Guest Post: Why The Wheels Are Falling Off China's Boom

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

Why The Wheels Are Falling Off China's Boom

The rot in China's economy is deeper than inflation and malinvestment.

Despite their many differences, the economies of China and the U.S. share a number of key traits: both are corrupt, rigged, crony-Capitalist, rely on phony statistics and propaganda and operate with two sets of rules: one for the Elites, and another for the masses.

Given these similarities, it's no wonder that the wheels are falling off both economies.

There are some key differences, of course, which will make the crashing of China's boom all the harder. China's leadership likes to do things in a big way, and so its campaign of "extend and pretend" over the past three years has been unprecedented.

This isn't just the consequence of a Command Economy overseen by a Central State; the "extend and pretend" boom was fueled by stupendous borrowing by local governments and private enterprise as well.

This flood of money has severely distorted China's economy, yet the imbalances are now normalized. The system and players have now become dependent on this level of stimulus, so withdrawing the distortions would have negative consequences. Yet allowing the flood of investment to continue will unleash higher inflation, which is already triggering social unrest: Chinese Street Vendor Dispute Expands into Violent Melee.

Thus China's leadership faces the same impossible conundrum as Bernanke has in the U.S.: Your Pick, Ben, But One Goes Off the Cliff (April 22, 2011).

When a system become this precarious and imbalanced, it can best be modeled by stick/slip destabilization: blaming the last grain of sand that destabilizes the entire pile for the collapse is to ignore the real cause: the entire system is unstable.

Here are a few factors which are widely misunderstood or discounted by the mainstream financial media.

1. Over-reliance on property speculation for profits. What if 60% of IBM's annual profits were earned from real estate speculation? Would this strike you as a sound company and economy? Yet that is the case for Lenovo in China: The Boom And Bust Of China's Rise (Zero Hedge):

Recently Liu Chuanzhi, the Chairman of Lenovo and the iconic figure of Chinese manufacturing, faced a serious dilemma while asked why of Lenovo Group’s profit in 2009 60% came from asset investment and only 40% came from manufacturing. He said “when the typhoons come, even a pig can fly in the sky. Everybody is profiteering from this. Why can’t we?” The typhoons refers to the property frenzy and the easy ways to make money.

2. Over-reliance on investment for GDP growth fuels malinvestment and systemic risk. "Meaningful probability" of a China hard landing: Roubini:

Roubini said investment was already 50 percent of gross domestic product. Sixty years of data had shown that over- investment led to hard landings, he said, citing the Soviet Union in the 1960s and 70s, and East Asia before the 1997 financial crisis.

Add one part unlimited ability to borrow to one part crony capitalism and one part command economy and you have a toxic cocktail of incentives to build things which make little sense financially or functionally.

China's second and third-tier cities are littered with sprawling (and empty) sports facilities, municipal complexes, university campuses, etc. which have been built for two reasons, and two reasons only: so local governments can meet their "growth targets" and local officials and their cronies can reap gargantuan profits.

The photos of empty cities are only the tip of the iceberg in terms of housing:

A Taxonomy of China Housing Market Bad Guys:

In the absence of official statistics, Caijing cites and estimate that an astonishing 50-70% of new apartments sold between 2007-2010 have been purchased by speculators and are now standing empty.

Two factors further distort the West's understanding of Chinese real estate. The markets in Beijing and Shanghai are different from those in second and third tier cities; talking about Beijing real estate is like talking about Manhattan property: extrapolations based on thin slices of Elite real estate are bound to be wrong.

Many know-nothing Western pundits repeat the tropism that China's rural population will soon fill up all those empty towers and cities. What they don't understand is that perhaps 10% of China's population can afford to buy a home, even in third-tier cities nobody in the West has even heard of. Most workers in China make $200 a month or less. Buying a condo for $100,000 is out of the question.

3. The Central Government is a domestic paper tiger. The West marvels at the seemingly powerful grip of the Communist Party and the central government's functionaries on the nation, but this control is akin to a radioactive substance: it decays very quickly with time and distance from Beijing.

When it comes to social compliance issues such as ordering people to wear masks in public and closing down cities threatened with epidemics, the central government's authority functions well.

