Final Indicator, if You Needed One, of a Looming China Crash

Here is what I remember from the late 1980's - just about every technocratic pundit of the leftish bent, and a number on the right, all hailed Japan as the government economic planning model the US should follow.  One fawning essay after another lauded Japan's MITI and its top-down approach to economic investment.

Practically within hours of when these editorials peaked, the Japanese economy began to crumble.  We know now that MITI and other Japanese officials were creating gross distortions and misallocations in the economy, and inflating an economic bubble with gobs of cheap credit.  These distortions have still not been entirely cleared from the Japanese economy 20 years later, and the country experienced what was called "the lost decade" which may become the lost two decades.

For over a year, it has appeared to me (and many other observers more knowledgeable than I) that China was headed for a crash for many of the same reasons as Japan.  I am now sure this is true,

The current debates about China's currency, the trade imbalance, our debt and China's excessive use of pirated American intellectual property are evidence that the Global Revolution—coupled with Deng Xiaoping's government-led, growth-oriented reforms—has created the planet's second-largest economy. It's on a clear trajectory to knock America off its perch by 2025....

There is no doubt that China will pass the US in total economic size -- it has three times more people than we do.  But their success is clearly due to the small dollops of free enterprise that are allowed in a statist society, and advances are made in spite of, not because of, the meddling state.

Exactly how much economic progress had China made before its leaders brought in the very free market ideas Stern says are dead?  None, of course.  To read China as a triumph of statism and as the death nell of capitalism, when in fact it is one of the greatest examples in history of the power of capitalist ideas and how fast they can turn around a starving and poverty-stricken country, is just willful blindness.

I will include just one other excerpt

While we debate, Team China rolls on. Our delegation witnessed China's people-oriented development in Chongqing, a city of 32 million in Western China, which is led by an aggressive and popular Communist Party leader—Bo Xilai. A skyline of cranes are building roughly 1.5 million square feet of usable floor space daily—including, our delegation was told, 700,000 units of public housing annually.

Meanwhile, the Chinese government can boast that it has established in Western China an economic zone for cloud computing and automotive and aerospace production resulting in 12.5% annual growth and 49% growth in annual tax revenue, with wages rising more than 10% a year.

My first thought on reading this was that Houston used to look exactly like this, with cranes all over the place building things, until we had an Administration that actively opposed expansion of domestic oil production.  My second thought is that this reads so much like the enthusiast essays written by leftists when they used to visit the Soviet Union and came back telling us Russia was so much superior to the US -- just look at the Moscow subway!

The emergence of hundreds of millions of people in China and India from poverty is exciting as hell, and at some level I don't blame Stern for his excitement.  But I fear that what he is seeing is the US housing bubble on steroids, a gross misallocation of capital and resources driven by a few technocrats who think they can manage a billion person economy from their office in Beijing.

Disclosure:  I seldom do anything but invest in generic bond funds and US stock funds, but right now I am out of US equities and I have a number of shorts on Chinese manufacturing and real estate.


  1. Noah:

    How many employee unions like the SEIU are there in China?

  2. Chris:

    Why do you feel the need to disclose the last fact?

  3. me:

    I agree with your assessment, although for different reasons (when I lived in China, I was struck by how much freer businesses could act - China today is much more cutthroat capitalist throughout than the US has been in the last 20 years). What'll change China real quickly is its own investment bubble (housing in cities is farther along than it even has been in the US, albeit without CDOs to help the crisis along), the troubles of its main markets (the US and EU competing for who can go into more a tailspin first) and it's problems with environmental and ethical issues (and by that I don't mean that the Chinese need the hilarious boondoggle of environmental feasibility studies but a bit more of "it's not ok to poison this food with lead to save a few cents even if my immediate family won't be affected").

  4. Craig:

    I agree with the comparison between Japan in the eighties and China now, but don't fall for the Keynesian baloney that Japan is stuck in lost decade land. Japan has experienced a decade without inflation, the central bank has been remarkably parsimonious about printing new yen. As a result, GDP is "stagnant" -- as it must be when the currency is stable. How can GDP rise if the number of yen stays the same?

    That doesn't mean that the economy is bad, though. Japan has a remarkably low 4.6% unemployment rate and living standards remain high. It also continues to maintain a trade surplus in the face of an ever-rising yen (anyone wonder why a failing country's currency continues to rise?). None of those statistics indicates a failing economy. We're just so accustomed to inflation here that an economy without it does not compute.

  5. SB7:

    ... I have a number of shorts on Chinese manufacturing and real estate

    Is there a simple way for a not-particularly-sophisticated investor to do that?

  6. Brian Dunbar:

    Our delegation witnessed China’s people-oriented development in Chongqing

    I will bet that Stern does not speak Chinese.

    Did he leave the guided tour at all, get out on his own? Talk to anyone not pushed his way by the authorities?

    The answers are likely no, no, and no. So he doesn't actually know anything.

  7. Sera:

    "Last night, the PBOC (China’s central bank) lowered the reserve requirement ratio (RRR) for Chinese banks by 50 basis points, down to 21% for large banks, freeing up an estimated RMB 400 billion ($63 billion) in new lending."

