Guest Post: China: Continued Boom Or Bursting Bubble?

Tyler Durden's picture

Submitted by Jim Quinn of The Burning Platform

China: Continued Boom or Bursting Bubble?

In a recent article, How China Ate America’s Lunch, Clif Carothers described what China has accomplished in the last thirty years:

In thirty short years, China was able to accelerate her GDP from $216 billion to $6 trillion. She amassed reserve capital of $3 trillion. She reversed America’s fortunes from the greatest creditor nation to the greatest debtor nation. She gutted America’s factories while creating the world’s largest manufacturing base in her own country. A measure of output that highly correlates to GDP is energy consumption. In June of this year, 2011, China surpassed the United States as the largest consumer of energy on the planet. While the US consumes 19% of the world’s energy, China consumes 20.3%.

While China was growing their economy by a phenomenal 2,800%, the US GDP grew from $2.3 trillion to $15 trillion – a mere 650% increase, of which 420% was due to inflation. There is no question that China’s progress has been remarkable. The question is whether that growth is sustainable and built upon a solid foundation.

In a February 2010 Casey Report article titled Is China’s Recovery a Fraud?, my thesis was the $2.1 trillion stimulus package rolled out by Chinese authorities after the 2008/2009 financial crash was leading to enormous malinvestment.

The officially announced stimulus package in November 2008 totaled $586 billion and was to be invested in key areas such as housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income building, tax cuts, and finance. In reality, the central government pumped an additional $1.5 trillion into the economy in an effort to maintain social stability through the subsidization of its industrial base. Chinese banks funneled cheap loans to state-owned enterprises in order to manufacture artificial profit margins to keep Chinese goods competitive and employment maximized. In the short term, the stimulus produced the desired effect.

Specifically, the Shanghai Index – which had topped out at 5,913 in October of 2007 and had fallen to a low of 1,678 by November 2008 – responded to the stimulus by rebounding to 3,300 in January 2010, as the chart below shows.

As with all monetary and fiscal stimuli, however, the initial high is always followed by a hangover. Today the Shanghai Index stands at 2,350, down 29% from when I penned my article. China is also experiencing accelerating inflation, a real estate bubble of epic proportions, a looming banking crisis due to the billions in bad loans made by Chinese banks as commanded by the Chinese government, and growing social unrest due to rising food and energy prices.

There are few opinions in the middle regarding the China story. People are either convinced China is a juggernaut that can’t be stopped and will become the dominant world power (a recent, global Pew Poll found that 47% of respondents think China is or will be the dominant global power), or they see a colossal bubble that will burst and cause worldwide mayhem. While some might think my world-view has a negative slant, I tend toward what I think is healthy skepticism that causes me to view things in a more realistic manner.

Based on the facts as I understand them, the Chinese government has created a commercial and residential real estate bubble in an effort to keep peasants employed and not rioting in the streets. In the case of the US subprime mortgage bubble, critical thinkers like Steve Eisman and Michael Burry figured out it was a bubble three years before it burst. Jim Chanos and Andy Xei have been warning about this Chinese bubble for over a year. They have been scorned by the same Wall Street shills who denied the US housing bubble. As Eisman and Burry proved (reaping billions), just because you are early doesn’t mean you are wrong.

Inflated Dreams

The table below paints a troublesome picture of rising inflation and gigantic over-investment in real estate. And this takes into account the fact that, much like the Bureau of Labor Statistics (BLS) here in the US massages data, the Chinese statistics are tortured by the Party to paint the best possible picture. Even still, the Chinese government’s own numbers show inflation escalating as economic growth is slowing.

And the trend is not improving: The latest data show year-over-year inflation surging by 6.4% in June and food prices skyrocketing by 14%. With annual disposable income of less than $2,500 in urban areas and just $600 in rural areas, food and energy account for a huge percentage of the average Chinese person’s daily living expenses. The Chinese authorities are terrified by the revolutions sweeping across the Middle East and are desperate to put out the inflationary fires.

To contain stubbornly high inflation, the Chinese central bank has raised the benchmark interest rate three times this year, including the latest rate hike of 25 basis points announced on July 6. In an attempt to rein in excess lending, it has also hiked the reserve requirement ratio six times, ordering banks to keep a record high of 21.5% of their deposits in reserve.