But when it comes to actually controlling local government, Beijing's level of control is near-zero. This can only be understood by having sources within local government; talking to Chinese yuppies in fancy hotel bars and Beijing officials will never get you close to the way things actually work in China: the real action is all at the local government level.

4. Local governments have an impossible dual mandate: growth at any cost, to maintain employment and social stability, but rein in the financial sources (debt) that fund the quick-and-easy "growth": real estate development and grandiose infrustructure projects.

There is no way out of this double-bind. The Central Government recently took $400 billion of bad debt off local government books, but this is simply more "extend and pretend": the local governments have no other way to meet aggressive growth targets except more malinvestment funded by borrowed money.

China's debt problem not solved

China Lending-Binge Hangover Looms in 2013

China Local-Government Debt Risk Needs ‘Attention,’ Bank of China Says

5. Local government is hopelessly, intrinsically, deeply corrupt. Authorities are constantly claiming to be strengthening the rule of law, but "rule of law" doesn't mean the same thing as in does in the U.S. and Europe: Social Signs Point China to The Rule of Law.

"A focus on stability without the rule of law can turn social management efforts into ingredients for social control and repression. And that can lead to vicious cycles of injustice."

Scrape away the Communist rhetoric and social engineering-speak, and China is culturally still Confucian, meaning that authority trumps any set of rules. The judiciary and courts in China operate only until they become inconvenient to a ruling Elite. At that point the ruling is overturned, the case is buried or dismissed, etc.

As noted above, the rubber hits the road in China not in Central Government edicts but in the opaque machinations of local government, and local government makes up the rules as it goes along, placating various crony Elites and Powers That Be at any given moment.

If anyone thinks the citizenry isn't angry about systemic corruption, then they've been spending way too much time with Chinese yuppies in fancy bars and dissembling officials.

6. Much of the "growth" and profits have come from ruthless exploitation and predation. The civil unrest that is igniting all over China is partly a result of continual, grinding oppression and predation by the local Elites. Thugs push around poor vendors--is this your idea of "rule of law"? How about pushing peasants off their land for luxury condo developments?

This sort of exploitation by local authorities and their cronies draws a ho-hum response from the Western media; corruption and predation has been normalized--unless you're the one being pushed off your land and given a pittance in compensation.

7. Income disparity is extreme in China
. With much ado, high-speed train lines have been constructed at break-neck speed. But as our young Chinese friends complain, the ticket prices are out of reach of the average worker: Bullet train ticket prices set:

There will be two speeds of train, 300 km/h and 250 km/h. The faster train will take 4hr 58min and will charge 555RMB for second class, 935RMB for first class, and a "Business Block" for 1750RMB. The slower train will take 7hr 56min and will cost 410RMB for second class and 650RMB for first class.

It's nice to have all this fancy infrastructure, but at best 10% of the populace can afford to use it.

8. China excels at building new things rapidly, but fails at maintenance
. For the past 30 years, the mindset has been: tear it down and build a replacement. Buildings that are barely 20 years old are routinely torn down in China and replaced with much grander structures.

Unfortunately, this mindset doesn't support the sort of painstaking maintenance required to keep high-speed trains operating over the long-term. In Japan, crews go out daily to inspect the Shinkansen bullet train rail lines, hundreds of kilometers of track.

There is precious little evidence that China has the cultural and institutional infrastructure to maintain the hudnreds of kilometers of high-speed lines that have been built. It all works well when new, but how about in five and ten years?

9. The dilution of truth and fact have poisoned the culture. The same can be said of the U.S., of course. China: Truth, Rumors, and a Basket of Fruit:

But recognizing the true source of the illness-the consistent, deliberate misuse of truth for political purposes—-is out of the question, for the moment. So authorities will continue racing around in an attempt to shore up the existing system, in which “lies will now be accepted as truth and truth be defamed as a lie.

The article quotes Hannah Arendt:

"The absolute refusal to believe the truth of anything, no matter how well it may be established. In other words, the result of a consistent and total substitution of lies for factual truth is not that the lies will now be accepted as truth and truth be defamed as a lie, but that the sense by which we take our bearings in the real world—and the category of truth versus falsehood is among the mental means to this end—is being destroyed."

