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China’s economic successes during the past ten years have been very impressive.
It has remodeled its economy along the guidelines of free market principles.
And its population has been rapidly growing.
Together those two trends have yielded rapid growth and spectacular wealth building, and they bode well for long-term gains.
However, wealth formation is never evenly distributed. And social tensions tend to erupt, especially during times of brisk growth off of a very low level.
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| Social tensions are explosive in China. But without freedom of speech, investors can’t monitor the situation. |
The problem for investors is that there’s no freedom of speech in China, and news of social unrest in rural areas seldom reaches the international media.
Consequently, we never really know the degree of internal conflicts within the country.
Remember Japan’s Uber-Bureaucracy, the METI?
China is still ruled by the old communist elite and a central planning bureaucracy, which historically doesn’t work …
In the 1930s, many European and American intellectuals wanted to believe that the Soviet communists and the European fascists — both running central planning economies — were the right answers to the dire times.
We know the sad results of those experiments.
Then, in the second half of the 1980s, Japan’s economic miracle made the headlines. People all over the world deemed the Japanese Ministry of Economy, Trade and Industry (METI) the kernel of Japan’s success.
The clever combination of central planning and free markets was heralded as the right way to rule the world economically.
Many books were published recommending the introduction of the Japanese model into the western world. Without it, the demise of American economic supremacy was said to be unavoidable.
However, the pundits overlooked the shaky base of Japan’s aim for the stars. Two major speculative bubbles: A stock market bubble and a real estate bubble were the real drivers of Japan’s brisk, but unhealthy growth. When those twin bubbles burst, the miracle ended abruptly, and Japan has yet to recover.
So is China any different?
I think the real question is this …
Can Vendors Prosper When
Their #1 Client Is Starving?
The U.S. was a major emerging market during the 19th century. Therefore, maybe we can learn something about China by looking at America’s history.
In doing so, a conclusion and a caveat becomes clear: Even if the long term bullish forecast for China comes true, it will not be a straight line up. Instead it’ll be a difficult journey with many ups and downs, as well as backlashes and crises along the way.
Take the bear market of 2008 as an example …
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| In 2008, the decoupling theory for Asian countries didn’t pan out. That’s because most of them had an export-based economy, and the U.S. was their #1 client. |
The hopes of decoupling vanished when the Shanghai Composite Index fell more than 70 percent from high to low. Today these hopes are back … slightly modified. Now the hope is that China and other Asian countries will be the new growth engine and pull the world economy out of recession.
Last year, the strong export orientation of most Asian countries was my major argument against the decoupling thesis. My logic: If the U.S., their major client, was in trouble, how in the world could its vendors prosper?
Well, we now know they couldn’t. But can they now? Can the vendors indeed become the global growth engines? I still have my doubts.
China Starts a Dangerously
Huge Credit Boom …
Some economic figures, such as those for housing and autos, seem to point to a strong recovery in China. Others, especially export figures, do not. This is a dangerous mismatch in my opinion, pointing to the development of grave misbalances.
The Chinese government forecasts GDP growth of 8 percent. And the World Bank’s estimate isn’t far behind at 7.2 percent. Yet the World Bank’s bureaucrats estimate that 6 percent of this growth stems from China’s huge stimulus programs.
Will this stimulus turn out to be a short-term straw fire, or will it jumpstart the economy for good?
We’ll have to wait for the answer. In the meantime, I see one very dangerous development in China today: Skyrocketing bank credit growth.
In June, bank loans increased by $224 billion. For the first half of this year loan growth was up more than $1 trillion. That’s about three times the year-ago rate!
To put today’s number in greater perspective, in all of 2008 loan growth was up by $700 billion. In 2007 it rose by roughly $500 billion, and in 2006 by $455 billion.
This extremely strong credit growth is dangerous, because it goes hand in hand with lower credit standards. If you want to know what that means, just ask anyone at Fannie Mae or Freddie Mac about accepting risky mortgages. What’s more, nobody knows the risks inherent to the Chinese banking system!
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| For the first half of this year, bank loan growth in China was about three times higher than a year-ago. |
Whenever I see bank credit growth surging, my warning lights start flashing like crazy. Financial history clearly tells us that credit booms are always followed by busts — sometimes sooner, sometimes later. And China will be no exception to this time proven rule. So the Chinese banking industry is definitely a sector worth watching now.
It will be very interesting to see how the Chinese stock market behaves during a new bear market leg in the European and U.S. stock markets. If it holds together, I would interpret this as a strong sign that this bank credit boom is just the beginning of something much bigger … something that will grow into a major bubble.
If that happens, commodity prices will probably surge dramatically. And the Chinese stock market will not be far behind. For this to come about, though, credit growth has to continue. So now you know what to look for during the coming months.
Best wishes,
Claus
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