Bursting the Chinese Bubble

This is one of the more interesting things I have read this week, and confirms a hypothesis I have developed, which is that whenever the Left in this country begs that we emulate some fast growing government planned economy, we are probably looking at a bubble about to burst (e.g. the Left's desire to emulate Japan's MITI in the late 80's and their envy of China's authoritarian economic interventions today).

The Royal Bank of Scotland has advised clients to take out protection against the risk of a sovereign default by China as one of its top trade trades for 2011. This is a new twist.

It warns that the Communist Party will have to puncture the credit bubble before inflation reaches levels that threaten social stability. This in turn may open a can of worms.

"Many see China's monetary tightening as a pre-emptive tap on the brakes, a warning shot across the proverbial economic bows. We see it as a potentially more malevolent reactive day of reckoning," said Tim Ash, the bank's emerging markets chief.

At some level, the dynamic is not surprising and is one seen in every developing country -- early development is based on export markets taking advantage of low cost labor.  But as growth proceeds, demand for labor increases and bids up labor costs.  A transition has to occur from exporting low-cost merchandise to making a higher-value products and services for the domestic market.  Dislocations are nearly inevitable

On a recent visit to a chemical plant in Suzhou, I was told by the English manager that wage bonuses for staff will average nine months pay this year. This is what it costs to keep skilled workers. His own contract is fixed in sterling, which has crashed against the yuan over the last two years. "It is a sobering experience," he said.

China may have hit the "Lewis turning point", named after the Nobel economist Arthur Lewis from St Lucia. It is the moment for each catch-up economy when the supply of cheap labour from the countryside dries up, leading to a surge in industrial wages. That reserve army of 120m Chinese migrants everybody was so worried about four years ago has already dwindled to 25m.

This tends to be made worse in a heavily planned economy.  As any Austrian-schooler will tell you, government intervention in the economy and credit markets tend to distort investments, pushing investment capital from the most productive uses into less productive assets that are favored by the government distortions.  Thus the Japanese 80's and American 00's real estate bubbles.  And now the Chinese:

The froth is going into property. Experts argue heatedly over whether or not China has managed to outdo America's subprime bubble, or even match the Tokyo frenzy of late 1980s. The IMF straddles the two.

It concluded in a report last week that there was no nationwide bubble but that home prices in Shenzen, Shanghai, Beijing, and Nanjing seem "increasingly disconnected from fundamentals".

Prices are 22 times disposable income in Beijing, and 18 times in Shenzen, compared to eight in Tokyo. The US bubble peaked at 6.4 and has since dropped 4.7. The price-to-rent ratio in China's eastern cities has risen by over 200pc since 2004

  • delurking

    China default? Aren't they sitting on a whole pile of US$, and rapidly buying more? We could worry that they will have to stop buying our debt and that therefore US$ will decline in value (or that they might even sell some, leading to greater us$ decline). But sovereign default seems pretty unlikely, unless that means something other than what I think it means.

  • DrTorch

    Getting mixed messages here

    http://sweetness-light.com/archive/presumed-leader-china-gdp-is-made-up

    "In truth, there are really two Chinas. The China of the people who are allowed to live in the cities, who are gradually growing more prosperous, thanks to working in what often amounts to slave labor camps.

    But the vast majority of the Chinese still live in the countryside and in unimaginable poverty. They are kept out of the cities by force, and so have no hope for themselves or their children. China has no ‘open borders’ lobby."

  • caseyboy

    delurking, you are correct in that China is a major US debt holder. They also own a significant stockpile of gold. Their cash results from very favorable trade accounts. Due to the low cost of labor, Chinese goods are imported by a wide range of countries. As their wages move up their competitive advantage diminishes. They are attempting to mitigate the effects through currency manipulation, however, that could prove difficult to finesse. Much like our Fed's QEII attempt to increase inflation. Might be hard to get that horse back into the barn.

    China certainly has a real estate bubble that needs to deflate. Things could get out of hand quickly resulting greatly reduced cash flow. They may have to dump the gold and the US debt they own. That could be the event that undermines the gold rally we've been experiencing the past couple of years.

    May you live in interesting times.

  • Keith Weiner

    This is a short video I produced on prices, inflation, cheap credit, and bubbles:
    http://www.youtube.com/watch?v=v76PM6-4yGk

    The problem with real estate (and all bubbles) is that it destroys capital. Capital cannot be printed, it has to be saved the hard way and slowly.

  • DrTorch

    Gracias for your writing. I used this quote, "As any Austrian-schooler will tell you, government intervention in the economy and credit markets tend to distort investments, pushing investment capital from the most productive uses into less productive assets that are favored by the government distortions. " to describe what's happening w/ the EtOH markets. Lots of people in middle America will get burned, b/c they invested in less productive assets relying on subsidies and other interventions to create the profit.