China’s Bubblishness

The recent boom in the Chinese economy, fueled completely by massive amounts of credit dumped into the economy by a stimulating government, will come to an end. If the recent tightening by the Chinese government is any signal, it might be in the immediate future. The question is how will the bust happen and what will it look like.

A recent report from Pivot Capital Management believes a crash will be this year:

We conclude that the capital spending boom in China will not be sustained at current rates and that the chances of a hard landing are increasing…

Similarly to the housing and consumption bubbles in the Western economies, credit has played a pivotal role in the investment bubble in China. Since the beginning of the decade up to H1 2009, domestic credit in China has expanded 50% more than GDP (chart 5). China is an outlier compared to the other BRIC countries in terms of the credit to GDP ratio (140% as of H1 2009) and is already beyond the levels that historically have led to sharp and brief credit crises in the past (chart 6). If loans continue to grow at the current 35% rate, credit to GDP ratio will be close to 200% in China already in 2010, even with GDP expanding at 10%. This is a level similar to the pre-crisis Japan in 1991 and USA in 2008. All this points to that credit in China is not going to be able to grow for much longer without risking a major crisis.

But others are not so sure the crash will come so soon. The Economist critiqued the Pivot report saying:

a close inspection of pessimists’ three main concerns—overvalued asset prices, overinvestment and excessive bank lending—suggests that China’s economy is more robust than they think. Start with asset markets. Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37. Granted, prices jumped by 80% last year, but markets in other large emerging economies went up even more: Brazil, India and Russia rose by an average of 120% in dollar terms. And Chinese profits have rebounded faster than those elsewhere. In the three months to November, industrial profits were 70% higher than a year before.

Andy Xei meanwhile gets a sense that the crash will come in 2012 when he sees the Fed tightening monetary policy.

The growth outlook, on the other hand, is dimmer. On the demand side, developed economies will continue to suffer high unemployment and property deflation. Despite a strong export showing in December, China’s exports are unlikely to grow as they did in the previous five years.

Personally, I don’t see the Fed waiting until 2012 to tighten monetary policy. Political pressure will be too strong. (Though it might not be until very late 2010 or sometime early 2011 since the prevailing view at the Fed is to wait until the recovery is stronger before they start tapping the brakes.)

However, that doesn’t mean that China is going to bust this year. In fact the unraveling could be relatively mild if the Chinese pull back on their aggressive stimulative programming of the economy. Whether the Chinese realize their credit flood is unsustainable or not, they are acting like it is and that might save them from a serious blow up.

Then again it might be too late.

The Economist report dismisses housing value increases as an important indicator, but the numbers are more intense then they let on. To begin with the national average of values is not a perfect indicator given the vast differences in land prices from city to city across China. In certain cities values have skyrocketed an eye-popping 400 percent in the past year:


That certainly has the makings of a serious bubble that is on the order of the Japanese asset bubble bursting, despite the Economist’s discounting of the idea.