Is Communist China Resilient Enough to Endure?

Despite the many proclamations that the 21st century will be "the China century," China's communist party government (the CCP) is facing a growing number of challenges -- economic, demographic, political, and international. There is no guarantee that the present form of government in China will survive the next decade, let alone the next century.

Having governed China for 63 years, the party is approaching, within a decade, the recorded longevity of the world's most durable one-party regimes — the former Communist Party of the Soviet Union (74 years), the Kuomintang (73), and the Revolutionary Institutional Party of Mexico (71). Like a human being, an organization such as the CCP also ages.

...China's rapid economic development has thrust the country past what is commonly known as the "democratic transition zone" — a range of per capita income between $1000 and $6000 (in purchasing power parity, PPP). Political scientists have observed that autocratic regimes face increasing odds of regime change as income rises. Chances of maintaining autocracy decrease further once a country's per capita income exceeds $6000 (PPP). China's has already reached $8500 (PPP). And nearly all the autocracies in the world with a higher per capita income are petro-states. So China is in an socioeconomic environment in which autocratic governance becomes increasingly illegitimate and untenable.

...Since the fall of the Soviet Union, top CCP leaders have resolved not to repeat the Soviet tragedy. Their policy has been, therefore, resisting all forms of political reform. The result is, unfortunately, an increasingly sclerotic party, captured by special interests, and corrupt and decadent opportunists like Bo. It may have over 80 million members, but most of them join the party to exploit the pecuniary benefits it provides. They themselves have become a special interest group disconnected with Chinese society. If the fall of the Soviet Communist Party (CPSU) offered any real lessons, they are definitely not the official Chinese narrative that Gorbachev's political reforms brought down the party. The sad truth is: the Soviet regime was too sick to be revived by the mid-1980s because it had resisted reforms for two decades during the rule of Brezhnev. More importantly, the CCP should know that, like the millions of the members of the CPSU, its rank and file are almost certain to defect in times of a regime crisis. When the CPSU fell, there was not a single instance of loyal party members coming to the defense of the regime. Such a fate awaits the CCP. _Minxin Pei_in _the Diplomat

Of course, it is not clear that Communist China is technically a "communist" nation, as envisioned by Karl Marx. Referring to China as communist is largely an acknowledgement of how the very corrupt Chinese government chooses to designate itself. But China's government is essentially a "totalitarian" government:

The difference between a totalitarian party and an authoritarian party is that the former is far more deeply and extensively embedded in the state and the economy. The CCP controls the military, the judiciary, the bureaucracy, and the economy to a far greater extent that the KMT or the PRI. Extricating a totalitarian party from a state is far more difficult. In fact, such a feat has never been tried successfully. In the former Soviet Union, it led to regime collapse. In Eastern Europe, democratic revolutions did not give such regimes a chance to try.

So the task for China's new rulers is truly daunting. _Minxin Pei

Daunting? Closer to impossible, in the long run, given the corrupt intransigence of China leadership from the military to Beijing to local governments.

Gold is pouring into China as a repository of wealth. Well-placed Chinese who are able to move capital out of China, are doing so. If China ever allows the ordinary Chinese person to freely invest his assets overseas, watch out for an explosion of capital flight from the middle kingdom.

China is increasingly balanced on the razor's edge. The CCP had best take care not to give the tightly coiled internal unrest and frustration inside the country even the slightest opportunity or excuse to spring forth.

Lessons from Spain; A Caution for China

This article is taken from an earlier published posting on abu al-fin blog

Beijing-based economist Michael Pettis has family roots in Spain. Michael's personal experiences with friends and family involved in the Spanish real estate bubble provide object lessons on a much wider scale:

I remember in 2003 my mother had a New Year’s Eve party at our family home in Málaga, in southern Spain, at which over 80 people sat for dinner, including most of my old friends still around from high school days. That night I had one of those epiphanies (as you often do on New Year’s Eve, I guess) about the real estate market when I suddenly realized that nearly every one at the party was involved in one way or the other in real estate. Most of the people there (including my Persian sister-in-law) were real estate developers, real estate agents, real estate lawyers, architects, or owners of building and construction companies. All of them lived off (and had prospered mightily from) the real estate boom in southern Spain.

But this cannot be, I thought in my naiveté. If the only industry around is real estate, then we must be living through a real estate bubble of enormous proportions.

Later that night I spoke to one of my old high-school friends, Andy, who was at the time a prosperous real estate agent with houses in Marbella (purchased on borrowed money, naturally), a Mercedes, and all the trappings that accrue to an immensely charming and self-confident real estate agent during a real estate boom. In our conversations, and ones that took place subsequently over the next few years, I warned him that the property market in the south of Spain looked out of control, and it would be a good idea from him to diversify his savings out of real estate.

Same old same old

Of course Andy didn’t. He explained to me that what we were seeing in southern Spain was not a bubble because there were very strong reasons to believe that real estate prices were undervalued and were going to rise a lot more. Europe, he told me, is aging rapidly, and old people, as everyone knows, like nothing better than to retire in some warm and sunny place, preferably on the beach. With an infinite supply of European old people and limited European beachfront property, mostly in Spain, Italy, and Greece, where in addition you had great food, warm-hearted people, and plenty of immigrants to keep the prices of services (and servants) down, it was certain, Andy explained, that real estate prices would not decline. The demand was insatiable at almost any price.

This seemed like a perfectly reasonable argument on the face of it, and it was widely proposed to justify ever-soaring Spanish real estate prices for many years, not just on the Spanish coast but also, perhaps a little bizarrely, in every nook and cranny of the country, including some pretty gray and inaccessible building projects outside cold, northern industrial cities.

