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Opinion

China: the coming costs of a superbubble

China may seem to have defied the recession and the laws of economics. It hasn't. When China's bubble bursts, the global impact will be severe, spiking US interest rates.

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China lies. It goes to great lengths to maintain appearances, including censoring media and jailing those who write antigovernment articles. That’s why we have to rely on hard data instead.

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Steroids ‘R’ Us

Today the global economy is stabilizing, thanks to Uncle Sam and other “uncles” around the world. But the consumers of Chinese-made goods are still in debt, unemployment is high, and banks aren’t lending. You might think the Chinese economy would be growing at a lower rate. But no, it is growing again at nearly 10 percent, as though the financial crisis never occurred. 

Though this growth appears to be authentic – electricity consumption is back up – it is not sustainable growth, because it is based on an unprecedented stimulus package and extraordinary government involvement in the economy. 

In the midst of the financial crisis, in late 2008, Beijing fire-hosed a $568 billion stimulus into the Chinese economy. That’s enormous! As a percentage of GDP, it would be like a $2 trillion stimulus in America, nearly triple the size of the one Congress passed last year.

It gets even more interesting. Unlike Western democracies, whose central banks can pump a lot of money into the financial system but can’t force banks to lend or consumers and corporations to spend, China can achieve both at lightning speed. 

The government controls the banks, so it can make them lend, and it can force state-owned enterprises (one-third of the economy) to borrow and to spend. Also, because the rule of law and human and property rights are still underdeveloped, China can spend infrastructure project money very fast – if a school is in the way of a road the government wants to build, it becomes a casualty for the greater good.

Government is horrible at allocating large amounts of capital, especially at the speed it is done in China. Political decisions (driven by the goal of full employment) are often uneconomical, and corruption and cronyism result in projects that destroy value.

To maintain high employment, China has poured money into infrastructure and real estate projects. This explains why, in 2009, new floor space doubled and residential real estate prices surged 25 percent. This also explains why the Chinese keep building new skyscrapers even though existing ones are still vacant. 

The enormous stimulus has exacerbated problems that already existed, threatening to turn China into a less shiny but more drastic version of debt-riddled Dubai, United Arab Emirates.

What happens in China doesn’t stay in China. A meltdown there – or even a slowdown – would have severe consequences for the rest of the world.

It will tank the commodity markets. Demand for industrial goods will fall off the cliff. Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5 percent mortgages and 6 percent car loans.

No shortcuts to greatness

We look at China and are mesmerized by its 1.3 billion people, its achievements of the past decade, its recent economic resiliency, and its ability to achieve spectacular results on the fly. But we have to remember that economic bubbles are usually just a good thing taken too far. The Chinese economy is no exception. Its long-term future may be bright, but in the short run we’ve got a bubble on our hands.

Everyone wants a shortcut to greatness, but there isn’t one. China has been trying to bend the laws of economics for a while, and with the control it exerts over its economy it may seem that it’s succeeded. 

But this is only a temporary mirage, which must be followed by a painful reality. No, there is no shortcut to greatness – not in personal life, not in politics, and not in economics.

Vitaliy N. Katsenelson is a portfolio manager/director of research at Investment Management Associates in Denver. He is the author of “Active Value Investing: Making Money in Range-Bound Markets.”

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