Even with inflation surging, the Manufacturing Output Index fell to 47.2 in July – the lowest in 28 months, and indicating contraction. China’s automobile industry, which overtook the US in 2010 with sales of 18 million autos, has experienced a dramatic slowdown, with growth of only 3% through June versus 32% growth last year. For all of 2011, the China Association of Automobile Manufacturers expects sales to decline versus 2010.

Real Estate Out of Reach

In response to the 2008 worldwide financial collapse, Chinese authorities unleashed $2.1 trillion of stimulus, or almost 33% of GDP. This compares to the US stimulus of $800 billion, or 5.5% of GDP, spent on worthless Keynesian pork. Unlike the US, where no jobs were created, China’s command-and-control structure funneled the stimulus into building cities, malls, roads, office buildings, and residential units. Millions of Chinese were employed in creating properties for which there was no demand. Moody’s approximates that China’s banks have funded at least RMB 8.5 trillion (US$1.3 trillion) of the RMB 10.7 trillion of outstanding local government debt, which was a significant portion of the 2008 national stimulus package. When the central authorities tell the banks to lend, the banks ask, “How much?” The result has been soaring real estate inflation and malinvestment.

Everyone has seen the pictures of the ghost cities (Chenggong) with no inhabitants; ghost malls (South China Mall, Dongguan Mall) with no shoppers; residential towers with no residents; and roads with no cars. Analyst Gillem Tolluch from Forensic Asia Limited describes the scene in China today:

China consumes more steel, iron ore and cement per capita than any industrial nation in history. It’s all going to railways that will never make money, roads that no one drives on and cities that no one lives in. It’s like walking into a forest of skyscrapers, but they’re all empty.

There are 218 million urban households in China, and the central government ordered local governments to build 36 million more units by 2015. They just have one small problem: Prices for apartments in Shanghai and other major metropolitan areas have soared by over 100% in the last five years.

The average size of a “cheap” apartment in second-tier Chinese cities is 60 square meters (650 sq ft) and fetches an average price of $1,230 per square meter, or $73,800. Mid-tier apartments in Shanghai or Beijing sell for $3,500 per square meter, or $210,000 for an average size apartment. “When prices are over 20 times more than annual household income, it’s not affordable,” says Andy Xie, an independent economist in Shanghai. Millions of working Chinese have been priced out of ever owning property and blame the corrupt local government cronies and connected speculators. Anger is simmering among the masses.

Confirming the overvaluation, a report by the Chinese Academy of Social Science points out that in the country’s metropolitan centers today, house prices per square meter generally amount to between 50% and 100% of average annual incomes. “To secure a flat of 90 square meters, an average working family in Beijing and Shanghai will have to work for more than 50 years to pay off their loans, compared to five to 10 years in the developed world,” according to the report. Report authors Lu Ding and Huang Yanjie conclude that, “[S]ky-high housing prices have undermined housing affordability and caused great anxiety and resentment among the public, who are wary of the conspiracy among ‘speculators’ – developers and government officials in charge of real estate businesses.”

House of Cards

China has methodically and relentlessly grown their economy for the last thirty years. However, as the US and Europe discovered the hard way with their real estate busts, if one makes an abundance of cheap-money loans to speculators, prices will rise far above the true value of the asset bought with the debt. And in time, the bubble must burst. The pressure in this bubble is mounting. Andy Xie lays out the real situation on the ground in China:

No other government in the world would spend that kind of money. If you go to local Chinese cities, you will see what they spent that money on: Tens of millions on just trees, parks and government buildings.

All of the major ratings agencies are warning about an impending banking crisis in China. Fitch downgraded the country’s credit rating and warned there was a 60% chance the Chinese banking system will require a bailout in the next two years. Just like the US, China has too-big-to-fail banks, with five banks accounting for 50% of the lending in China. In a July 2011 report, Moody’s cautioned that the non-performing loans on the balance sheets of Chinese banks could rise to between 8% and 12%, versus the 1% proclaimed by Chinese officials. China’s regulators have belatedly applied the brakes, but it is too late. The house of cards looks susceptible to just the slightest of breezes.

Fraser Howie, managing director at CLSA in Singapore, captured the essence of the coming collapse in his recent assessment:

If you are going to address the misallocation of capital in the banking system and credit system, that’s going to have huge knock-on effects on the profitability and viability of the banks. And if there were a major banking crisis, you would start to see money trying to get out of China. What would the government do to maintain stability? You could have a whole host of problems. It’s almost far too complicated to contemplate.

