China on Course Catching Japanese Disease

Hugh Askew wrote me a message with a request to write something sensible to the story published in the Financial Time from yesterday. “China is heading for a Japan-style bubble”

“If China continues to follow the Japanese template, the end of the dollar peg will be the trigger event, setting off a Godzilla-sized credit binge. Why would China’s rulers embark on such a disastrous course? Because the alternative – unleashing deflationary forces stored up over years of mercantilist policies – would be too painful to contemplate. That was the choice made by Japanese policymakers, who had a hundred years’ experience of managing a quasi-capitalist economy.
This time a denouement would be one of the biggest bubbles in history, probably in scale and certainly in number of people involved. Could China weather the subsequent financial turmoil as stoically as Japan? It seems unlikely; at the least, its ascent to global hegemony would suffer a brutal interruption.”

Anyone who thinks China can save the world from recession needs to read former Morgan Stanley analyst Andy Xie’s opinion on the matter. Andy reckons China is the next giant Ponzi scheme set to collapse. Andy predicted the bubbles in Japan, Southeast Asia, and Silicon Valley and most recently in the US housing market. So when Andy speaks, everyone should listen.

Credit expanded for half a century. The Bubble era at its end caused trillions of dollars worth of errors. Exporting nations like China had gotten into the habit of earning net sales from the U.S.A. of $2 billion per day. Those earnings provided much of the speculative capital that created the Bubble era prices. Instead of a healthy new boom, the guess is that China is enjoying a sick echo of the old bubble.

Almost every government, led by the U.S.A., attempt to re-inflate the bubble with guarantees and stimuli equal to an entire year's annual output of the world's largest economy. Since every dollar or Euro, etc is borrowed it makes sense that every single one will have to be withdrawn from the world economy at some point.

One of the major risks indeed is China’s currency regime. At present, it’s loosely pegged to the dollar. Should that change and China’s currency appreciate, exports from China would plummet. This appreciation in currency is inevitable. One of the most well regarded economists in China, Yu Yongding, is calling for the Yuan to become “internationalized and used as a reserve currency” within five years.

On average, world trade fell 31 percent in January 2009. To varying degrees, recession and depression gripped globally.

"The outlook for global consumption remains bleak. Exports are likely to remain lacklustre until global consumers regain their appetite for consumption,"

It looked, as China would be able to decouple from the developed world. But it was heading towards recession just like everyone else. It was thought that the clever Chinese seem to have found a twist big enough to change course overnight. Almost unbelievably, China seems to have pulled off the much-desired "V-shaped recovery." Instead, of contracting, China's figures show it is expanding at a more than a 8% rate.

China might be lying, of course. It seems very unlikely to that China could have recovered so quickly. This is not a recession it is depression. And depressions demand structural changes, which takes time. It seems very unlikely that China could have recovered so quickly.

Besides, other developing economies are reporting the same - increases in exports after a catastrophic collapse at the end of the last year. However one can measure the collapse easily by looking at the Baltic Dry Index - which keeps track of bulk-shipping rates. It fell by more than 90% last year. From its low, it's doubled - up 100%. But that still leaves it down 80% from a year ago.

China says it is growing. But if it were really growing it would be using more fuel and more electricity. Instead, “industrial demand for gasoil, used by factories and commercial plants, fell 12.6% in the first quarter. Also electricity generation has been going down. The last seven months' power output has been 8.5% below that of a year ago.”

"Over 15,000 factories in the Chinese provinces of Shenzhen, Guangzhou, or Dongguan have already shut down, with many more slated to close over the months ahead.”

“Half of China's toy factories have shut down. In fact, at least 67,000 factories overall closed in the last six months of 2008, with another 60,000 factories in the Wen Zhou Province alone about to shut down.”

"As many as 27 million Chinese are already out of work - with 20 million of them streaming out of the cities and back to the abandoned farms of the Chinese countryside."

What the Chinese are doing today is much like what the Japanese did in the mid-1980s. “Fearing a fall-off in the earnings of Japanese business from trade, Japan’s Ministry of Finance directed a torrent of low-interest bank loans into the manufacturing sector that were backed by a “nod and a wink” from the Bank of Japan.”

Then, the Japanese turned their central planning skills to the task of avoiding the kind of creative destruction that capitalism had in store for them. So far they have preventing the necessary restructuring for the last and likely also for the next 20 years. Brain dead banks were kept alive. Zombie companies remained in business. And an amount of money equal to more than an entire year's total output of all the Japanese people was spent in futile 'stimulus' efforts. Today, Japanese stocks are still selling for 75% less than they were in 1989. Japanese property, too, is only worth about a quarter of what it was worth at the top of the boom.

The big banks knew they could lend profitably to manufacturers because the government implicitly guaranteed the loans. The manufacturers took the money at low nominal interest rates. It was, after all, almost free money. As expected, Japanese manufacturers found themselves awash in liquidity. And they looked to deploy this cash in asset speculation, rather spending on capital goods or other aspects of the real economy. Like the feds created the housing boom and bust.

China now is another Asian economic superpower that has replaced Japan as the world’s largest trade-surplus country. However it is making the same mistake that Japan made in the 1980s.

Analyzing the Chinese stimulus program of an equivalent of US Dollar 570 billion reveals that it is likely that another down cycle in the global economy is triggered. In fact, China is the single biggest economic threat to everyone else in this world.