dividdend and capital gains.

Anonymous said...

in Jan 2009, the index touched 1500 so it depends on the crisis on how deep it may be.

Keppel Corp more affected by oil and overseas property not necessary reflecty Singapore environment,so is semcorp, F&N mainly local property play and that sector may take a long time to recover,so the better bet may be the banks, SIA and SMRT if you have a three years view from the 1500 index.

Anonymous said...

On the contrary. The danger is that we will do well.

Anonymous said...

Singapore growth relies on the external environment and if global is nit doing well, it's foolish to think that we can do well

Anonymous said...

Now that Sin is open to all and sundry, it stands to gain from everyone rich from anywhere China, India, Indonesia, USA, Europe, in short anywhere.
The Filthy Rich will bring their assets and the Economic, Financial and Security(Anti Terrorism) Experts from India, USA and India will come to improve our Sin GDP.

Singapore will have GOLDEN ERA coming its' way, BUT, will Singaporeans have a glittering golden time???


Anonymous said...

We are small. We have leveraged on wealth to cushion the adverse with ease. If others see us a safe haven, more will come. We are riding on their wealth.

Anonymous said...

Me likes to emphasize here that these foreigner experts will definitely contribute to Sin.
As to whether the average Singaporeans benefit from their contributions, me really don't know. Me surmises that at least their employers will benefit immensely from them(Foreigner Experts).


DanielXX said...

Sinkies have grown too complacent. It is time for a real good recession to wake them up to the competitiveness of life. It will do those GenY and GenZ youngsters still in their Facebook dreams a lot of good.

I can sense that the political mandate globally is for a recession rather than inflation. This is because many people have realised the latter only serves to enrich the already rich. In that case, human envy dictates that they would rather everybody suffer instead of just they themselves suffer. What this means is that the 2011 situation is different from 2008. Back then it was "anything to save the system". Now it is "whatever the majority want". Remember next year is erection year for Obama.

Anonymous said...

I see you need a good obsession for plenty of erection. That way, you can wake up in a pool of recessionary sperm and compete with anyone who swim in your pool of sperm.

Ghost said...

Frankly I don't see it as a problem as long as the debt is being held by the central government. The central government is not going to cause problems for itself by forcing the provinces to pay the debts when they know the provinces don't have the money to pay. That is like shooting yourself in the foot.

fallingdown said...

It is scary but unlikely because China has massive reserves and much of the debt is held domestically so all it needs to do is to kick the domestic debt can further down the road. I think that when all other nations explode from the debt bomb, only China will be left standing because they have a fast growing middle class and a very focused and disciplined. It helps that they have a very focused state controlled economy that till now is very sharp and good at extracting concessions from companies coming to do business in China (technology transfers). What will happen is that even in such a scenario, their cash reserves will keep China going and because all other nations will have flatline economies, they will be forced to give even more concessions to China because they must go to their to survive. This will accelerate the whole process and by and large we will enter a new age. I think that will last for a very long time since every other country will be essentially dead or become a satellite or vassal state so keeping them down is not an issue.

zhaoyu said...

It is not so bad, lah. Japan's total debt to GDP exceeds 480%! Canada has a higher ratio than China, you wouldn't say canada is on the verge of collapse would you.
See this link for full rankings:

A sampan story.... said...

Peter owes Paul who owes Simon and in turn also owes Peter.

Paul says he cant pay Simon
unless Simon lends him more money

Simon cant lend unless Peter says ok

But Paul wants Peter to pay.

Meanwhile, ah seng looks at the situation, shakes his head and is very worried because he just bought a share in Peter's fishing boat... at a very high price.

Looks like no choice but to continue.. since Mat, the neighbour looking with green eyes.

Let the music play on...

The said...

/// The Chinese govt has US$3.2B in foreign reserves ///

Either you mistook billions for trillions (typo), or you missed out three zeros.

Now that the error regarding the humongous reserves issettled, don't you think all the doom-sayers are over-reacting?

lan sai said...

Yah, agree with you, The.

Sounds so much like chicken little..

"the sky is falling!"
"the sky is falling!"

and we wait, and wait,and wait.

and chicken shit dropped out..

lan sai

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