The weakness in the argument, of course, was that although there might have been near-infinite demand, this could not justify near-infinite increases in prices, especially since the demand itself was likely to be highly pro-cyclical because the Spanish economy had itself become dependent on real estate development. As long as the economies of the cold northern European countries were booming, in other words, the demand from retirees for beach houses would stay high, but any slowdown in the economy would reduce demand in Spain at the worst possible time.

And as Spanish real estate slowed, the impact would be exacerbated by a much sharper slowdown in the Spanish economy caused by the slowdown in real estate, which had become a major driver of the economy. If a substantial portion of the Spanish workforce depends on a booming real estate market – and not just those directly dependent, but also those indirectly dependent, like bankers, restaurateurs, retailers, travel agents, and so on – then any slowdown in the real estate sector is itself seriously self-reinforcing.

We have now seen how this works in Spain, but in China we are still using a similar argument to explain why real estate prices cannot drop significantly. Our Chinese version of the old-people-love-to-live-on-the-beach argument is the urbanization argument. As long as Chinese workers continue to move from the country to the cities – and urbanization has been one of the most dramatic consequences of Chinese growth in the past three decades – then there is likely to be a near infinite demand for city property, and so prices can only go up. And because prices can only go up, speculative demand for real estate is not speculative, it is precautionary.

This claim seems at least as plausible as the Spanish argument justifying infinite price increases, and was probably true a decade ago, but it runs into the same problem that the Spanish story ran into (and indeed that nearly every previous case in history of a real estate bubble, which has always started with a plausible story). First, no matter how much demand we can project into the future, rising prices can nonetheless outpace rising demand because rising prices can themselves stimulate further demand, in which case rising prices are unsustainable. This should be obvious, but the point is often lost in the giddiness that accompanies rapidly rising prices.

Second, and this is key, the rising demand is itself pro-cyclical. This is the most dangerous part of the process and perhaps the least well understood. Rising demand driven by the urbanization process is itself subject to underlying growth in the economy, since it is growth in turn that drives the urbanization process.

What’s more, when we reach the point as we did in Spain several years ago, and have reached in China too, in which a substantial part of the growth that drives the urbanization process is itself created by real estate development, then any slowdown in underlying growth is likely to be seriously exacerbated by a corresponding slowdown in real estate development. This is because the economy is caught in the reverse side of the feedback loop that helped drive prices on the way up – slowing growth leads to slower demand for urban real estate, which leads to slower real estate development, which itself leads to slower growth. _Michael Pettis

Patrick Chovanec explains why his cautionary language about the Chinese economy is not just empty words

Walter Russell Mead remarks on the falling Chinese growth numbers, and wonders what they portend for the future of the global economy.

Most of the developed world is caught up in the twin destructors of exponentially rising debt, and demographic decline. Up until recently, it was thought that China, India, Brasil, and Russia were exceptions to this widespread decline. But that rosy viewpoint may be wrong.

In fact, it seems that the Anglosphere may be in the best position to weather this lengthening global recession, if the US can rid itself of the parasitic regime that is currently sucking the life's blood out of the US private sector.

Good luck this November.

Reality Check: What Does Chinese Economic Growth Really Mean?

China promoters have long touted the admittedly amazing economic growth numbers coming out of China. And even now, in the middle of a global downturn involving both Europe and China, investors' eyes still turn to China when scouting for isolated patches of growth:

China has long been seen as the country with the biggest potential to prevent the world from falling into another 1930s-style depression, helping to offset contraction in North America and Europe. Admittedly, China is highly dependent on markets in both regions for exports, and thus for wages and domestic consumer spending. And admittedly, the economic data coming out of Beijing have been called into question. Yet growth there will still be the most robust of anywhere in the world, according to forecasts from Oxford Economics via Datastream – real GDP should grow 7.5 percent in China this year. But that’s almost anemic compared to the country’s recent track record of annual double-digit GDP advances. _Fiscal Times

But even if one takes the Chinese economic growth figures at face value, there are any number of details which could devil your dreams, should you decide to make big and bullish bets on China.

News of a slowdown in China’s economic growth has been building of late, and many disparate theories have been offered in explanation of the phenomenon. One issue facing the country has been debated particularly heatedly. Commentators cannot seem to reach a conclusion on whether the Chinese economy is a victim of over-investment.

...The story, in simple terms, begins with the restrictions China places on the maximum deposit rates allowed by banks there. These restrictions, though slightly relaxed earlier this month, leave borrowers accepting very low rates on deposits, because of lack of other investment opportunities.

The low rates allow money to flow to borrowers, who pay very low rates on their loans. That means householders are effectively losing money to subsidize the borrowing of investors. The Chinese financial system is being used as a machine, that allows this to happen.

The borrowers in China are the local and central government agencies, real estate developers, corporations, and other infrastructure investors. Because their investments are effectively subsidized, they face lower repercussions than borrowers face in free market conditions.

...China’s low interest rate constraints mean investment that is concentrated in a single area, and therefore provides economic growth in the short term, has its cost spread across the entire country through the household financial system.

The cost of building the infrastructure is much higher than the benefits that come from it. This is over-investment. The scourge is exacerbated by the structure of the country’s financial system. The subsidized lending leads to worse decisions being made because market realities are not in force.

China’s per capita income and worker productivity mean that the level of capital stock in the country should land at a much lower equilibrium level. Advanced infrastructure is not saving labour as much as it does in Germany or the United States. China is over-investing.

