(originally published in April 2011 by YaleGlobal Online, picked up by the Khaleej Times, The South China Morning Post, The Korea Times, and numerous others)
Mega malls and empty purses
China is not only a booming country, for years it has been one of the world’s fastest growing economies. Industrialisation, urbanisation, modernisation and entrepreneurship all appear to be on steroids in the world’s most populous nation. There’s relative consensus among global investors that China will continue growing at eight per cent for the foreseeable future, providing much needed support to the global economy.
By almost any metric, economic progress in China over the past several decades has been phenomenal: GDP per capita, literacy rates, health care, infant mortality, life expectancy and national wealth have all improved remarkably.
However, as the famous disclaimer reads on most mutual fund advertisements, “past performance is no guarantee of future performance,” and this appears to be the case with respect to China’s progress. In fact, China today exhibits many of the signs that characterise the great speculative manias throughout history.
Might China slow to a more sustainable GDP growth rate, say five per cent, in the coming years? Significant evidence suggests that such an outcome is not as outlandish as the global investment community currently believes. A Chinese slowdown of this magnitude would have material impacts upon commodity markets, emerging markets and even the S&P 500’s business and earnings mix. In short, how China goes, so goes the world economy. Given this global economic interdependence, it’s highly imprudent for policymakers and investors not to consider the possibility of such a slowdown.
Given the highly uncertain and probabilistic nature of booms, busts and the sustainability of growth, the application of a multidisciplinary framework seems particularly apt in determining various scenarios and their relative probabilities. Consider the approach one takes to identifying animals: You stumble upon an animal and seek to determine what type it is. You might first look at it, followed by listening, and observing its behaviour. So if the animal has feathers and webbed-feet, and “quacks” while waddling, the probability of it being a duck is high.
Likewise, the same method can be used to assess the Chinese economic boom, using multiple lenses to determine the relative likelihood of a forthcoming bust.
From a microeconomic perspective, one method of identifying an asset-price bubble is to spot self-fulfilling or reflexive dynamics underway. In China today, higher prices in many of its asset markets are generating demand more rapidly than supply. Such dynamics are rarely stable and create situations prone to rapid corrections.
Consider property markets in which willingness to lend and prices rise together in a self-fulfilling manner. Chinese bankers have been lending money against collateral, the value of which is in part rising because of the banker’s willingness to lend. As property prices rise, banks’ collateral is worth more; the bankers feel more secure and smart, so they lend more. The cycle repeats. Unfortunately for the bankers, they’ll eventually discover that they themselves created the sense of safety and intelligence that they enjoyed. As happened with the subprime collapse in the West, reality eventually sets in, bankers step back and collateral values fall.
From a macroeconomic perspective, most asset bubbles are associated with “easy” or cheap money that drives overinvestment and overconsumption. Evidence of such easy money can be found in Chinese commercial real estate, where both entire cities – like Kangbashi, in Inner Mongolia – as well as gigantic malls remain virtually empty. ‘Time’ magazine profiled Kangbashi as a modern “ghost town,” and foreign newspapers have referred to the South China Mall in Dongguan as the “mall of misfortune.”
Chinese buyers have also set recent world records in the prices paid for a dog and a pigeon!
From a political perspective, we need to acknowledge the fact that the Chinese government remains communist in spirit, albeit increasingly less so. The party’s structure drives uneconomic activity as provincial leaders aspire to get noticed by producing more jobs and generating more GDP than the other provinces. Anecdotal reports are alarming: Perfectly usable infrastructure is destroyed and rebuilt to generate GDP. Likewise, job creation and economic activity are prioritised over sustainability and profitability.
The ramifications of a meaningful slowdown in Chinese economic activity are profound, ranging from the risk of domestic social instability to a collapse of several commodity markets.
On the global economic front, China’s voracious appetite for commodities has motivated significant expansions throughout the global commodity complex, and many industrial markets, including shipping, capital goods and more, continue to be driven by Chinese demand.
Unfortunately, the forthcoming slowdown may arrive at a particularly inopportune time. Many Australian and Brazilian mines have undertaken massive capacity expansions. Likewise, many Norwegian and Greek dry bulk-shipping companies have expanded their fleets in anticipation of rising demand. To accommodate this need for more ships, many Singaporean and Korean shipyards expanded their capacities. And so the story goes… What happens if the very foundation upon which these expansion stories are built is faulty? Might the emerging-markets tale that’s been the darling of global investors be less compelling than widely believed?
And what happens to multinational companies in a slowing world? Might the demand for US treasuries drop, resulting in higher costs for capital in the United States? Is it conceivable that the consensus belief that the renminbi will appreciate is instead met by depreciation as Beijing grasps at hopes of export-led growth? How might 25 per cent depreciation affect global imbalances?
The stakes are high. Policymakers, investors and corporate boardrooms must consider the risk of a material Chinese slowdown. Despite the allure of “China is different” explanations, there is a reason well-read and seasoned investors claim the four most expensive words in the English language are “it’s different this time.”
Vikram Mansharamani, PhD, is the author of Boombustology: Spotting Financial Bubbles Before They Burst (Wiley, 2011). For the past two years, he has taught the popular undergraduate seminar “Financial Booms and Busts” at Yale University © 2011 Yale Center for the Study of Globalisation