Why The Wheels Are Falling Off China’s Boom

Why The Wheels Are Falling Off China’s Boom

The rot in China’s economy is deeper than inflation and malinvestment.

Despite their many differences, the economies of China and the U.S. share a number of key traits: both are corrupt, rigged, crony-Capitalist, rely on phony statistics and propaganda and operate with two sets of rules: one for the Elites, and another for the masses.

Given these similarities, it’s no wonder that the wheels are falling off both economies.

There are some key differences, of course, which will make the crashing of China’s boom all the harder. China’s leadership likes to do things in a big way, and so its campaign of "extend and pretend" over the past three years has been unprecedented.

This isn’t just the consequence of a Command Economy overseen by a Central State; the "extend and pretend" boom was fueled by stupendous borrowing by local governments and private enterprise as well.

This flood of money has severely distorted China’s economy, yet the imbalances are now normalized. The system and players have now become dependent on this level of stimulus, so withdrawing the distortions would have negative consequences. Yet allowing the flood of investment to continue will unleash higher inflation, which is already triggering social unrest: Chinese Street Vendor Dispute Expands into Violent Melee.

Thus China’s leadership faces the same impossible conundrum as Bernanke has in the U.S.: Your Pick, Ben, But One Goes Off the Cliff (April 22, 2011).

When a system become this precarious and imbalanced, it can best be modeled by stick/slip destabilization: blaming the last grain of sand that destabilizes the entire pile for the collapse is to ignore the real cause: the entire system is unstable.

Here are a few factors which are widely misunderstood or discounted by the mainstream financial media.

1. Over-reliance on property speculation for profits. What if 60% of IBM’s annual profits were earned from real estate speculation? Would this strike you as a sound company and economy? Yet that is the case for Lenovo in China: The Boom And Bust Of China’s Rise (Zero Hedge):

Recently Liu Chuanzhi, the Chairman of Lenovo and the iconic figure of Chinese manufacturing, faced a serious dilemma while asked why of Lenovo Group’s profit in 2009 60% came from asset investment and only 40% came from manufacturing. He said “when the typhoons come, even a pig can fly in the sky. Everybody is profiteering from this. Why can’t we?” The typhoons refers to the property frenzy and the easy ways to make money.

2. Over-reliance on investment for GDP growth fuels malinvestment and systemic risk. "Meaningful probability" of a China hard landing: Roubini:

Roubini said investment was already 50 percent of gross domestic product. Sixty years of data had shown that over- investment led to hard landings, he said, citing the Soviet Union in the 1960s and 70s, and East Asia before the 1997 financial crisis.

Add one part unlimited ability to borrow to one part crony capitalism and one part command economy and you have a toxic cocktail of incentives to build things which make little sense financially or functionally.

China’s second and third-tier cities are littered with sprawling (and empty) sports facilities, municipal complexes, university campuses, etc. which have been built for two reasons, and two reasons only: so local governments can meet their "growth targets" and local officials and their cronies can reap gargantuan profits. (read more here)