...Politics in China is undergoing its most egregious challenges in decades this year. The succession plans for the replacement of the country’s leaders have already been rocked by scandal. Something special will be needed to avoid the worst effects of the over-investment problems that have been created in recent years.

That is unlikely to come from these appointments. China is still conservative when it comes to reform, even when faced with economic slowdown. The recent tremors in the party’s system of choosing successors, could bring to the fore a more open method of investing leaders but it is not likely to do so.

China’s government has allowed over-investment to become rampant in the east Asian giant. It is not a sustainable situation. If something is not done at the highest levels in the country there will be a market readjustment that will shake China and the rest of the world.

Pettis also makes a startling statement on China:

” A mainland think tank, Unirule, estimated in 2011 that monopoly pricing and direct subsidies may have accounted for as much as 150 percent or more of total profitability in the state owned sector over the past decade. I calculate that repressed interest rates may have accounted for another 400 to 500 percent of total profitability over this period.?Monopoly pricing, direct subsidies, and repressed interest rates all represent transfers from the household sector.”

_Value Walk

China Financial Markets _ Michael Pettis' blog

Another look at threats to economic stability in China from Patrick Chovanec

Inbred Chinese State Owned Enterprises Hope to Monopolise Coming Shale Gas Boom in China

Meanwhile, belated news of coal and other commodities stockpiles growing to record levels, and reports of faked electricity utilisation data being leaked to financial media, suggest that someone in China may be trying to project a false impression.

The political class in China benefits from the massive economic inequality fueled by corrupt state owned enterprises. As long as Chinese wage earners cannot invest outside of China, corrupt insiders have the means of re-distributing hard-earned funds from the pockets of wage earners, into the pockets of political insiders and the well-connected.

How is that different from the situation existing in western countries? In western countries, citizens can invest overseas, can move to other countries relatively easily, and are generally not being held as captive blood donours to the same extent as their counterparts inside China.

How long can this China scam of massive malinvestment continue? Time will tell.

International Capital Seeks Safe Haven

Russia's capital flight is intensifying under a threatened international economic crisis and collapse of the global oil & gas price bubble

Russia, which relies on oil and gas exports for half of its budget revenue and Europe as a market for more than 50 percent of its exports, may suffer a worse recession than in 2009 if energy prices plunge, according to Dmitriev.

..."There is large-scale capital flight from Russia, despite the economic recovery," Dmitriev said. "And this capital is flying into the epicenter of the global financial crisis, which is in Europe. That is actually the same as creating a food supply in the center of an atomic explosion." _SFGate

China's rich elites are unnerved by the twin political and economic situations popping up in the middle kingdom, and are looking for a safe place to stash their cash and valuables.

The two China crises are entwined, although the China bubble had been looking for an excuse to deflate for a few years.

The Eurozone is beginning to feel the stress of the building chaos and fiscal crises in Greece, Italy, Spain, and Portugal. An underswell of capital flight is starting to build, even in Europe.

The world is watching the US for any sign that the former global economic bulwark is willing to turn away from its mindless and wasteful spending spree of the last few years that has occurred for no better reason than support for political cronies and a suicidal green energy starvation.

If November elections in the US provide reassurance of a long needed change in US fiscal and monetary policies, global markets may be reassured before the bottom completely erodes.

China's Real Estate Economy Unraveling

• The market is not poised to recover, but will continue to see greater downward pressure on prices;
and
• Real estate investment is likely to flatten out or start falling, erasing several percentage points of GDP growth.

_Patrick Chovanec

Bad loans and shady business practises dot the landscape of the domestic Chinese economy -- from the local and regional governments all the way to the top. Many of these problems are coming to light at the same time that the CCP regime is experiencing the greatest political threat and instability since Tienanmen Square in 1989.

More from China specialist Patrick Chovanec:

China’s developers are playing out a kind of prisoner’s dilemma: rush to complete, in hopes of cashing out. But while supply keeps going up, demand is going down. In late March, a central bank (PBOC) survey reported that only 14.1% of Chinese consumers were looking to buy a house in Q2, the lowest level since 1999. Only 17.7% expected home prices to rise in Q2, and 62.9% said they still consider prices to be too high. So all those rushed completions only add to the glut already on the market, driving prices down further and giving buyers — investors and aspiring residents alike — all the more reason to hold off for a better deal. Perhaps this is why Qin Hong, deputy head of research for the Ministry of Housing and Urban-Rural Development (MOHURD), told the Oriental Morning Post in late March that she doesn’t expect housing prices to rebound significantly for the rest of the year. A strong rebound is impossible, she said, due to the continued property tightening policy and high housing inventory (my italics).

The second implication of the dynamic I’ve just described is that the “resilient” growth in real estate investment that seemed to promise a “soft landing” is not very resilient at all. It’s more like the last gasp of a market that’s running out of steam. Once the surge in completions plays out, the declining number of new starts will become the pipeline, and growth in property investment will flatten or go negative. Property investment accounts for roughly a quarter of gross Fixed Asset Investment (FAI), and net FAI accounts for over half of China’s GDP growth. As I noted in January, in a back-of-the-envelope thought exercise, if property investment plateaus (growth falls to zero), it could shave as much as 2.6 percentage points off of real GDP growth. If it fell 10% (in real, not nominal terms) it could bring GDP growth down to 5.3%. _Chovanec.wordpress.com

China hand Michael Pettis is another Beijing-based economist who is expecting a China hard landing. For those investors who haven't considered what a China hard landing would mean for global markets, the answer is: Nothing good.

Global demand for commodities from crude oil to coal to steel ore etc. hinge upon the Chinese economy's ability to import. As global demand cools, global prices should decline.

