Streetwise Professor

October 31, 2011

Bear Down, China Bears

Filed under: Economics,Financial Crisis II — The Professor @ 7:42 pm

I am a longtime China bear.  The basic reasons for my skepticism are (a) an economy that relies on extensive government intervention and direct and indirect control of prices will inevitably experience massive misallocations of resources that will eventually require substantial rebalancing (“recalculation” in Austrian terms), and (b) the financial sector is particularly distorted, an myriad credit losses have been papered over in schemes that would make Enron’s Andy Fastow blush.  Massive fixed investment can generate remarkable increases in GDP, but there is reason to be skeptical about the efficiency of these investments.

Initial signs of cracking include an evident imminent collapse in the housing bubble, a steep selloff in the stock market, and growing problems in the vast shadow banking sector and municipal finance.

A couple of pieces that discuss this include this article and an interview with Jim Chanos.  From the article:

An alarming report from Schroders said Chinese banking operates in a “twilight zone” of phony accounting and shadow money and it’s all coming apart. “Almost half of all credit creation in China is off balance sheet,” wrote the team at Schroders.

They think this situation could unravel “over the next three to six months,” producing a huge crisis with international implications. Most Chinese banks, they predict, will end up as “zombie banks.”

. . . .

Albert Edwards at SG Securities warned that China’s long-running investment boom has no precedent and is bound to burst. “China is a ‘freak’ economy,” he wrote. “To my knowledge no other economy in history has experienced such high investment/GDP ratios and seen so many sequential years of strong investment growth.” The Asian tigers in the 1990s? Japan? Nothing comes close, says Edwards.

The Chanos interview is definitely worth watching.  The interviewer does her best to push the China case, but Chanos smacks her down pretty effectively.  And there’s a bonus line in the interview.  When asked about China helping Europe, Chanos responds that Sarkozy is the worst possible person to send to ask them for money.  And from initial reports, it appears that he’s right.  Although methinks that anybody the Euros could have sent would have been received just as coldly.  What could they possibly offer?

What happens in China definitely bears watching (sorry–couldn’t resist).  Financial steroids and narcotics help maintain appearances for a while, a la Michael Jackson, but eventually it all falls apart.  And in a place as big China, with its seething social undercurrents, that would not be pretty.

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  1. SWP, could you, at least, give a date to the Ever-Imminent China Apocalypse?

    Because without this, predictions are usually near useless (seeing as in the long-run almost all predictions will come to pass one way or another).

    Comment by Sublime Oblivion — October 31, 2011 @ 8:34 pm

  2. Is it possible that they get away with printing lots of money and recapitalizing the banks?

    Comment by Surya — October 31, 2011 @ 8:44 pm

  3. Three points on China: one is the rational expectations of the Chinese banking sector: they have been bailed out several times in the past decade and a half. The complication is that the money provided by the financial sector seems to have been the lubricant that has kept the various interests at bay – whenever there is trouble, a few executions have been carried out and money applied to ease tensions. Given this, and like our own Wall Streeters, why wouldn’t they be expect to be bailed out again? Inflation be hanged.

    Secondly in any Imperial court – and the Chinese ARE a collective Imperial court system of government, bad news doesn’t necessarily get transmitted that easily to the top. A lot of people comment on how the Chinese censor the internet. What is not commented on is that this means they are looking at it and it can act as a proxy for opinion. Aren’t the monitors of the internet acting as the old Imperial Censor system worked, trying to give the central government a feel for what is going on outside the formal chain of command? This along with (and conflicting with)the informal systems of guanxi – hierarchical interest groups attached to powerful figures – makes understanding what is going on, and the leaderships ability to control actions at lower levels.

    The point is that the Party’s responses, and their ability to respond to particular challenges work out through a system that we may not really understand. In other words it can become unpredictable in times of stress – even for them. Stress has usually come when there is a conflict in the leadership. The most severe recent repressions have been of the democracy movement and the Fa lung Gong: both were movements that sprang up outside of the party – in a new civil society that hasn’t existed since 1949. Given the reaction of the government they scared the pants off of the leadership.

    Finally the ongoing social unrest adds to the tensions – it is like background noise or energy that may rise to threaten parts of the leadership. The more unrest, the more energy. To threaten the system it has to be organized. Throughout the Communist period anger has been focused and movements let loose by elements of the leadership as a means to fight internal struggles. Examples include the the Hundred Flowers, Great Leap Forward, Three modernizations, etc. These have sometimes gotten out of control e.g the Cultural Revolution. The danger now has TWO potential sources, however. It can either materialize if there is another falling out or struggle within the leadership, or as the result of an as yet unknown social movement which arises to challenge the legitimacy of the Party.

    The Chinese have managed a remarkable 20+ years of controlling forces destructive to what they see as their national (Party) interest. This is the longest period in the last 120 years. At some point something is going to happen that challenges this.

