The Looming Depression – China Meltdown

20 Mar

China’s economic miracle has come with a number of costs. They have largely financed the US economy as a methodology to drive exports extending over $2 trillion in credit to the US to keep economic growth going.

The issue is that despite having 1.2 billion people – less of 10% of China’s manufacturing output is meant for the domestic market. Many of the products are beyond the means of the average worker. This has meant a massive slowdown as the US economy has imploded.

Interestingly enough, just as the US Government has tried to stem the tide with economic stimulus money, and has the ability to not only control the flow of money, but the lending practices of the banks – this has resulted in a massive real estate bubble instead of real economic growth. The precursor to a China meltdown will likely be the implosion of it’s overheated real estate market. There is a ton of inventory on the market, yet prices are still rising – as our own meltdown proves, that is not sustainable forever.

A second hit is going to be the movement of manufacturing back into the US, as both the US Government and increasingly restive public apply serious pressure to industrial and manufacturing companies to help in lowering unemployment. This could also have serious repercussions on the economy of India.

China: the coming costs of a superbubble

The world looks at China with envy. China’s economy grew 8.7 percent last year, while the world economy contracted by 2.2 percent. It seems that Chinese “Confucian capitalism” – a market economy powered by 1.3 billion people and guided by an authoritarian regime that can pull levers at will – is superior to our touchy-feely democracy and capitalism. But the grass on China’s side of the fence is not as green as it appears.

In fact, China’s defiance of the global recession is not a miracle – it’s a superbubble. When it deflates, it will spell big trouble for all of us.

To understand the Chinese economy, consider three distinct periods: “Late-stage growth obesity” (the decade prior to 2008); “You lie!” (the time of the financial crisis); and finally,  “Steroids ’R’ Us” (from the end of the financial crisis to today).

Late-stage growth obesity

About a decade ago, the Chinese government chose a policy of growth at any cost. China’s leaders see strong gross domestic product (GDP) growth not just as bragging rights, but as essential for political survival and national stability.

Because China lacks the social safety net of the developed world, unemployed people aren’t just inconvenienced by the loss of their jobs, they starve; and hungry people don’t complain, they riot and cause political unrest.

Remember the 1994 movie “Speed”? A young cop (Keanu Reeves) had to save passengers on a bus that would explode if its speed dropped below 50 m.p.h. Well, China is like that bus with 1.3 billion people aboard. If the Communist Party can’t keep the economy growing at a fast clip, the result will be catastrophic.

To achieve high growth, China kept its currency, the renminbi, at artificially low levels against the dollar. This helped already cheap Chinese-made goods become even cheaper. China turned into a significant exporter to the developed economies.

Normally, if free-market economic forces were at work, the renminbi would have appreciated and the US dollar would have declined. However, had China let this occur, demand for its products would have declined, and its economy wouldn’t have grown at roughly 10 percent a year, which it did during the past decade.

The more China sold to the United States, the more dollars it accumulated, and thus the more US Treasuries it bought, driving our interest rates down. US consumers responded to these cheap goods and cheap home loans by going on a buying binge.

However, companies and countries that grow at very high rates for a long time will inevitably suffer from late-stage growth obesity. Consider Starbucks: In 1999, it had 2,000 stores and was adding 1.8 stores a day. In 2007, when it had 10,000 stores, it had to open 5.5 stores a day in a desperate bid to keep growth rates up. This resulted in poor decisions and poor quality – a recipe for disaster.

In China, political pressure for full employment has led to similar late-stage growth obesity. In 2005, China built the largest shopping mall in the world, the New South China Mall: Today it’s 99 percent vacant. China also built up a lavish district in a city called Ordos: Today, it’s a ghost town.

You lie!

All good things come to an end, and great things come to an end with a bang. When the financial meltdown erupted in 2008, US and global banks started dropping like flies. Countries everywhere suffered contraction.

Even China.

During the crisis, Chinese exports were down more than 25 percent, tonnage of goods shipped through railroads was down by double digits, and electricity use plummeted.

Yet Beijing insisted that China had magically sustained 6 to 8 percent growth.

China lies. It goes to great lengths to maintain appearances, including censoring media and jailing those who write antigovernment articles. That’s why we have to rely on hard data instead.

