By Gordon G. Chang Gordon G. Chang – Thu Jan 21, 12:41 pm ET
New York – Has the global economy recovered? Forecasters say there will be an uptick this year of 2.4 percent, but they’re forgetting something. China could fail soon, and, if it does, the world’s most populous state will drag the rest of us down.
At this moment, a Chinese crisis seems like the last thing we should be worried about. After all, last year China overtook America as the planet’s largest car market and passed Germany as the biggest exporter.
On Thursday, Beijing announced that growth for the fourth quarter of 2009 was 10.7 percent and 8.7 percent for the entire year. Some analysts said the numbers were so strong that the country zoomed past Japan to become the world’s second-largest economy. Stock markets, property prices, you name it: Everything Chinese is soaring.
Dubai was once soaring, too. Global markets therefore, shuddered in November at the news that Dubai World, Dubai’s state investment firm and biggest corporate debtor, had asked for an extension on its $59 billion of obligations. Troubles in the booming emirate had been evident for some time, but stock investors were nonetheless caught unawares, apparently thinking a default would not occur.
They were obviously wrong. Global markets, for the time being, got past the shock, in part because the emirate is small. China, on the other hand, is not. Legendary short-seller James Chanos, who predicted the failures of Enron and Tyco, calls the country “Dubai times 1,000 – or worse.”
Like Dubai at the beginning of last year, China is now reaching the peak of a bubble. At first glance, there is not much that connects the tiny city-state with the continent-sized nation. Yet both of them suffer from overexpansion.
China’s export-led economic model delivered spectacular growth in the post-cold-war period of seemingly never ending globalization and economic development. Yet global trade is now stagnant after dropping significantly last year. As a result of troubles abroad, Chinese exports declined 16.0 percent in 2009. There is little prospect for a sustained recovery this year.
Beijing, ignoring advice from Washington and other capitals, did not in the boom times try to restructure its economy to favor consumption. Instead, the Chinese government sought to take maximum advantage of then-surging foreign demand. The role of consumption, therefore declined – falling from a historical average of 60 percent of the economy to about 30 percent last year. No country has a lower rate.
To make up for slumping demand abroad and sluggish consumer spending at home, the State Council, the central government’s cabinet, announced a stimulus plan in November 2008. Beijing originally said it would spend $586 billion through 2010. In the first full year of the program however, it has directly and through state banks disbursed about $1.1 trillion in stimulus funds.
The plan, not surprisingly, is creating gross domestic product, but growth is an artificial “sugar high.” For one thing, Beijing’s stimulus spending last year was around a quarter of the total economy. Now, perhaps as much as 95 percent of China’s growth is attributable to state investment, as a Chinese analyst noted recently.
Despite the massive state spending, the country’s economy is not particularly robust. Power consumption statistics, a crucial indicator of economic activity, show the economy expanding at only two-thirds the announced rate.
Moreover, essentially flat consumer prices last year belie official reports of roaring retail sales. So does the full-year 11.2 percent decline in imports, another sign of sluggish domestic demand. And if the economy is really growing by double digits, why is Beijing insisting on continuing its stimulus?
Yet however fast the economy is growing, China’s policies are unsustainable. First, the central government will be hard pressed to find the money to continue the spending spree. Budget deficits are going up fast, a constraint on additional expenditures. More important, Beijing’s regulators are concerned that the state banks, the primary source of stimulus funds, are overextending themselves and accumulating bad loans.
New York Times columnist Thomas Friedman, however, thinks none of this will be a problem. Arguing that China is not the next Enron, he gives this advice to Mr. Chanos: “Never short a country with $2 trillion in foreign currency reserves.”
Yet Beijing’s record-setting reserves – now $2.4 trillion – are essentially unusable for this purpose. Why? China’s leaders need local currency, the renminbi, to deal with domestic needs. If they convert reserves into renminbi, they will cause the currency to zoom up in value and choke off the critical export sector. Foreign reserves have only limited uses in domestic crises.
Second, the state's stimulus plan is taking the nation in the wrong direction. It is favoring large state enterprises over small and medium-sized private firms, and state financial institutions are diverting credit to state-sponsored infrastructure. Over the past three decades, China's economy has expanded at an average annual rate of 9.9 percent because of the private sector, but now Beijing is renationalizing the economy with state cash.
