Thursday, 1 April 2010

The Chinese economic bubble

John Mangun
Outside the Box
Business Mirror

IT is probably appropriate to talk about China on a day during a week when no one is really interested in the financial markets and the global economy because no one is really interested in talking objectively about China at any time.

China has become the world’s beauty queen, strolling down the catwalk in a designer gown, dripping with jewels for all to see, and without a care in the world.

Yet behind closed doors when the makeup comes off, there may be little more than dyed hair, cosmetic teeth and a surgically enhanced body.

Becoming a major player in the past decade, China has made billions of dollars of investments, particularly in mineral wealth, venturing into countries and forming business partnerships that seemed unlikely just a short time ago. Chinese influence has reached into every corner of the planet. In what seems like just a moment, it has eclipsed Japan as the economic leader of Asia.

The global political influence of China is seen in almost every geo-political move from the Middle East to North Korea and even South America.

Western concerns about Iran’s nuclear program must be validated with China. As the Obama administration heads into a nasty trade war with Brazil over agricultural subsidies, both sides look over their shoulders at China to see which way the Red Dragon may turn.

The Chinese business/government economic culture is supposedly geared to the long term, in line with the thought of Confucius, “If a man takes no thought about what is distant, he will find sorrow near at hand.”

However, if you look at Chinese economic policy through the past decade and today, most policy has been dominated by short-term thinking, oriented toward immediate gains. And economic bubbles are a guaranteed result of that sort of economic policy.

As the US borrowed with no thought to having to pay those debts in the future, China, too, followed policies with little concern about future consequences.

A decade ago, China embarked on a program of economic growth at any cost. It sold its manufactured goods to the US to fuel that growth. China kept its currency artificially cheap to energize its exports. When the US ran out of cash, it loaned billions to keep the US buying its goods in order to keep its 10-percent annual growth rate going. Because of its huge foreign reserves and its willingness to loan all the funds the US consumer needed to “Buy Chinese,” US interest rates went lower and lower, creating an unprecedented demand for cheap borrowed money to buy more cheap goods and eventually “cheap” homes.

When growth is the only objective, foolish decisions are made. China built the largest shopping mall (by leasable area) in 2005 that, even now, is 99-percent empty. In 2001 China created the prefecture-level city of Ordos costing hundreds of millions. Yet the city is a “ghost town” with a population density of 17 people per kilometer (Cebu City is 750).

As China built its export markets, domestic consumption actually fell from an historic average of 60 percent of the total economy to less than 30 percent today, the lowest domestic consumer contribution to the economy of any other nation. With exports dropping 20 percent in 2009, China has spent $1 trillion to stimulate its economy. By comparison to GDP size, that is like the US spending $5 trillion in stimulus. Today, as much as 95 percent of China’s growth is attributable to government investment.

At least 20-percent government stimulus has gone into the stock market and real estate. China has flooded its economy with infrastructure and real-estate projects to maintain high employment. In 2009 new commercial floor space doubled and residential real-estate prices increased 25 percent. The Chinese continue to build new skyscrapers even though existing ones stand vacant.

The policies that China is pursuing, holding the line with stimulus until exports recover, are based on the belief that those exports will rebound on the back of a growing US economy. China has more faith in Obama than the rest of the world. Because of the lack of domestic demand, they have no choice.

If the US economic-growth engine can begin to absorb Chinese goods at the pace before, China can substitute this economic activity for its stimulus efforts.

 But if they cannot replace the stimulus money with export income, China is in deep trouble.

 For a decade, China’s economy grew on its exports. Now the economy is growing on unsustainable government infrastructure projects that do not continue to create growth in the future. Private project spending funded by cheap stimulus lending is constructing office buildings that no one is occupying and buying real estate at higher and higher speculative prices. The money is not building small/medium enterprises that create lasting employment and lasting growth.

 China can use its massive foreign reserves only so far in the domestic economy. As those dollars are turned into renminbi for local spending, it is inevitable that they will have to revalue their currency upward, putting future pressure on their exports.

 If the global economy cannot soon absorb Chinese exports to grow that economy, the bubble that has been created by government stimulus will burst because China will not be able to sustain its stimulus spending without creating high inflation, already at a 16 month high.

 The world will face severe consequences if China experiences a meltdown or even a slowdown. Commodity prices will fall. Chinese demand for industrial goods will fall. The dollar will fall while US interest rates will rise as Chinese appetite for US debt drops.

 China’s long-term future may be wonderful, but in the short run, the world has a Chinese bubble on its hands, an economic bubble that has the potential to explode

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