The Chinese Ponzi Bubble

Everyone knows that China is the economy of the future. But beware of a potential blow-up of the Chinese economy.

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 but also the most recently one in the US housing market. So when Andy speaks, people should listen.

“One of the biggest risks 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.”

A study by the Peterson Institute for International Economics reckons “it’s by as much as 15-25%. And that’s after accounting for a 21% appreciation since 2005.”

"The outlook for global consumption remains bleak. Exports are likely to remain lacklustre until global consumers regain their appetite for consumption," wrote Jing Ulrich, managing director at JPMorgan in Hong Kong. China might be lying, of course. In addition on average, world trade fell 31 percent in January 2009.

To varying degrees, recession and depression has gripped globally.
It seems very unlikely that China could have recovered so quickly. This is not a recession, but a depression. And depressions demand structural changes, which take much more time.

Chinese stock and property markets have bubbled up again. It was fuelled by bank lending and inflation fear. Chinese stocks and properties are 50-100% overvalued. As recently as last Monday the stock market came down by 19%. The odds are that both property and stock markets will adjust even more before the end of 2009. Those markets have become a giant Ponzi scheme. The prices are supported by appreciation expectations. As more people and liquidity are sucked in, the resulting surging prices validate the expectation, which prompts more people to join the party. This sort of bubble ends when there isn’t enough liquidity to feed the beast.

Analyzing the Chinese stimulus program reveals that it is likely that another down cycle in the global economy will be triggered. In fact, China is the single biggest economic threat to every other nation.
This is contrary to conventional wisdom, which holds that China is leading a turnaround in the global economy. Far away from the well established assumption that China is contributing to the solution of the global depression. Ultimate China’s stimulus program is aggravating the underlying problem, because it is multiplying supply in a world plagued by excess capacity and collapsing demand. Simply said, China is stimulating the wrong phenomenon.

Beijing has flushed trillions of yuan into expanding capacity in sectors already suffering from collapsing demand amplifying the overhang of over-capacity.

To underline this conclusion: “Chinese officials themselves, Li Yizhong, chief of the Chinese Ministry of Industry and Information Technology, has proclaimed that China will withhold approvals of new steel projects for at least the next three years. Li told in a press conference on August 13 that oversupply has become a serious problem because China’s annual production capacity of 660 million tons exceeds estimated demand by an astonishing 190 million tons.”

One of Li’s spokesmen put it this way: “The industry must produce according to market needs and avoid adding to the excess capacity. They should avoid reckless investments. The government must also take action to curtail additional investments by companies that are already in excess.”

Strangely enough, Li’s warning is being ignored by the Chinese regime. That could bring China in danger of entering the same kind of deflationary spiral that left the once booming Japanese in the doldrums for close to two decades and the rest of the world –except Brazil- presently is experiencing.

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. The big banks knew they could lend profitably to manufacturers because the government implicitly guaranteed the loans. Manufacturers took the almost free money. Rather than spending this money on capital goods or other production improvements in the real economy, they spent it consumptive, creating the housing boom and bust. Likewise the feds caused about 20-years later. Extinguishing the fire with high-octane fuel – read more credit - to pay-off debt! Sounds meanwhile familiar.

China at this time 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.

“China’s leaders have instructed Chinese banks to lend trillions of yuan (CNY7.4 trillion so far = 1 trillion US$) to Chinese manufacturers. These are mostly old-line state-owned enterprises that are the least productive sector of the Chinese economy. As a result, Chinese M2 money supply has increased by 28.5%. And yuan based lending has soared by 34.4%.”

Beijing -perhaps unwittingly- is inflating a gigantic bubble. And that when it is going to burst, it will trigger an even greater global crisis than the one Japan experienced during its “lost decade.”  And the world still is experiencing today.