10. The wealthy Elites are not committed to staying in China to work out a more equitable and sustainable future.

China's 'Wealth Drain': New Signs That Rich Chinese Are Set on Emigrating

Chinese Entrepreneurs Are Leaving China

11. The Central Government's infrastructure projects are increasing the odds of environmental catastrophe.
For example, China's water crisis--canals diverting Yangtze to Yellow River and Beijing.

12. The strange brew of crony Capitalism and Command Economy creates a market nobody believes in
. The distrust in central management and profits based on the current 'extend and pretend" borrowing binge is visible in the Shanghai stock market:

Reforming the Status Quo would require reining in local government and remaking it. There are no mechanisms to do so. That is China's problem in a nutshell, and why the wheels are falling off the "extend and pretend" boom.

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kito's picture

Zhè ji?huo shì wúnéng!!!!!

Greeny's picture

Yes, China could slow a bit, but what that "slow" very means? Instead of 10% growth, back to 7% or so? I hope someone can attach those falling off Chinese train growth wheels onto US train. Dark site: Bunch of lowlifes actually enjoying every drop in potential US recovery or anything that could be positive in some way.. Cheering up every point DOW drops, even Chinese is now under the target to satisfy total collapse fantasies. You not gonna get it, whatever you're betting on.. Got it? You are betting on World end, collapse, revolution and chaos and you gonna lose, all of you. Fair enough? Just watch and see.. Maybe tomorrow Bernanke will falsify Job Numbers and < 400k will show up? So much for conspiracy.. hah? I love to bet against depression people like most on this board.. Yeah, of course *Junk*.. what else is new.


Kito, you are probably the only positive person

in this "collapse patriots" club..

Mark Noonan's picture

You're ignoring the reality - a cruel and corrupt oligarchy running a dictatorship cannot get it right over the long term.  Heck, even a well-disposed tyranny is bound to blow it.  You can only get economic rationality in a free market - an economic and political free market.  China has neither; utter collapse is certain...the only question is how long it will take.

kito's picture

"cautiously positive"

vato poco's picture

you're in a casino. a fine, swank, brand new casino. glittering women, men dressed to the 9's. top hats & spats territory. you walk up to an open spot on the craps table. the dealer warns you, the boxman warns you, everybody losing their butts off warns you: "it's an ice-cold table! beware!" so you watch for awhile, and sure enough they're right: point, 7. crap dice. point, 7. so, not *wanting* to LOSE, you take a sensible strategy when faced with cold dice: you bet the 'don't pass'.

the cold rolls continue, everybody but you at the table loses their ass, but you make money. a lot of it.

then what happens? you're faced with a very hostile table glaring at you for cursing the (already cold) dice, and somehow spoiling the craps juju. so lets recap: you observed a cold table, and used a strategy to take advantage of that fact. does that make you a 'depression junkie'? or just 'a little less dumb than most'?

it appears to most careful observers that our economic titanic's hit an iceberg, and will sink soon. yet according to you, hopping onto a lifeboat is being a 'depression person'? good luck with that, bubba. that water looks COLD.

ZackLo's picture

2 drunks holding each other up and they just got done pounding the last bottle of everclear...and are about to get in a fight..

Djirk's picture

when China catches a cold....

Dr. Acula's picture

...the rest of the world contracts AIDS?


Fed_Printstone's picture

...the rest catch SARS? Bird flu? Melamine milkshakes?

TruthInSunshine's picture

OT -

Either ZeroHedge is getting billions of page views a day (maybe), is the target of DOS or other attacks by some pissed off Sellside ConPigs of Wall Street (but their probably too fat and lazy to initiate such efforts), or is the target of Government Internet Truth Squads (possibly).

In any event, I find Zero Hedge absolutely invaluable, as it has literally broken stories that have turned out to be 100% verifiably accurate, prior to any other source I know of, in any format, anywhere.

So, Zero Hedge, let me know how and where to send my anonymous tribute to further the interests of ensuring you stay online and secure, behind an impenetrable fortress of technological three-steps-ahead-readiness of those in the private and public sector who hate truth tellers.