There is not an economy on Earth that has been permanently exempted from the laws of economics, despite what politicians, pundits, and greens may say.

More from Mish on China Slowdown

Michael Pettis Nails 12 Predictions on the Gate to the Forbidden City

Beijing-based economist Michael Pettis is now making public 12 daring predictions regarding the near-to-intermediate term economic future of China. For those hoping for China to lead the world into a bright new economic recovery, the predictions make for sour reading.

1. China will be the last major economy to emerge from the global crisis. My basic argument was that the global crisis was caused by the necessary reversal of the great trade and capital imbalances of the past decade, and a country can only be said to have emerged from the crisis when those underlying imbalances had been resolved.

Since China’s contribution to the global imbalances has been its excessively high savings rate, China could not emerge from the crisis until the high savings rate had been reduced to a more reasonable level.　Since 2007-08, of course, the opposite has happened, as Beijing has exacerbated its domestic imbalances in order to keep growth rates high.　 But without infinite debt capacity this cannot go on.　 I think it is pretty clear that over the next few years China will be forced to address and reverse the high savings rate, and it will only be after this happens that China can be said to have emerged from the crisis.　 This may take a decade or more.

2. Chinese consumption will continue to stagnate or decline as a share of GDP until the growth model is abandoned.　 By “abandoning” the model I mean that transfers from the household sector to subsidize rapid growth must be eliminated and reversed.　

This is really a continuation of the first prediction.　 It is too early to say, but 2012 may be the first year in which consumption growth will outpace GDP growth, but only if GDP growth turns out to be much lower than expected – say below 7%.　 As long as GDP growth rates exceed 7%, there can be no real rebalancing of consumption.

3. Although there were many factors that explained both rapidly rising GDP and the contracting consumption share, financial repression would eventually be recognized to be the key factor.　 It took many years to make this point, but it has become pretty clear to everyone that financial repression is at the heart of China’s problem.　 This may explain Premier Wen’s recent and rather shocking attack on the banks, although in my opinion it will still be at least another year or two, if ever, before we see any real liberalization of interest rates.　

Remember that the more debt there is, the harder it is to raise interest rates, and the longer we take to raise interest rates, the more debt we run up.　 In the end I suspect that financial repression will be eliminated not by an increase in nominal rates but rather by a decline in GDP growth (remember that the size of the financial repression tax is a function of the difference between nominal GDP growth and the nominal lending rate).

4. Investment is being misallocated on a massive scale and this was not due to any special Chinese characteristic but was rather a fundamental requirement of the way the system operated. Although there are still some economists who disagree that investment is being massively wasted, I think this is so well understood by now that there is no need to belabor the point.

5. Debt is rising at an unsustainable pace and debt levels will become unsustainable well before the end of the decade.　 This follows from the above point – if investment is debt funded and if it is being wasted, then by definition debt must be increasing at an unsustainable pace – i.e. faster than debt-servicing abilities.

I suspect nonetheless that in another year or two no one will doubt that the Chinese growth model tends towards unsustainable debt and that we are rapidly reaching the limit.

6. When specific debt problems are identified, resolute attempts by Beijing to resolve them would be warmly welcomed by analysts but wholly irrelevant – because the problem of debt was systemic, not specific.　 This follows from the above.　 The issue is not that specific borrowers may run into debt problems.　 It is that the run-up in debt is systemic and cannot be prevented as long as China maintains the existing growth model.　 If there is rapid GDP growth, say anything above 6% or 7%, debt within the system must be rising at an unsustainable pace.

7. Privatization, a topic all but forbidden in polite company, would become a very hot topic of conversation by 2013-14.　 I have discussed why in this issue of the newsletter.

8. As some policymakers gradually became aware of the problem with the growth model and the risk of crisis, a fundamental political split would emerge between those that demanded rapid reform and those that wanted to maintain control of resources.　 The problem is that continuing the growth model will lead to a debt crisis, but abandoning the model will lead to much slower growth, and especially to much slower growth in the accumulation of state sector assets.　 This is politically very difficult for many to accept and will lead to more political conflicts over the next few years.

9. Chinese government debt will continue to balloon through the rest of this decade.　 Privatization is the best way to effect the transfer of wealth from the state sector to the private sector, and would be especially efficient if privatization proceeds were used to extinguish debt, but for the reasons discussed above it will be extremely difficult to do it.　 This means that debt build-up and the state absorption of private sector debt will continue for many years.

10. If the transition is not mismanaged, average Chinese GDP growth rates will drop to 3% for the 2010-20 decade.　 As my bet with The Economist suggests, this is one prediction that is still an outlier.　 The Economist(and many others) still believe that Chinese growth will make it the largest economy in the world before the end of the decade, but much slower growth is what rebalancing requires and it is hard to make the numbers work at growth levels much above 3%.　 By the way if I am wrong and Chinese growth this decade is materially higher than 3%, my prediction is that the “lost decade” of much lower growth stretch out over two decades.

11. If China rebalances correctly, then much slower GDP growth rates will be accompanied by only slightly slower growth rates in household income.　 In that case there need be no social instability.　 The political risk comes from instability at the top, not at the bottom.

12. Non-food commodity prices are set to collapse over the next three to four years.　 “Collapse” is not too strong a word.　 China’s share of global demand for such commodities as iron, cement, copper, etc. is completely disproportionate to its size and almost wholly a function of its very high growth in investment. 　As investment growth drops sharply, as it must, global demand for non-food commodities will plummet. _Michael Pettis via Mish

Hedge funds cut commodity bets on slowing China growth

This is what Pettis has been saying all along, although he typically does not spell things out this way.