  8. Will:

    @Craig Japan unfortunately has one of the highest debt to GDP ratios in the world, up there with Zimbabwae. Currently their own populace purchases nearly all of their governments bonds and are willing to accept very little interest. With the demographic shifts in Japan (people getting older, cashing out their retirement) Japan will have to rely on outside funders who won't be willing to accept such a low rate. WIth ZIRP they allowed the total debt to grow to record proportions while the interest they paid on it dropped, this can only work so long.

    Secondly the majority of new money is created by banks in the form of credit, governments are responsible for little relative to credit market. These would be the same zombie banks they should of allowed to fail years ago. Someone is probably still paying off their 100 year mortage.

  9. todd:

    The numbers don't add up. 1.5mm of usable sqft per day? If each housing unit is 1200 sqft thats 456,250 units in a year. 900 sqft is 608,333 units in a year. So the livable space is less than 30 x 30? Sounds like a freaking workers paradise. We should do the same thing here, life would be so much better? I wish all these people who know so much better than everyone else would get out of the way!

  10. Vivek Kumar Sinha:

    Your Information is very informative.
    Engineering jobs

  11. el coronado:


    What we need is a reverse ETF for businesses located near the Three Gorges Dam. 'Cause when that sucker collapses - and based on chinese bullet train, etc longevity results; and historic seismic activity on the 6(!) active fault lines it's near it shouldn't be too much longer - everything in that flood plain is toast. It's pure capitalism. Money to be made. I'm sure they won't mind.

  12. Floyd McWilliams:

    I have some minor experience with China because my wife immigrated from there. From what I can see, the huge boom is real, and China has actual capitalism. (My wife was mystified when we were considering doing some work on our property, and I explained that we had to beg a planning board for approval. In China you would just build whatever the hell you wanted.)

    The enormous growth in housing stock is because most of the population has been living in crappy old run-down buildings; it is a response to actual demand.

    I would be very wary of being short China. Even if there is a bubble, that does not indicate that the growth of China is a sham. Would you want to be short nineteenth-century America, which had occasional panics and recessions?

  13. caseyboy:

    @Will, true public debt in Japan is high at 180% of GDP, however, private debt has deleveraged to 113% of GDP from 250% in 1997. The US private debt ratio stands at 250%. Japan consumers have sufficient liquidity to consume and save (buy their own public debt). And they make a better return doing it than our .06% 5-Yr T-bill return.

  14. Dan:

    I owned a mutual fund focused on China. After losing way too much money, I sold it earlier this year. I'm not regretting the sale, only that I waited too long.

  15. Allen:

    I'm sorry to nit pick but 3 times the population? China has about 1 1/4 billion people and the US about 310 million. I'd say four times as many in population is more accurate.

    @Craig, I like the questioning. "How can GDP rise if the number of yen stays the same?" ---> As you probably know, one can take into account inflation when measuring GDP. That's normally done but usually broken out into a different GDP measurement than the one normally used in skin-deep media reporting.

    As for the answer to your question, producing things of more value.

  16. IGotBupkis, Official Lefty Accounting Magician:

    >>> These distortions have still not been entirely cleared from the Japanese economy 20 years later, and the country experienced what was called “the lost decade” which may become the lost two decades.

    While I agree with your overall thesis, the last 15-odd years have next to nothing to do with Japan's screwups in the 1980s and entirely to do with the government's continual and almost absurd faith in neoKeynesianism as a solution to its problems since that time. At some point, you'd think that they'd give up, but apparently the government of Japan is made up of the Japanese version of Eurolibtards, unable to learn jack if Jack stood over them with a chainsaw and a crowbar.

  17. IGotBupkis, Official Lefty Accounting Magician:

    Speaking of building in China, this should provide a great deal of faith in their system:

    Collapse Of 13 Story Building in China

    And it's interesting to note when looking for the above, I found a LOT of links to headlines like this:

    Factory building collapse kills four, injures four in north China

    And this one, with pix:

    4 dead, 3 injured in building collapse in east China

    And, regarding all those new buildings he's so effusive about:

    Short-lived buildings create huge waste

    Yeah, let's get US some more o' that!

  18. IGotBupkis, Official Lefty Accounting Magician:

    Another lovely example of centralized planning:

    2.8b kWh of wind power wasted

    "Hey, let's put in all this wind power, then NOT spend any money in wiring to the homes that would use it!! DOHHH!" :D

  19. IGotBupkis, Official Lefty Accounting Magician:

    >>>So the livable space is less than 30 x 30? Sounds like a freaking workers paradise.

    Todd, while I like being spoiled, Americans ARE a bit spoiled as I understand it. Everything is smaller in Europe and "The Orient" compared to America.

    I've gathered from a number of "talking heads" type films that many single people in the Orient live in studios and efficiencies, from what I can see.

  20. Panzersage:

    Here is a nice little note over the environmental effects of China's rapid industrialization. Air so polluted it is literally off the charts.