Gold Man-Sacks's picture

I wonder what Peter Schiff's response to this would be.  He's diehard China all the way.

TruthInSunshine's picture

Advantage Chanos, who's quite the China bear.

I'm not a follower of anyone, but I can't deny Chanos has been far more correct than incorrect on his publicly spoken past predictions and general forecasts than anyone else who comes to mind.

Temporalist's picture

Where's Hugh Hendry to weigh in on this?

redpill's picture

Not really.  I had Europac put together a small international portofolio for me, and out of ~10 stocks only two were based in Hong Kong.

Just because Schiff sees China as undergoing certain changes (which will ultimately benefit them) does not mean he always sees Chinese companies as the best investments.

Gold Man-Sacks's picture

EuroPac may make custom portfolios, but Peter, himself, is extremely bullish on China.  He says it all the time on his show (can you think of another country he's more bullish on?).  Euro Pacific's first (and only at that time) mutual fund is called EP China Fund.



redpill's picture

That's true in a broad sense, that doesn't mean it's a blanket approval by him to throw money after companies or assets just because they are Chinese.


Whether this boom is turning into a swoon for the time being or not, long term where do you think it is likely more growth would come from if not China?  They have a massive untapped domestic consumer market that will eventually be far superior in terms of growth compared to the ever-declining west.


Manthong's picture

I don't know what Peter would say but as a business proposition, China likely can keep their ponzi going a lot longer than we can which makes them more of a buy now.

TruthInSunshine's picture

Take all of China's reserves and in consideration of where, how and when they derive their income and current surplus, that pile of money won't last long if there aren't enough jobs being produced to keep up with population growth, let alone a crisis which sees the unemployment rate gap up significantly for any extended period of time.

China is a ticking demographic time bomb.

topcallingtroll's picture

This huge set of "reserves" in us treasurys amounts to about 2000 dollars per person in china.  They are poor and eat snakes and rats.  You think they really like to eat snakes and rats?  Beef consumption has been increasing as they get wealthier.

China is still very poor and very desperate and very fragile in spite of  how some people may live in some of the cities.

hedgeless_horseman's picture

I have seen snakes for sale in Chang An food markets and elsewhere.  Never have I seen a rat for sale in a market.  

I am always impressed by the vegetable farms in the highway medians.  We have much capacity for that type of farming here in the USA.

I wish we could import the 45 minute shampoo for a $1.00, but Super Cuts will never make it at those prices.


As a sidebar, in regards to China, I suggest reading at the very least chapter ten of Tom Standage's excellent book, A History of the World in Six Glasses.  

MonsterZero's picture

I think a good US - China conflict will fix all these economic ills.

Sudden Debt's picture

5 to 1...


even Rambo and Chuck wouldn't like those odds...


Dr. Acula's picture

Chuck Norris makes onions cry.

Due to a genetic mutation, every cell in Chuck Norris's body has its own beard. 


VyseLegendaire's picture

Good article.  China is as done as the US, haha.

falak pema's picture

why you laffing? You will fall with the rest

TruthInSunshine's picture

I'm not laughing at China or the Chinese.

I do not wish them any ill will.

I do not and will not view the Chinese People as my enemy, despite my own government's best propaganda.

I know you weren't addressing your question to me, but I do believe the Chinese economic structure is very diseased, and has been built upon false long-term assumptions and ill-advised capital allocation decisions, and that the Chinese Government will have far less leverage than many believe in terms of dictating terms (for a variety of reasons I won't bother to expound upon here and now).

BigDuke6's picture

In Australia we observe China very closely and i can tell you predictions of its demise have been going around for about 10 years now.

Its getting closer but it may take a bit longer than many think.

Whether this is due to papering over the cracks par excellance we'll see by the size of their bust... whenever that may be.

luciusfargo's picture

Our government certainly isn't predicting an imminent demise. In fact, China alone is going to plug that $50b budget hole. Let the good times roll.

laomei's picture

Ah yes... the thing everyone has been saying for years and finding any excuse to hype up whenever they get the chance... China's not going anywhere.

buzzsaw99's picture

emerging. markets. bitchez.