More: Interesting background and supporting information for the pathologically curious from Zarathustra

Inflating the Bubble When the Alternative is Collapse

With house prices and sales both falling, the biggest risk for the Chinese economy is a sharp slowdown in construction. Official data paint a bleak picture, with zero growth in new residential floor space under construction in the first two months of the year.

But that is a record of building that has already taken place—not a look forward. For a glimpse into the future, it is worth taking a look at what developers themselves are saying about their plans for investment. _WSJ

WSJChina's massive spending and building spree has propped up the global commodities bubble for years now. Prices have fallen along with sales, but China's big investors seem to have little choice but to continue to build a ballooning infrastructure to nowhere.

Land sales may take a hit as developers focus on using existing reserves rather than buying more. Evergrande says its national land footprint is "basically complete." That is bad news for local governments that rely on land sales to generate revenue.

...For the real-estate sector, higher completion rates will add to the existing overhang of unsold property and pressure for prices to fall. _WSJ

With fixed investment constituting 50% of GDP, and the value of that investment on the decline, the unwieldy Chinese economy seems to be built upon an increasingly slippery slope.

More:
7 Signs of Impending Recession in China?

~ China Warning Sign #1: GDP Slowdown

In the last quarter, China’s economy grew by 8.9%. When you compare it to the sub-3% GDP growth in the United States, it sounds phenomenal. But put it into context, and you realize it represents the slowest pace in two-and-a-half years for China. This isn’t some blip, either. China’s government is calling for even more deceleration. It recently lowered its GDP growth target to 7.5%. Another problem? Those numbers aren’t exactly trustworthy…

~ China Warning Sign #2: Unreliable Statistics

If you don’t have anything to hide, you tell the truth, right? Well, if that’s the case, China has a problem. Last month, the country’s statistics bureau revealed that local governments were forcing businesses to report “seriously untrue” data. The net effect? GDP, based upon local government figures, was 8.8% higher than the national figures calculated by the statistics bureau. And this comes on top off all the small-cap Chinese companies that have already been outed as complete frauds.

~ China Warning Sign #3: Imports

The latest trade figures from Japan showed a 14% drop in shipments to China. Most of the decline can be attributed to machinery deliveries. That means construction activity in China, which helped fuel a majority of its growth in recent years, is waning.

~ China Warning Sign #4: Manufacturing

In March, the HSBC/Markit Flash Purchasing Manager’s Index (PMI) hit a four-month low. The latest reading came in at 48.1, down from 49.6 in February. Keep in mind, anything below 50 signals a contraction.

~ China Warning Sign #5: Employment

On the heels of lower manufacturing activity, hiring dropped to a two-year low. How is the Chinese consumer supposed to fuel economic growth it they’re not employed? Just curious.

~ China Warning Sign #6: Government Debt

In America, we know all too well what happens when we overeat at the debt buffet. Banks need to be bailed out. And the engine of economic activity – consumer spending – grinds to a halt. Well, China’s the next country set to learn this the hard way. As of September 2011, China’s local banks issued 9.1 trillion yuan (or about $1.4 trillion) in loans to local governments. And local government debt, which is supposed to be illegal, now stands at about 25% of China’s GDP. Big whoop? It certainly is when that debt is being collateralized by inflated real estate.

~ China Warning Sign #7: Real Estate

After years of soaring prices, property values are now falling in China. Of the 70 cities tracked by the National Bureau of Statistics, prices fell in 48 cities in January and not one city experienced gains. _EM

International commodity investors want to know what is happening inside the China economy, because China accounts for so much of global commodity demand -- including crude oil. Without the China bubble, global commodities markets could be in trouble.

Sounding Out the Hiss of China's Leaking Bubble

...in Beijing on Tuesday the mood was sombre as the government announced the country’s lowest increase in gross domestic product in 10 quarters. _FinancialTimes

If China's internal growth is stalling, that would put yet another drag on countries such as Germany and the United States, which are counting on strong exports themselves to help compensate for sluggish growth at home. _EconomicTimes

You cannot trust official economic statistics coming from the CCP government, or its regional branches. Not if you wish to protect your assets, and the assets that have been entrusted to you. More from an independent observer inside China:

So what evidence do we have that a construction slowdown may be occurring? Official data on housing starts does exist, but it’s not a reliable metric....A better approach is to look at the market for construction inputs. The clearest picture we have is for steel. According to a friend of mine who is an analyst in the steel and commodities sector, and recently completed a countrywide tour of talking to producers, sentiment in China’s steel industry is as gloomy as he has ever seen it. In November, Chinese steel output was down -8.8% month-on-month, down for the sixth month in row. More importantly, it was down -0.6% year-on-year, indicating this was more than just a seasonal or partial fall-off from the all-time highs it hit in the first half of 2011, which were driven in large part by demand for cheap rebar for construction. Apparently, the demand that drove that boom has almost entirely disappeared. Interestingly, according to one report by Shanghai Security News, steelmakers say that actual sales in 2011 failed to match official “social housing” construction data. Figures released by the China Iron and Steel Association last week indicate that steel output continued falling in December, by 3.87% month-on-month.

Not surprisingly, two things have happened. First, domestic iron ore prices have plummeted as unused stockpiles have accumulated. The China Iron and Steel Association recently announced that its iron ore price index has fallen 22% in the past four months, since the beginning of September, while iron ore inventories at Chinese ports rose to 96.8 million tons by the end of 2011, up 32% from the year before (Chinese iron ore imports were still up 10% y-on-y in December, but analysts expect buying to slow in coming months, due to flagging demand). Second, Chinese steelmakers are suffering. According to Caijing, more than 1/3 of them experienced losses in October and November, and the industry as a whole saw a net loss of RMB 920 million (US$ 146 million) excluding investment gains. The magazine said industry executives foresee an even tougher year in 2012.

