Stimulus is a Phantom Menace (Part 2)

Human Action has written a fair amount about China of late.  The great juggernaut of the East has continued to surge ahead in recent months which is prompting giddy onlookers to predict China will be the next global superpower by yesterday.  Now don’t get me wrong, China clearly has a lot going for it: Productive workforce, prudent culture, disciplined leaders, rampant infrastructure investment, major urbanisation rates, economies of scale, rapidly modernising populace, growth off a low base, resources, etc etc.  All good stuff. 

But there are also a few truths about China that cannot just be wished away: 

• China is still a very centrally planned system.  Always a negative for achieving lasting growth.
• China is an ageing society due to low birth rates (growth in China’s working age population will be slower in the next decade than in the previous one)
• Chinese are famous gamblers, meaning China will endure massive financial and asset bubbles and busts
• China is not exempt from the laws of economics and finance 

As far as the last two points are concerned China has thrown everything and the monetary kitchen sink at its recession.  As we explained in Stimulus is a Phantom Menace (Part 1), the policy makers have pumped money into the system to sustain the unsustainable bubble conditions of the recent past. 

China will sooner or later be faced with the tough choice of letting its economy go through the inescapable painful correction, or unleashing more of the Phantom Menace on its people.  The monetary stimulus efforts have been truly gigantic in China, meaning that capital is being destroyed even while the official growth stats show major new capital formation.  The needs of Chinese people are not being optimally met. 

Investors have been getting rather jittery of late that China will start tightening monetary policy.  As usual the actual data are the exact opposite of investor beliefs.  China mortgaged 30% of its GDP in 2009 by pushing massive credit into the private sector and in January 2010 Chinese banks pushed out $200bn in new loans, one fifth of the planned annual quota for 2010 and 5% of GDP.  But while China keeps the taps flooding forth, crunch time is looming soon.  Perhaps these cool government heads the China bulls are so fond of talking about will make the sane choices.  If they don’t it’ll be an inflationary hell in China over the coming years.  

Bill Mellor wrote an excellent piece earlier this week about the ominous signs of a bubble in China.  Read it. 

Some of the wackier examples of the monetary excess going on in China include: 

• Multiple skyscrapers being built in a village of 30,000 people (read a brilliant take below on what skyscrapers tell us about booms and busts)
• The village, Huaxi, plans to build the worlds 2^nd tallest building at 538 meters
• Retail sales jumped 17.2% y/y in early February
• Property prices across 70 cities up 9.5% y/y
• State owned enterprises are speculating on property instead of focussing on their core business
• Office vacancies in Beijing at record highs
• Rebuilding bridges in perfect condition in Jianyang to ‘stimulate’ the economy
• Random and entirely new downtown built on windswept plains 25km from an urban centre in Ordos in inner Mongolia
• Mark Mobius (China Bull) dumped the stock of a Chinese food company after learning that it was using funds raised on capital markets to speculate on property rather than process soybeans 

In a country the size of China the list could literally be endless as the central planners bungle from one mountain of Keynesian wastage to another.  It’s no wonder Jim Chanos is calling China, “Dubai times 1000″.

Meanwhile the capital base gets squandered and wealth is destroyed.  Make no mistake, if China is able to grow meaningfully in the years ahead (I’m talking real growth not the frothy statistical smoke-and-mirrors kind) it’ll be despite not because of its economic policies. 

Even China must man up to the economic realities of this world, and even China, still only 7.5% of the global economy compared to the US economy’s 23%, cannot keep eroding its capital structure indefinitely without eventually running its economy into the ground and ruining its tremendous potential. 

China’s monetary excess has to stop soon or it will create a major crash that could potentially lead to a recession or, at the very least, years of suboptimal growth. 

The Phantom Menace can disguise itself as a Dragon just as easily as it can Uncle Sam.

Booms and Busts – Globe Asia – January 2010