There is one sure thing regarding bubbles: They always pop. It’s in their nature.

“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.”Ludwig von Mises

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GeneMarchbanks's picture

Beating this topic to death are we? It never gets old, yet people in the West who think China is a bigger concern than an insolvent banking system on two continents are continually sucked in by China affairs that will not cause any real crises. The story is still the collapse of the West where, lets not forget, the real problems originated.

prains's picture

Beating this topic to death are we?

 

don't be mislead, although not the message in this article, if you listen carefully that beating is the drums of war way off in the distance. Once the flow charts come out at the UN security council, it's game on.

AldousHuxley's picture
  • housing bubble
  • bad debt hidden by banks
  • unaffordable healthcare
  • demographic time-bomb
  • rampant corruption
  • income disparity

 

Sounds like China copied US right down to the economic collapse.

SheepDog-One's picture

Yep Gene, for the moment we have the luxury of looking down our noses at whats up with China...whats up with Europe...when we're sitting on the worst mess of all by far right here!

LawsofPhysics's picture

Might as well replace "China" with "the world".  Lots of card houses out there.

AldousHuxley's picture

well china pegged their RMB to dollars, so US banking system is Chinese banking system. Wall st. screwed Americans as well as the Chinese.

US is like a fake sugar daddy and China is like a gold digger. Chinese gold digger had a fun ride but now realize that American sugar daddy is really broke and actually the party was on gold digger's credit card.

 

long-shorty's picture

China is the Lenny Dykstra economy. Just because you once had a lot of assets doesn't mean you won't be broke went you spend the assets poorly, and simultanously borrow against your assets and spend that money poorly too.

long-shorty's picture

forgot to mention, very short CLF via options.

 

SheepDog-One's picture

'Chinas House of Cards'...the title could easily replace China with US and it would be no different.

What does it matter what China does, its all lies anyway. Until the day of complete melt down, all will be well so whatever. Drink heavily.

halflink123's picture

I would say the opposite-most of the Wall Street shills have been saying china IS in a bubble. If chanos aint a wall street shill i don't know who is.  Even more so, he's US centric and buys the US crock and bull.

Fact: China has more reserves than national debt.

 

Fact: China makes everything for the whole planet.

 

Fact: US cant compete w China and is running $T trade deficits w the country.

US is bankrupt, China is not. 

 

 

SheepDog-One's picture

Fact: China doesnt care if 1 billion of its people have to die to keep its 'economy' going.

SheepDog-One's picture

And you talk like an asshole. 'Progressive' LOL what did you do start listening to Glenn Beck last month?  No I dont talk like a 'progressive' fuknut I talk like a realist and point out that its irrelevant to talk about 'Chinas economic state' without pointing out they really dont give a shit...and unfortunately we're so stupid we're heavily in debt to them. 

imapopulistnow's picture

China is rapidly tranforming their nation from one of adject poverty to developed nation status.  Wages and working conditions are relative.  Much better than in China in the past but obviously not to western standards yet.  But they will be.  The important matter is they are continuously improving.  Wages annually increase more than inflation, workers can buy more every year than the year before and they are willing to work hard and educate their young knowing that the future is theirs to hold.  China's leadership cares very much about the welfare of their people, both from the paternalism embedded in their culture and pragmatically from the concern that they must keep their people reasonably happy in order to retain power.  Will their bubble crash like ours did in 2008?  Perhaps, but what they have going for them is $1.5 trillion in foreign reserves and 6 to 1 bank reserve requirements.  We entered our bubble with 30 to 1 bank reserves (excluding the many off balance sheet mechanisms).  China is building millions of low cost housing units to offset the construction declines from thier speculative real estate bubble.  They are further taking measures to encourage domestic spending to offset the obvious decline in exports to bankrupt developed nations.  They just capitalized their banks as a preventive measure rather than wait for a Lehman to collapse first.  They cautiously observe our mistakes in economic mismanagement and adjust accordingly.  You will likely be working for one of them in the future when the Yuan become the world's reserve currency and they buy our assets for pennies on the dollar.   (I suggest you replace the Che Guevara poster in your cubicle with one of Chairman Mao before they arrive).

imapopulistnow's picture

adject = abject, progresive = progressive

mjk0259's picture

Yes and US economy crashed every twenty five years or so during it's ascent to global domination. Even if China does crash, it will keep rising at least to approximately Japan level which is close to, if not better, then rapidly declining US level. Not that I look forward to this.