    Comment by Sotos — October 31, 2011 @ 8:59 pm

  4. @S/O. Milton Friedman said he was very good at predicting ultimate outcomes, but terrible at predicting the timing. I feel the same way. It is particularly difficult in a situation like China, where the government has many policy levers that it can pull to try to delay the process–but in so doing, only makes the ultimate reckoning all the more painful. Collapses are inherently a non-linear phenomenon, and predicting when things go non-linear is by the nature of the problem virtually impossible to do. Small shocks to initial conditions can lead to discontinuous adjustments. It’s the nature of the beast.

    @Surya–that’s what they’ve done several times, but there is a limit to that. When resource misallocations get too far out of whack, all the money printing in the world won’t help. Cf., current situation in the US housing market.

    @Sotos [the S’s are wild tonight, I guess]–the information revelation problem you mention is an important source of potential instability. When shocks come, lack of information at the top leads to decisions that can exacerbate problems, not mitigate them.

    Put differently, the centralization that gives Tom the Tool Friedman the chills makes for a fragile system. It permits the buildup of imbalances, impedes self-correction, and interferes with information flow.

    The ProfessorComment by The Professor — October 31, 2011 @ 9:16 pm

  5. So you’re saying government intervention is a bad thing. To some extent I agree, but a lot of the details have been left out for readers to make a fair judgment. Housing bubble, yes, that’s pretty much collapsing reflected from the daily short sell ratios on many Chinese property stocks listed in HK. Falling demand plays a role, but mostly because speculators anticipate the Chinese gov to throw in more monetary tightening measures, because:
    1. The Chinese gov is getting a lot of pressure from the ‘post 80’s’ that they can afford housing.
    2. They’re implementing subsidized housing in the 12th 5 year plan to make sure the lower class can afford homes.
    3. Restrictions on controlling the bubble, ie foreigners are only allowed to buy 1 property in China, locals can’t buy more than 3 homes, etc etc.
    4. Property developers are have been experiencing difficulty borrowing from banks in the past 6 months. Many have turned to issuing new shares or bonds to stay afloat.

    A lot of these interventions are actually positive for the economy in the long run in my opinion. Yes they pumped out a lot of money that drove supply over actual demand, but they’re righting their wrongs now, and its evident in many of their current policies. One of their top priorities in the past year have been driving domestic consumption and they did a pretty good job on that. And trust me they’ve already been cutting down on investments.

    Comment by Insom — October 31, 2011 @ 10:58 pm

  6. Milton Friedman said he was very good at predicting ultimate outcomes, but terrible at predicting the timing.

    Quite. The Economist was warning of the UK house price bubble since 2002/3, and every year they said that for each year they are wrong, the problem does not go away but gets worse. And sure enough, 2008 was the year it all came crashing down. Now it is common to hear people saying “Oh, but back then nobody was saying this!” whereas in actual fact they were, but were being laughed at.

    Comment by Tim Newman — October 31, 2011 @ 11:32 pm

  7. In that case, could you at least tell us how bad it will be when The Day comes?

    Because if, say, after all the doom-mongering all that happens is that China slows down to 5% for a year or two, then resumes growing at 7%, most people would call it an inconsequential blip.

    And quite distinct from, say, a scenario in which its GDP crashes by 5% or 10%, and then stagnates for several years.

    Comment by Sublime Oblivion — November 1, 2011 @ 1:12 am

  8. I can’t imagine China collapsing despite my ongoing philosophy of one-party systems, dictatorships, or whatever you want to call them, being a disaster waiting to happen. I suspect that enough bad things could happen that their competitive advantage could take a huge hit and give Western nations an edge they haven’t had for a long time. Though still small, there are patterns emerging where manufacturers are returning to their own nations to set up production again. Of course, they may just go to Vietnam or other cheap places, but the trend is interesting. Still, with China and the U.S. so intertwined economically these days, I’d be interested to know how China’s collapse would be an automatic plus for the U.S. It can’t be that simple.

    Comment by Howard Roark — November 1, 2011 @ 1:11 pm

  9. I don’t agree with S/O that all is ducky in the People’s Republic, but nonetheless, separating out genuine signals from the usual Oceania (the Anglosphere empire) has always been at war with Eurasia (Russia) and Eastasia (China) noise is hard to do.

    Also, on another favorite subject of Russophobic SWP commenters — here comes the Georgian billionaire who says Misha the Tie Eater done started the Georgia war.

    Comment by Mr. X — November 2, 2011 @ 2:32 pm


    I love the smell of panic in the morning – it is the smell of freedom.

    Comment by Sotos — November 7, 2011 @ 7:17 am

  11. @Sotos–then you’ll love this and this. Enjoy!

    The ProfessorComment by The Professor — November 7, 2011 @ 6:42 pm

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