Steroids ‘R’ Us

Today the global economy is stabilizing, thanks to Uncle Sam and other “uncles” around the world. But the consumers of Chinese-made goods are still in debt, unemployment is high, and banks aren’t lending. You might think the Chinese economy would be growing at a lower rate. But no, it is growing again at nearly 10 percent, as though the financial crisis never occurred.

Though this growth appears to be authentic – electricity consumption is back up – it is not sustainable growth, because it is based on an unprecedented stimulus package and extraordinary government involvement in the economy.

In the midst of the financial crisis, in late 2008, Beijing fire-hosed a $568 billion stimulus into the Chinese economy. That’s enormous! As a percentage of GDP, it would be like a $2 trillion stimulus in America, nearly triple the size of the one Congress passed last year.

It gets even more interesting. Unlike Western democracies, whose central banks can pump a lot of money into the financial system but can’t force banks to lend or consumers and corporations to spend, China can achieve both at lightning speed.

The government controls the banks, so it can make them lend, and it can force state-owned enterprises (one-third of the economy) to borrow and to spend. Also, because the rule of law and human and property rights are still underdeveloped, China can spend infrastructure project money very fast – if a school is in the way of a road the government wants to build, it becomes a casualty for the greater good.

Government is horrible at allocating large amounts of capital, especially at the speed it is done in China. Political decisions (driven by the goal of full employment) are often uneconomical, and corruption and cronyism result in projects that destroy value.

To maintain high employment, China has poured money into infrastructure and real estate projects. This explains why, in 2009, new floor space doubled and residential real estate prices surged 25 percent. This also explains why the Chinese keep building new skyscrapers even though existing ones are still vacant.

The enormous stimulus has exacerbated problems that already existed, threatening to turn China into a less shiny but more drastic version of debt-riddled Dubai, United Arab Emirates.

What happens in China doesn’t stay in China. A meltdown there – or even a slowdown – would have severe consequences for the rest of the world.

It will tank the commodity markets. Demand for industrial goods will fall off the cliff. Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5 percent mortgages and 6 percent car loans.

No shortcuts to greatness

We look at China and are mesmerized by its 1.3 billion people, its achievements of the past decade, its recent economic resiliency, and its ability to achieve spectacular results on the fly. But we have to remember that economic bubbles are usually just a good thing taken too far. The Chinese economy is no exception. Its long-term future may be bright, but in the short run we’ve got a bubble on our hands.

Everyone wants a shortcut to greatness, but there isn’t one. China has been trying to bend the laws of economics for a while, and with the control it exerts over its economy it may seem that it’s succeeded.

But this is only a temporary mirage, which must be followed by a painful reality. No, there is no shortcut to greatness – not in personal life, not in politics, and not in economics.


Posted by on March 20, 2010 in General


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4 responses to “The Looming Depression – China Meltdown

  1. brotherbrown

    March 20, 2010 at 7:47 PM

    The cost of steel rose through the roof from2003-2007 as China construction usurped much of the world’s steel supply. But the US overbuilt too, and it will take some time for commercial real estate to regain its footing.

    California is in a gubernatorial election cycle. Former Governor and Current State Attorney General Jerry Brown is the likely Democratic nominee, while the Republicans have a competitive race featuring Insurance commissioner Steve Poizner and former Ebay CEO Meg Whitman, a political first-timer.

    Whitman is going to prove to be an interesting candidate if she wins the republican primary in June. For twenty years, she didn’t bother to vote regularly. Her claim is that she knows how to create jobs, yet when you check Ebay’s 10-Ks you’ll see that of 16,000 employees, 7,500 of them are off-shore. In the context of their business model, which is a web-based platform for buyers and sellers to exchange goods and services in a marketplace where Ebay makes money facilitating the deal, what do the 7,500 off-shore employees do that could not be done in the state of California?


    • t-shirts101

      March 20, 2010 at 9:19 PM

      In light of this information, Whitman’s opponent could threaten that she will off-shore state jobs if she’s elected – to save CA money.



    • btx3

      March 20, 2010 at 10:15 PM

      I hope Jerry Brown makes an issue of it as she is the likely Republican candidate. I’m not sure however, I’d like to take over California at this point in time with the budget and economic woes. Whomever gets the job is in for a rough road.



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