 

rosiescenario's picture

"...and unfortunately we're so stupid we're heavily in debt to them. "

 

....and they were dumb enough to buy our paper........inflation always favors the debtor....Ben will print us out of our problem.....we hope.

halflink123's picture

Fact: China doesnt care if 1 billion of its people have to die to keep its 'economy' going

remember US has been in wars for a decade? how many americans died? you think US cares if its people die? or any politicians?

 

Its not right, its sick but China isnt unique in this

SheepDog-One's picture

Yea of course, what are you trying to argue with me for I agreed, only backed up the facts a bit more. Just further pointed out its a ridiculous discussion to begin with, China will starve out a billion people to make its 'economy' work, if need be.

malek's picture

So does this make the previous 3 facts go away, or irrelevant in comparison?? Whistling past the graveyard, are you?

moskov's picture

So Americans care about Chinese people for how to  keep their economy going? Pretty pretty impressive coming out of THE PARASITE OF GLOBAL ECONOMY

SheepDog-One's picture

Yea exactly, this is only a momentary luxury seeing as how we sit on the biggest mess of all by far!

SMG's picture

Fact: China's reserves are backed by absolutely nothing.

Fact: In return for making everything for the planet, China has recieved trillions of pieces of toliet paper.

Fact:  US is ahead of China in miltary power and food production. Also China cannot feed itself on it's own.

US wins this one, but I think they will be very unhappy once they find out what has happened.  If there's any Chinese reading this, please remember the US is controlled by the Illuminati Oligarchy an they are the ones who did this to you.   I would hate to see WWIII caused by this costing billions of lives.   

 

moskov's picture

Fact: China's reserve is backed millions of skilled workers and world's largest manufacturing base.

 

Fact: US military power in real term is useless since China and Russia has enough nuclear heads to destroy the enire planet more than 20 times. the urban myth of China cannot feed themselves is just another delusional bullshit backs by nothing. 

 

If US is controled by Illuminati, then China would make sure Illuminati also disapear once for all. Chinese secret society is everywhere. Peace

SMG's picture

China has accomplished alot in the last few decades and should be proud of that.  I'm just saying that I hope all this gets resolved without WWIII.  Nobody wants to see that but the Oligarchy.

reader2010's picture

Thank for very much for your ignorance.

long-shorty's picture

Your "fact" is crap. Debt implicitly guaranteed by the Chinese federal government is somewhere in the neighborhood of 2.5x their foreign currency reserves.

 

TheSilverJournal's picture

China is fine. They have huge down payments so hardly anyone will lose their house to the bank. Any money the Chinese spend on infrastructure or building empty buildings is better than getting absolutely nothing out of it by investing it in soon to be worthless US Treasuries. And when the USD goes into hyperinflation, the Chinese will be much better off because they will no longer be able to sell their goods to the US in exchange for USDs that Bernanke just runs off the printing press and instead they'll consume those goods themselves.

Mugatu's picture

 

Chinese bubbles
Running out of time?
Make me happy
Make me feel fine

Chinese bubbles
Please don't get worried
Loads of bad debt
Will you get buried?

I am the inventor of the Piano Key Necktie!

 

chindit13's picture

They have huge downpayments gained from Mom and Pop borrowing against the family company in the shadow banking system at rates of 25-180% per year.  The connected plutocrats and cronies might have the cash to put down large downpayments, but the masses---who are buying---do not.  They have a population where 99% earn 50,000 yuan or less a year, the equivalent of $8000.  From this pittance, how many years does it take to "save" that 40% downpayment, after subtracing for rent, food, commuting, school fees, etc.?

Empty cities and homes decay naturally unless regular maintainance is carried out.  They decay even faster if there is substantial pollution, and faster still if the quality of construction was abyssmal.  China might have gotten the GDP boost---via debt---but they will get very little use out of these empty structures.

Potemkin economy.

broke433's picture

You forgot the gold bubble.

gwar5's picture

China = Bust.... and they know it.  The West is too broke to buy their stuff and their own domestic consumption is not accelerating fast enough to take up the slack despite the Chi-Coms' big efforts. 