Cement and glass also show a marked deceleration in growth. Cement output in November grew 11.2% y-on-y, but that represented a significant fall-off from 17.2% y-on-y expansion for the first 11 months as a whole, and the 17.3% y-on-y growth the industry saw in November 2010. Glass also saw a similar deceleration, growing 7.1% y-on-y in November, compared to 17.0% y-on-y from the first 11 months. Cement prices have been declining steadily over the past few months, a trend that Fitch projects will continue into 2012, due to overcapacity. It notes that, because of their high level of investment in building even more capacity, major Chinese cement producers are cash flow negative.

Copper presents a more unusual picture. China’s copper imports in December hit an all-time record high of 508,942 tons, up 47.7% y-on-y. However, there is little reason to believe this was driven by end user demand. Most analysts I’ve talked to believe it was primarily due to a resurgence in speculative arbitrage based on the gap between copper prices in Shanghai and London, and possibly renewed interest in using stockpiled copper as collateral for obtaining loans — both practices spurred by expectations of monetary easing. In short, the Chinese are buying copper, like homes, to trade not to use.

Of course, land is also a key construction input. I’ve already written about the dramatic fall-off in local government land sales to developers, here as well as here. Newly released year-end figures show that Beijing’s overall revenues from land sales in 2011 dropped 35.7% compared to 2010, despite robust sales in the first half of the year. Land sales revenues for residential projects plunged even more steeply, by 55.4%, while the average auction price for residential land dropped 30.5% (from RMB 7,317 per sq. meter to RMB 5,088). In Shanghai, total land sales revenues dropped 20.0% y-on-y, and average the average price of residential land plummeted 41.0%. _Patrick Chovanec

And so on . . . . A fascinating look at some of the generally unspoken numbers behind the numbers from Patrick Chovanec, Professor at Tsinghua University School of Economics and Management, in Beijing.

It is remarkable how many people continue to take official statistics seriously, without the slightest degree of scepticism. In the short term, it is probably easier to take everything on trust. In the long term, such an approach is disastrous.

Portions taken from an article previously published on abu al-fin

Maybe Instead of Killing Them All, We Should Send Them to China?

US law schools are pumping out new graduates like a torrent of toxic waste. Elie Mystal thinks that Obama should create an "Americorps" for law graduates. But Al Fin legal scholars think the fallout from the US lawyer glut has become so bad for the US economy and US society, that extreme measures are called for.

No, Al Fin law scholars don't favour the Shakespearean solution of "first kill all the lawyers!" Instead, these legal gurus recommend sending all US law school graduates to China to act as bank examiners, construction inspectors, labour union organisers, environmental overseers, and political activists. It is time to restore international equilibrium! The program should run for roughly 30 years, after which we can send US law graduates to China to help sweep up -- clean up the mess their predecessors have made. By then, the US should have recovered from its own lawyer-instigated collapse, and be ready to provide foreign aid to a much-diminished China.

From: The Best Colleges

Excess attorneys are toxic to any society, but particularly to societies which have no means by which to dispose of the excess. Automatic deportation of US law graduates to China upon graduation would solve a whole host of problems, according to the legal sages of Al Fin.

China's Dangerous Bubble: CCP Had No Choice

Update 6December2010: More on the China bubble via TNE. China is an insular society and culture, so that by the time outsiders comprehend what is going on, it may be too late to save themselves from the fallout.

Stories about China's economy are typically upbeat, presenting the country as the most prominent success story of the recent prolonged global downturn. But you can also hear discordant notes such as this:

“It is the greatest bubble in history with the most massive misallocation of wealth,” said James Rickards, formerly of hedge fund Long Term Capital Management. He told a business summit in Hong Kong that stock market speculation on credit and wasteful spending by officials were disasters waiting to happen. _Times

We expect to hear China bears talking about a "China Bubble" in real estate, commodities hoarding, infrastructure (to nowhere), and so on.

Despite the global downturn, China's economic growth rate remains above 10 percent. But there is mounting evidence that Beijing has misallocated vast amounts of capital, touching off a real-estate crisis that could yet drag the world's second-largest economy down to earth. _Reason

But when even the China bulls begin sounding cautionary notes, it is time to look more closely at the middle kingdom's state of affairs.

There is undoubtedly a bubble emerging in some of the stock prices of Chinese companies, so be really cautious about where you place your bets in the coming months. _ShaunRein_China_Bull

Can the Chinese government deal with this inflationary phenomenon before it brings the entire house of China tumbling down? Opinions are mixed.

I believe China’s ability to alter its own course is grossly exaggerated. As a net exporter with relatively minimal internal consumption as a source of economic activity, it is basically at the mercy of importing nation’s ability to buy their goods. Any attempt to stoke the ability of these nations importing will be ancillary at best. The “reported” success of their bubble blowing is showing only one side of the equation – the bubble blowing. Signs of a traditional bubble (such as the one whose bursting the US and Europe are struggling to escape from) are everywhere, yet the mainstream media has not focused nearly as much attention on such. Unless the laws of basic human nature has changed, expect to see China suffering from the effects of profligate excesses just as the others that tried to inflate their economies the quick and easy way did. _ZeroHedge

One of the problems is that Chinese communist officials themselves are heavily invested in state owned banks and industries, and stand to lose a great deal if they face the economic bubble and misallocation honestly. Corruption in high places is almost as bad in China as in Russia, Cameroon, or other developing nations. As a result, it is likely that the bubble of lies will grow to devour much of what the decades of partial economic reform have accomplished.

