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It is Not the Century of China

July 2, 2013

Through my own paying attention of what’s taking place in the world and reading a lot I learned of a billionaire investor who was so gung-ho on China being the economy of the future. Something just did not seem right to me about someone being so bullish on China to the extent that he would make his daughters learn Mandarin. The claim being that China will be a very significant player internationally. As a world citizen you must be aware of these contentions and study the situation carefully anytime someone tells you to that there is this one great place or product that will be the future you must look at the situation with a skeptical mind and learn more. The twenty-first century does not belong to China and it is not on the rise. I will share with you what is going on. China’s construction boom is unprecedented in human history. By some estimates, as much as 50 percent of their GDP is now driven by fixed investment, a large part of which is construction.

Far from encouraging a more consumer-driven economy rather than export-driven, consumer spending as a percentage of the economy has actually decreased while the construction part of the economy has become absolutely dominant. I think this is the part that billionaire investor Jim Rogers probably likes so much, that China is more a nation of producers instead of consumers. I believe his Henry Ford populist investment morals are getting in the way of reality. Even at the height of our housing bubble, construction was only 17 percent of our economy. At its height during Spain’s housing bubble it was 23 percent, and in Dubai it approached 30 percent at the peak of its speculative construction boom. Some people feel this construction bubble is unsustainable, although not surprisingly most people do not see it as unsustainable and think it can go on for many more years.

For those who think it will slow down, a lot of the discussion surrounding the fall of this construction boom revolves around whether it will have a soft landing or a hard landing. Massive state-controlled and –directed bank lending, which was fueled in part by printed money, has been the driver for all these construction projects. Hence, many believe that it is well within the government’s ability to control the slowdown.

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While I concede that there is an increasing productivity in home electrical appliances, cellular phones, and motorcycles and that it has surpassed that of the United States. I can personally tell you that South America nations like Colombia are the ones doing most of the buying of China’s motorcycles and that Huawei cellular phones may be more affordable but of lesser quality and that will make it suffer in the long run. But in the end, historically speaking, what makes or breaks economies is two things: housing and the automobile industry. It is in the housing construction market where China will suffer.

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There is the very likely possibility that the Chinese government cant so easily control economic growth, especially if the growth is based on an economically unsustainable driver. In fact, using nonmarket methods, such as forced bank lending, to create construction projects for which there is no market demand could easily make a downtown even harder for the government to control when it begins to go bad–as it inevitably will.

China’s growth over the past couple of decades has been driven by the government’s opening up the Chinese economy increasingly to market competition and market forces. However, its growth in the past few years has come from just the opposite—government controlled nonmarket intervention. And, I might add, the only reason they have the financial power to do something so unwise as massive forced bank lending for construction is the enormous economic gains made from their move toward a more free-market driven economy.

So, far from being the economy of the twenty-first century, I think the possibility arises for China to endure not just a hard landing, but an economic meltdown due to a collapse in construction compounded by slowing exports. At the very least, it seems highly unlikely that China’s government can navigate an exit out of this construction bubble any more carefully than the United States or Spain. Just maintaining their current growth rates means maintaining the unbelievable amount of construction they are currently doing and then doing even more every year, plus not having any downturns in exports—in fact, they need continuous increases in exports. It all sounds highly unlikely and very much like the Japanese export- and construction-fueled economy of the 1970s and 1980s that finally popped in a most spectacular fashion.

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Some cheerleaders like Jim Rogers might be able to tell us why China is so well managed that it can avoid what happened to the United States, Japan, and Spain, but it seems like pure cheerleading at its best. Not only do I not believe China is better managed or the economy of the twenty first century but that China’s non-market economic management—the massive government intervention to circumvent market forces—is actually going to result in a far bigger collapse than that faced by any of those countries when their construction bubbles popped. The best comparison is Japan, since, like China, it was fueled by massive export growth as well as massive internal construction-related growth. The Japanese story ended in great turmoil, even though it was a much more advanced and capably managed economy than China when its bubbles popped.

For the worlds bubble economy, a meltdown by China would have unusually harsh consequences. Even China cheerleaders like Jim Rogers is not sounding so bullish about China unless they make their currency convertible by 2012. Well, it is now 2013 and they haven’t made their currency convertible nor done anything about the housing bubble. China is not only the second biggest economy in the world; it is providing almost all of the growth in the world since the financial crisis. I believe this is what got investor Jim Rogers so gung-ho in the first place. So it is having an outsized impact on the United States and world economy. If it pops, it will be a big disappointment, especially if the hard landing becomes a meltdown.

Like so much about China and the economy in general, it is hard to know exactly when such a meltdown could occur because it is so dependent on government actions (Chinese government) and psychology. But it is likely we will see a more pronounced slowdown than we are already seeing in the second half of this year and either 2013 or 2014 will be the first real chance for a meltdown to occur. Like our own government, the Chinese government will fight for some time and, at some point, it simply won’t work. China is already a huge economy, and maintaining its high growth rates will become increasingly difficult under any circumstances. And when the growth stops, it won’t go gently into the night, but rather will likely go from dream straight into nightmare.

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From → Economics

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