Would You Chew China Bubble Gum?

BEIJING—China reported a surge in bank lending and sharply rising property prices last month, figures that reinforced growing worries that the world's fastest-growing major economy risks inflating a new bubble. _WSJ

Remember, it is one thing to create economic growth, but it is another thing to truly create wealth. If I commit to building a new commercial property in Shanghai I will undoubtedly contribute to GDP growth. However, if I have no tenants and the city already has a vacancy rate of 20pc, then I am probably destroying wealth. _Telegraph

Is China a safe haven for investment, far away from misguided and suicidal nations-of-debt such as the US and Europe? GDP growth figures and currency reserves suggest that China is capable of riding out very rough global economic storms. And yet there is something about the massive state control apparatus behind the Chinese economy that urges caution before making premature long-term economic commitments to the dragon.

With the collapse of the global economy, demand for Chinese exports has declined badly. Chinese banks have stimulated a nation-wide building spree that has consumed huge amounts of the world's commodities.

China has enjoyed the fastest-growing major economy for the past 30 years with an average gross domestic product growth rate of more than 10 percent annually. After a closer analysis, however, the China story starts to look more like that of Japan shortly before its stock and real estate markets collapsed almost two decades ago. With a skeptical eye toward the economic numbers released by the Chinese government and some investigative work, overheating of the Chinese economy becomes apparent. In my opinion, the country is investing heavily in infrastructure for which there is little demand, creating enormous excess capacity and putting the bubble at risk.

... With a government bent on short-term growth and investors eager to buy into China’s growth, credit is feeding inefficient capital investments in manufacturing, infrastructure and real estate. The declining return on these investments eventually will lead to a pullback in capital spending. Further analysis shows that China already has ample manufacturing capacity and does not require the additional capital spending. China is in line with developing countries with regard to its manufacturing base. It produces a lot more than the light industrials like toys, apparel and electronics that foreigners have come to recognize. In 2008, China produced 500 million tons of steel, more than the European Union, Japan, United States and Russia combined. Even at those levels, China has an additional 160 million tons in idle capacity. Cement production tells a similar story. China has an estimated spare capacity of 340 million tons in cement production, which is more than the consumption of India, the United States and Japan combined.

Easy access to credit in China has been a boon to residential construction activity and the real estate market. These construction projects have boosted GDP numbers while increasing the paper wealth of many Chinese government officials. Affordability ratios suggest that these real estate prices are unsustainable, and that we could see a mortgage meltdown in China on even larger proportions to that of the US. Indeed, since 2003, residential construction has far surpassed household formation. International Monetary Fund statistics note that home ownership is at 86 percent in China, compared to 69 percent in the U.S. at the peak of the U.S. housing bubble... _Cavalier

Most investors base their judgment on a combination of superficial appearances and gut feeling. But both superficial images and emotional intuitions can be manipulated by faked or exaggerated data. It has happened in climate science, and it has happened in economics too many times to mention.

during this new real estate boom, several investigations have discovered that real estate developers, desperate to offload nonperforming properties, have dumped mortgages onto state-run banks that are "facing enormous pressure from Beijing to rapidly increase lending to boost the economy."[9]

Thus, while market forces would have reallocated unused property, pushing prices down, the stimulus has catapulted markets such as Beijing and Shanghai into the top 50 most expensive globally, despite that the average resident earns a fraction of their industrialized peers.[10] _ Mises

Beijing is heavily invested in US debt -- federal, state, and municipal -- at various risk levels. Despite the Obama administration's demolition of any excuse of fiscal discipline in budgeting, Beijing remains reluctant to throw away its ever riskier investment in US securities. With exports continuing low into the distant future, and China's domestic economy building an overpriced infrastructure to nowhere, the shrinking value of US debt instruments may be the last China bubble to pop. Better hang on just in case.

16 Feb 2010 Update: Don't miss this look at the China Bubble from new blogger Crisis Maven