As empty apartment buildings, shopping malls, highway overpasses, and other shoddily built structures continue to collapse decades before their time -- their dust and rubble lost in the polluted and poisonous air, land, and water of China and the China Seas -- more observers are likely to flash to what is happening. When that happens, more investors will begin to exhibit a healthier caution when looking at opportunities in China.

China Bubble Drawing International Attention

Macleans

Billionaire investor George Soros said that there is “undoubtedly” a bubble in Chinese real estate, which could “reverberate” in the world if it bursts. _BusinessWeek

Up to 60% of China's GDP is based upon construction. The Chinese construction and real estate boom continues picking up steam, despite attempts by the Chinese government to calm things down.

To get a really rollicking bubble going, you need three things:

Cheap Money
A Great Story
Big Dreams
Über-bullish commentators (and biased long-only investors) almost always focus on No. 2, the great story, as if it were the eminently justifiable driver of the rise. They rarely acknowledge the importance of factor No. 1, cheap money, as a vital means of greasing the wheels.

And factor No. 3, big dreams, comes as a result of combining 1) and 2) with a childlike faith in the Buzz Lightyear slogan: "To infinity and beyond!"

By the standards of this simple "bubble conditions checklist" - cheap money, great story, big dreams - China has all three in spades. _TaipanPublishingGroup

In times of widespread recession and excessive public debt, large investors look for safe havens. At this time China appears to be one such safe haven, with what seems to be a perpetual motion growth machine.

Interestingly, visions of future growth in China are also fueling another ongoing investment bubble -- in commodities, including oil. Many analysts are convinced that China's growth runup is still in the early stages, and will continue to drive up prices of oil and other commodities. That rosy view contrasts starkly with the views of James Chanos, Marc Faber, and Kenneth Rogoff.

First, here are Mr. Chancellor's 10 criteria for mania:

1. A compelling growth story; 2. Faith in the competence of the authorities; 3. Huge increase in investment; 4. Surge in corruption; 5. Easy money; 6. Fixed currency regime; 7. Rampant credit growth; 8. Moral hazard (a belief that authorities won't let the bubble pop – and have the power to keep it going – so risk is ignored); 9. Financial structures turn precarious; 10. Rapidly rising property prices fuelled by money made in the bubble, which is plowed right back into the bubble. All these conditions are present in China – in spades.

And I'd add one more criterion, a reverse indicator, which emerges at the end of a trend: For example, a book telling us that our own economic system cannot compete with the new autocratic order. In the 1960s it was Russia that would bury us. In the 1980s it was Japan. And now it's China. A “scholar” named Martin Jacques just wrote a book titled, When China Rules the World: The End of the Western World and the Birth of the New Global Order . Yeah, right.

By whichever criteria you use, China is a classic mania. Still, you may ask, why should it pop now? _Globe&Mail

One cannot predict exactly when an investment bubble will pop. It has a lot to do with a growing public awareness that the jig is up. Image is everything in the bubble trade.

In China, the government has control of most public sources of information. And the Chinese government still has trillions in hard currency assets, saved from better days in the export markets. For now, Chinese investors are content to stash their money in local stock markets, real estate, and banks.

But if China ever gets around to cleaning up its rotten banks and state-owned enterprises, that job may take a huge chunk out of those hard assets to do right.

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

China's Economy: More Bubbles Than Lawrence Welk

China needs to depend more on improved efficiency for growth. But instead, the recent trend seems to be going the other way. Rising costs and weak demand are making manufacturing less profitable. Hence, capital investment is weak, as reflected in weak equipment import data.

Most local governments seem to embrace property development as a growth savior. But shifting surplus capital into property is likely to lower future growth by decreasing average capital efficiency. This deters consumption development by increasing property expenditure expectations, and threatens financial stability by increasing loan levels, using overvalued land as collateral.

...Xie says that China’s growth model is unsustainable because it produces what I would call a Latin American style distribution of income where the middle class is quite small. These comments echo thoughts from former Xie’s Morgan Stanley colleague Stephen Roach, who sees an economic safety net as critical to increasing domestic demand and forming the middle class of which Xie speaks.


Bottom line, China’s economy is a bubble economy right now. And bubbles do not deflate; they pop. _SeekingAlpha

...China’s educational system, despite all the money it receives, remains inappropriate for a modern society. Hu Jintao, China’s leader since 2002, has been reinvigorating Marxist education and reinforcing orthodoxy. That’s great, but only if you want to know what Engels or Mao thought about the value of labor or why the Communist Party must maintain a monopoly on power.


...Today, the failure to properly assess the output of small business is resulting in an overestimation of GDP because these enterprises, which tend to be more dependent on exports, are suffering more than the larger ones.

...Economic reform has stalled because China has progressed about as far as it can within its existing political framework.

Further economic reform would threaten the power of the Communist Party, so the Party will not sponsor much more change.

A true market economy, for example, requires the rule of law, which in turn requires “institutional curbs” on government. Because these two limitations on power are incompatible with the Party’s ambitions to continue to dominate society, China cannot make much progress toward them, at least as long as the Communist Party is around.

... _Forbes (Gordon Chang)_via_BrianWang

 Another skeptical look at China's economy

China's economy has prospered based upon several unsustainable factors. Among them are very low wages, foreign investment on a monumental scale, a huge export market, the willingness to ignore environmental quality in favour of all-out industrial expansion, the iron discipline of the party maintaining a national sweat-shop imbalance of power, relatively low energy costs (up until 2008), etc. Foreign companies continue to invest many billions into Chinese projects, but China's tendency to steal technology from business partners is becoming annoying to some badly burned corporations.

