2011-01-28

China's coming crisis

I used to think China would hit the development wall at around $10,000 in per capita GDP. There's still low hanging fruit in the economy, especially in the West, but as the country develops, the reforms needed to press on with economic development become increasingly large. If the current model of development has weaknesses, however, the crisis could come earlier due to bad debts, malinvestments, or other mistakes. For instance, in the United States, it was well known that Medicare and Social Security were going to be a major crisis in the coming years, but the financial crisis of 2008 accelerated the problem. The United States faces a debt crisis today and the looming threat of entitlements has been brought forward to the present.

You may have heard the arguments of China bears such as Jim Chanos or Hugh Hendry, but Fraser Howie and Carl Walter have a new book examining the country's economic system. They previously wrote Privatizing China in 2003, an excellent book detailing the privatization of China's state-owned enterprises and the growth of the stock market. I look forward to reading their latest book, Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise.

Asia Times has an interview with Fraser Howie, titled China not all it seems.
BAS: Does this sort of investing, absent the market forces pushing for new infrastructure versus the party deciding to pursue them, lead to overcapacity?

FH: Yes. In China, the Holy Grail for so many in local government is to go from nothing to something, so if you are a poor province or city and a factory announces it is going to get built, money all of a sudden becomes abundant. But this desire for growth before all else can and does lead to a massive misallocation of capital. But the real question is what will this overcapacity and misallocation of capital lead to? A lot of critics of China point to a property bubble collapse and say that's likely.

Sure, the property market in China may be a bubble in certain cities. But the Internet was a bubble as well and yes, it popped, but look at the Internet now - it is more powerful and central to the global economy than it ever was. Bubbles happen, the key is how you respond to them A more likely result of this overcapacity and it effects will be the upcoming test of what happens when the Chinese SOEs [state-owned enterprises] who were recipients of China's stimulus money need to start paying their loans back. It will be interesting to see how the markets respond if, in two or three years, these companies can't service their debt.

The assumption is the Chinese government will step back in if there are problems, but if investors don't get full disclosure we won't know how bad things really are. Look, we already know securitization in China is booming. Why is that? It's probably because Chinese banks are trying boost lending at any price without fully disclosing the risks, and who knows how much other off-balance-sheet activity is going on?
Asia Times also has a book review, titled The party principle.

The NYTimes has an interview with Carl Walter.

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