 

/OT anybody catch this already?  Madoff whistle blower, Harry Markopolos, catches Bank of New York Mellon and State Street Bank stealing billions from pensions.

Business insider October 7, 2011. 

 

And Now We Know Why Nobody Took Madoff Whistleblower Harry Markopolos Seriously... - Business Insider

 

 

TheSilverJournal's picture

Why is it good for the Chinese to ship their goods to the West at all? All the Chinese get for shipping their goods to us is pieces of paper. So they make a good and ship it to us and we make pieces of paper and ship it to them and you think that is bad for the Chinese if that process isn't sped up? The Chinese might not know it yet, but they don't want the paper, what they really want is goods. That's the whole point of trade, to trade these goods for those goods. WHEN THE CHINESE REALIZE THAT THEY ARE TRADING THEIR GOODS FOR WORTHLESS PIECES OF PAPER, THEY WILL STOP THAT TRADE, WHICH WILL BE A GOOD THING FOR THE CHINESE. Because now they will be able to actually benefit from the trade and will trade their goods for other goods. So to sum it up, when fiat hyperinflates away, the Chinese will be able to consume what they produce.

imapopulistnow's picture

They are trading their low cost labor for state of the art technology and some of the most modern factories in the world.  Japan successfully did they same thing - until they literally ran out of people and domestic demand due to a low birth rate.

TheSilverJournal's picture

Japan didn't run out of demand. Demand is infinite. People always want stuff. In fact, demand comes from supply because the only reason to supply something is to trade it for something else. So the thing to look at is really production. You only produce in order to consume and you can only consume what has been produced.

Japan had a bubble created from easy money and it never let that bubble implode which is kind of like the US except the US is now in much worse shape than Japan was because the US makes relatively little. 70% of the US economy is service sector. The main export of the US is the USD which is now just run off a printing press at a forever increasing rate.

i root for that fat jersey governor's picture

the problem is such discussion would not help your invesment decision in near-, mid-, or even long-term. The reality is the corrupt political power in Chins, for their own power, will do anything and everything to postpone that crash, to their wish, forever or at least a long time (at least long enough to make sure the current regime won't see it, or to be punished for it). Since there is no democracy there like the U.S. or EU, those bastards might be able to pull it off.

So when it comes to betting on the fall of China or the collapse of world economy due to China's fall, you really can not predict anything in a meaningful term to help my investing strategy - talking is getting old here.

moskov's picture

Wow. Is the VooDoo China Doll very popular in the US these days?

Where's the debt ceiling drama again? I need some of that to add to the enormous house of dollars cards.

buzzsaw99's picture

i like japs better than chinks. nothing personal.

moskov's picture

I like Japs too, but Americans, too pathetic to compare with Japs

kito's picture

"Millions of Chinese were employed in creating properties for which there was no demand"

 

chinas five years plan is to urbanize some 300 million people in the rural areas. no demand--ha!!! chanos and other china bears will be waiting a long time for something that will not happen. as jim rogers points out, their real estate exposure is limited in relation to the entire nation's economy. china will keep on rolling....buy yuan.

imapopulistnow's picture

Over 1.3 billion Chinese of which only 150 million have achieved western living standards.  Sure looks like a source of future demand to me.

kito's picture

exactlyyyyyyyyyyyyyy......

reader2010's picture

150 million have achieved western living standards.

 

Based on what? oil consumption? 

Archimedes's picture

I have read this script before..about 5 years ago! China is still here. And being early does make you wrong! I learned a while ago; Just because you know how the game ends you can still lose by placing bets too early. The world moves much slower than your mind. Patience and ride the ups and downs, try not to get frustrated and emotional. Eventually it will collapse but no one really knows when. So make money on the ups and downs....

moskov's picture

Even after the Cultural Revolution and Tiananmen Square. PRC is still here and continuing lending their money to the US aka the rest of the world. I have no idea why are the China Doom Story  keep chasing around those professinal's attention while their mess back home is 10 times greater. When China was building the Great Wall, I beg Americans was still out of this planet yet. For Americans: Don't be too childlike, grow up and be honest to your problem first

buzzsaw99's picture

China lends the usa trillions of dollars that China slaved for and which we print for free and you think **we** have a problem? LMFAO!!

moskov's picture

Yes.When China stops lending it, Print as much as you want. You would be rich

reader2010's picture

When China stops sending money our way,  our bombs will be dropped all over China.