TheFourthStooge-ing's picture

echo "emerging. markets. bitchez." | sed 's/emerging/submerging/'


Carl Spackler's picture

Throughout history, the kind of global confusion (China, US, Asia all broken) present today has led to significant outbreaks of war.

The next 10 years will be interesting times, to say the least.



M.B. Drapier's picture

I can't confirm its accuracy, but I found John Garnaut's "Is China Becoming a Mafia State?" talk eye-opening and scary. It features our old friend China Agritech among many other things. But the Fujin land war may be the scariest one, with no happy ending in sight. Talk about the problems of local government in China!

Dr. Acula's picture

>Mafia State

Kinda redundant, like "coniferous evergreen".


M.B. Drapier's picture

Did you watch the video? It's particularly not-redundant in the case of China.

Atomizer's picture

Universal healthcare and government subsidized nursing homes.

IMF working paper The Aging Population - 2002

Sudden Debt's picture

Point 10 is what is going to crash the chinese economy.

China is setting limits on investments on real estate, thus the rich guys are buying real estate outside the country.

Everything in silicon valey is being bought up by the chinese, so in Las Vegas, Florida, New York, Paris, Brussels,...

This capital flight is going to grind the chinese experiment to a halt pretty soon as local real estate markets will plumet down.


billsykes's picture

I say BS. Yes real estate is easy money, in booming times and building new stuff accomplishes all the gov't is trying to do. But what is really happening is that the Chinese look longer term, this generation may be cooked but down the road they are setting themselves up for a real superpower. Diversified investments all over the globe in resources.

They still have manufacturing, the US does not. The US unemployment numbers are BS, real unemployment is still around 20-25%+. As for china, well I just got back, guess what everyone has a job, I counted 9 bums in a city of 7m, here we have 1m people and 10k bums. Those Chinese bums were all very advanced age and some had no hands. Here, we have 20's early 30's all capable to work but they don't want to.

As per junky stuff, ya you wouldnt catch me on that new shanghai train, just google the NYT article about that, but also think of when "made in Japan" stuff was total crap.

Every rich person diversifies after they have made a certain amount of money, why not in passports?

$400B to go into loans to build stuff, ya sounds like a lot but in america, they just use it to shuffle and bailout financial firms that build nothing, that own nothing. And support new wars.

If I was on the other side of the table I would be more concerned about America getting desperate, desperate people do desperate things. You don't see china starting wars of terror.




Sudden Debt's picture

I don't like it a single bit!


But I agree with you 100%


Even if it does crash, they have the industrial base, and we don't.

Jim B's picture


If they are in trouble....  What does that make us....

Sam Clemons's picture

And as far as their citizens go, I believe they still actually at least BELIEVE in saving money. 

laomei's picture

Hahaha, the jinghu train is amazing and I already have my secretary waiting to buy tickets for it for my business trips.  Cheaper than flying and less of a hassle.  These trains represent the highest level of technology in the world and as much as you want to see it fail, it's not gonna do that.  High speed trains run on their own tracks and will relieve congestion on the normal rails while at the same time reducing reliance on flights.  This is a great thing.


When will the US get a train system that doesn't suck? Never, you gave all your money to the banks to piss away.  Haters gonna hate.

Sudden Debt's picture

China will soon start to price in their inflation on the products they sell as the state subsidising is getting to expensive for their govenrment.

This will bring inflation on a 5% monthly scale to us on imported crap.

Even Benny B. won't be able to hide that one.


TruthInSunshine's picture

I couldn't possibly know for sure, but given that Chinese TPTB are already considering outsourcing even more of their manufacturing to even lower wage Asian nations such as Vietnam, Thailand, etc., they are at least making serious contingency plans to try and deal with inflation while maintaining a high trade surplus (at least from a GNP, rather than GDP, perspective).

If the current trends deepen and become more entrenched, this is where the Chinese probably hope to counter Geithner's relentless pressure on currency revaluation, but they will still have to trade off domestic job growth even using this strategy, which is still a very, very high price for them.