Third, Beijing’s flooding of state enterprises with government cash will undermine their competitiveness, as a similar tide of money severely damaged Japan’s corporations during the bubble years.
Japanese managers discovered they could make more money managing cash than from anything else, and they therefore neglected their underlying businesses. Essentially the same thing is happening in China.
About a fifth of state bank loans have found their way into the country’s climbing stock markets, and another large portion is fueling property market bubbles. Worst of all, Macau casinos have enjoyed a recent boom, apparently attracting high-rolling Chinese cadres betting diverted stimulus money.
Finally, stimulus spending, as time goes on, becomes less effective in creating growth. The country already has one empty new city – Ordos in Inner Mongolia – and thousands of vacant facilities, especially shopping malls. New factories are underutilized.
For all its faults, the State Council’s spending program is just about the only thing generating growth at this moment. Unfortunately for the government, its plan is also creating imbalances and dislocations that will be difficult to handle this year.
Chinese officials, working in a state-led economy, once had the ability to defer problems. Yet the challenges they face have grown over time as they have pursued pro-growth policies instead of implementing structural change.
And that is why, when their growth policies run out of steam – as they soon will – China will become the next Dubai. Only bigger.
Gordon G. Chang is the author of “The Coming Collapse of China” and “Nuclear Showdown: North Korea Takes on the World.”
© 2010 Global Viewpoint Network/ Tribune Media Services. Hosted online by The Christian Science Monitor.
I tried to post about this a couple of weeks ago when I found the folowing article but it got denied so I found another article plus my original. So HAH!
Is short-selling China a good bet?
The drumbeat of doubt about the sustainability of China's economy grows louder... or at least that's what some folks want us to think.
Last month we talked to George Friedman at Stratfor about why he believes China is really investing in the U.S. so heavily:
Essentially, so many of China's domestic industries are crumbling that the last place Chinese investors want to park their money is close to home, Friedman says.
It was the same situation with Japan in the late 1980s and early 1990s, when investors from that country seemed to be buying up Western assets left and right, like the Pebble Beach golf resort.
"Was it a move about power? No, it was just they would rather have owned dirt in California than invest in Japan," Friedman said.
And now Jim Chanos, the hedge fund investor best known for shorting Enron and then raising doubts about the firm with reporters, is saying much the same about China:
As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China's hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like "Dubai times 1,000 -- or worse," he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.
"Bubbles are best identified by credit excesses, not valuation excesses," he said in a recent appearance on CNBC. "And there's no bigger credit excess than in China." He is planning a speech later this month at the University of Oxford to drive home his point.
Craig Pirrong, the University of Houston finance professor and author of the Streetwise Professor Blog, tends to agree with Chanos, having referred to China previously as the "Michael Jackson economy" kept performing by outsized doses of artificial stimulants:
That can work for awhile, but as MJ (not the SWP reader:) showed, the ultimate effects are likely catastrophic.
What I find hard to understand is why so many investors and commentators seem to have bought into the China growth story hook, line, and sinker. I don't expect everybody to be as skeptical as I am, or as Chanos is. But one would think that in the aftermath of a major economic contraction which plausibly resulted from an overly expansive monetary policy and various institutional factors that directed most of the ballooning credit to the real estate sector, the China boosters would at least pause to ask whether the same might be occurring in China. Or to question the reported growth, that always miraculously hits official targets, much in the same way as Enron's earnings always miraculously came in as expected, with metronomic regularity.
But not everyone is a big fan of Chanos and his outlook. Quantum Fund co-founder Jim Rogers thinks Chanos' knowledge on China might be a bit thin.
And the New York Times' Thomas Friedman has a bit of short-selling advice for Chanos. He acknowledges there are plenty of bubbles in China ripe for popping, but there are two reasons he'd hesitate to bet against China:
First, a simple rule of investing that has always served me well: Never short a country with $2 trillion in foreign currency reserves.
Second, it is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called "excessively rising house prices" in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China's central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves -- precisely to head off inflation and take some air out of any asset bubbles.
Posted by Tom Fowler at January 14, 2010 09:00 AM
Thoughts? Should we start short-selling China so we can make some money this coming recession?
Update:Coding issue is fixed. funny I got more comments about the coding than my last post got comments.