The situation (of technology theft, piracy, and nationalisation) is not nearly so bad in China as in Russia and other parts of the kleptocratic third world, but that could change quickly.

Top down, command economies are unsustainable in the long run. Without huge outside investment, China would not have grown even 1/10th the rate it has grown. If outside investment flees China for one reason or another, we will see just how unsustainable the CCP dictatorship truly is.

The current bubbles in commodities and real estate will reveal the brittleness of China's economy, when they burst. That will have most unfortunate repercussions.

China Blows its Own Real Estate Bubble

China is currently seen as the main hope and bright spot for the global economy. Chinese leaders and government representatives have clout backed up by cash, and they are not afraid to use it on the world stage. But what if the Chinese economy is largely based upon more "bubble psychology" -- the kind of bubble psychology that struck down many western economies?

How did this bubble get going? Low interest rates, official encouragement of bank lending, and then Beijing’s half-trillion- dollar stimulus plan all made funds readily available. City and provincial governments have been gladly cooperating with developers: Economists estimate that half of all local government revenue comes from selling state-owned land.

Chinese consumers, fearing inflation will return and outstrip the tiny interest they earn on their savings, have pursued property ever more aggressively. Companies in the chemical, steel, textile, and shoe industries have started up property divisions too: The chance of a quick return is much higher than in their primary business.

Built on Sand

“When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land,” says Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley’s top Asia analyst. “No one talks about their factories making money these days.”Newly wealthy towns are playing the game with a vengeance. Ordos is a city of 1.3 million in China’s Inner Mongolia region. It has gotten rich from the discovery of a big coal seam nearby.

An emerging generation of tycoons, developers, and local officials will go to any length to invent a modern Ordos. So 16 miles from the old town, a new civic center is emerging from the desert that could easily pass for the capital of a midsize country. An enormous complex houses City Hall and the local Communist Party headquarters, each 11 stories tall with sweeping circular driveways.

Nearby loom a fortress-like opera house and a slate-gray, modernist public library. Thousands of villas and apartment towers stretch into the distance, all built by local developers in the hope that Ordos’s recently prosperous will buy the places to be near the new center of power.

Serial Drama

Workers get bused daily to the new city hall, but the housing is still largely unoccupied.

“Why would anyone go there,” asks Zhao Hailin, a street artist in the old town. “It’s a city of empty buildings.” Ordos officials declined to comment for this story.

...The government is reluctant to crack down too hard because construction, steel, cement, furniture, and other sectors are directly tied to growth in real estate. In November, for example, retail sales of furniture and construction materials jumped more than 40 percent. At the December Central Economic Work Conference, an annual policy-setting confab, officials said real estate would continue to be a key driver of growth.

The worst scenario is that the central authorities let the party go on too long, then suddenly ramp up interest rates to stop the inflationary spiral. Without cheap credit, developers won’t be able to refinance their loans, consumers will no longer take out mortgages, local banks’ property portfolios will sour, and industrial companies that relied on real estate for a chunk of profits will suffer. _Bloomberg

The same story is repeated across China.  Once the large export market vanished, the Chinese government was forced to concoct something -- anything! -- to take its place.  If what they came up with was a real estate bubble, who are we to criticise?

Economic Boom China 2009: The Dark Side

The international media has been following reports of record commodity imports by China. The surge is being portrayed as reflecting China's recovering economy. Indeed, the international financial market is portraying China's perceived recovery as a harbinger for global recovery. It is a major factor pushing up stock prices around the world.

But China's imports are mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. But now that price curves have flattened for most commodities, these imports are based on speculation that prices will increase. Demand from China's army of speculators is driving up prices, making their expectations self-fulfilling in the short term. _Caijing.com_via_FabiusMaximus

Large numbers of investors and financial analysts have pinned their hopes for the global economy on China's back. The most polluting nation on Earth, one of the most dictatorial and most corrupt nations on the planet is being held up as the future of the planetary economic system.

But China's cheery economic numbers may be hiding a darker set of realities behind the bamboo curtain. Here is one critical look at China's economic situation that is worth a read. The Chinese economy may be in the middle of a huge financial bubble of its own.

China has been buying up commodities worldwide at a frantic pace -- trying to take advantage of bargain basement prices brought on by low global demand. This Chinese commodities "rally" has inflated the Baltic Dry Index and China's economic figures, but it may be on the verge of fizzling.

The emerging problem of toxic Chinese drywall sales to North America is likely to once again raise the issue of the Chinese Poison Train. Toxic products flowing out of Chinese enterprises into world marketplaces should have had a far worse impact on Chinese exports than they have done. Poor quality steel from Chinese foundries is another problem likely to come back to bite the dragon's tail.

The problem of excessive Chinese regulations and limitations on entry into the marketplace continue to give corrupt and inefficient State Owned Enterprises in China an unfair advantage over private enterprise. This corrupt inefficiency shows no sign of going away anytime soon.

The gullibility of those who take Chinese economic figures at face value is difficult to explain, outside of wishful thinking. Everyone is looking for the big score, and right now China seems to be the biggest score around. Wait and see.

Based on an article from Abu Al Fin

Update: News stories here and here illustrate the uncertainty and volatility within world markets.

It is unlikely that the Obama crew has more ideas than to "inject more liquidity". Like the "mechanic" whose answer to every car problem is to add a quart of oil to the engine. You must have had some reason to vote for him, America.