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China Fooled the World (But It Cannot Last)

Economics / China Economy Feb 18, 2014 - 12:53 PM GMT

By: Mike_Shedlock

Economics

Steen Jakobsen, chief economist at Saxo Bank emailed a pair of interesting links on the explosion of investment and debt in China.

First consider the BBC report How China Fooled the World by Robert Peston.

Robert Peston travels to China to investigate how this mighty economic giant could actually be in serious trouble. China is now the second largest economy in the world and for the last 30 years China's economy has been growing at an astonishing rate. While Britain has been in the grip of the worst recession in a generation, China's economic miracle has wowed the world.


Now, for BBC Two's award-winning strand This World, Peston reveals what has actually happened inside China since the economic collapse in the west in 2008. It is a story of spending and investment on a scale never seen before in human history - 30 new airports, 26,000 miles of motorways and a new skyscraper every five days have been built in China in the last five years. But, in a situation eerily reminiscent of what has happened in the west, the vast majority of it has been built on credit. This has now left the Chinese economy with huge debts and questions over whether much of the money can ever be paid back.

Interviewing key players including the former American treasury secretary Henry Paulson, Lord Adair Turner, former chairman of the FSA, and Charlene Chu, a leading Chinese banking analyst, Robert Peston reveals how China's extraordinary spending has left the country with levels of debt that many believe can only end in an economic crash with untold consequences for us all.

Will China Shake the World Again?

In part two of the series by Peston (both links are promos for the BBC video that will play Tuesday), please consider Will China Shake the World Again?

Perhaps the big point of the film I have made, to be screened on Tuesday (How China Fooled the World, BBC2, 9pm) is that the economic slowdown evident in China, coupled with recent manifestations of tension in its financial markets, can be seen as the third wave of the global financial crisis which began in 2007-08 (the first wave was the Wall Street and City debacle of 2007-08; the second was the eurozone crisis).

Why do I say that?

Well in the autumn of 2008, after the collapse of Lehman, there was a sudden and dramatic shrinkage of world trade. And that was catastrophic for China, whose growth was largely generated by exporting to the rich West all that stuff we craved. When our economies went bust, we stopped buying - and almost overnight, factories turned off the power, all over China.

I visited China at the time and witnessed mobs of poor migrant workers packing all their possessions, including infants, on their backs and heading back to their villages. It was alarming for the government, and threatened to smash the implicit contract between the ruling Communist Party and Chinese people - namely, that they give up their democratic rights in order to become richer.

So with encouragement from the US government (we interviewed the then US Treasury Secretary, Hank Paulson), the Chinese government unleashed a stimulus programme of mammoth scale: £400bn of direct government spending, and an instruction to the state-owned banks to "open their wallets" and lend as if there were no tomorrow.

Which, in one sense, worked. While the economies of much of the rich West and Japan stagnated, boom times returned to China - growth accelerated back to the remarkable 10% annual rate that the country had enjoyed for 30 years.

But the sources of growth changed in an important way, and would always have a limited life.

Toxic investment

There are two ways of seeing this.

First, even before the great stimulus, China was investing at a faster rate than almost any big country in history.

Before the crash, investment was the equivalent of about 40% of GDP, around three times the rate in most developed countries and significantly greater even than what Japan invested during its development phase - which preceded its bust of the early 1990s.

After the crash, thanks to the stimulus and the unleashing of all that construction, investment surged to an unprecedented 50% of GDP, where it has more or less stayed.

Here is the thing: when a big economy is investing at that pace to generate wealth and jobs, it is a racing certainty that much of it will never generate an economic return, that the investment is way beyond what rational decision-making would have produced.

But what makes much of the spending and investment toxic is the way it was financed: there has been an explosion of lending. China's debts as a share of GDP have been rising at a very rapid rate of around 15% of GDP, or national output, annually and have increased since 2008 from around 125% of GDP to 200%.

"Most people are aware we've had a credit boom in China but they don't know the scale. At the beginning of all of this in 2008, the Chinese banking sector was roughly $10 trillion in size. Right now it's in the order of $24 to $25 trillion.

"That incremental increase of $14 to $15 trillion is the equivalent of the entire size of the US commercial banking sector, which took more than a century to build. So that means China will have replicated the entire US system in the span of half a decade."

There are no exceptions to the lessons of financial history: lending at that rate leads to debtors unable to meet their obligations, and to large losses for creditors; the question is not whether this will happen but when, and on what scale.


Wine Country Conference II

Want to hear a live discussion of what Steen Jakobsen thinks about Europe and China?

Then come to the second annual Wine Country Conference which will be held May 1st & 2nd, 2014.

We have an exciting lineup of speakers for this year's conference.

  • John Hussman: Founder of Hussman Funds, Director of the John P. Hussman Foundation which is dedicated to providing life-changing assistance through medical research
  • Steen Jakobsen: Chief Economist of Saxo Bank
  • Stephanie Pomboy: Founder of MacroMavens macroeconomic research
  • David Stockman: Ronald Reagan's budget director, best-selling author, former Managing Director of The Blackstone Group
  • Mebane Faber: Co-founder and the Chief Investment Officer of Cambria Investment Management
  • Jim Bruce: Producer, Director, and Writer of Money For Nothing: Inside the Federal Reserve
  • Chris Martenson: Reknown speaker and founder of Peak Prosperity
  • Mike "Mish" Shedlock: Investment advisor for Sitka Pacific and Founder of Mish's Global Economic Trend Analysis

In addition, we expect confirmation from a number of other highly respected fund managers and speakers. This year's event is two days and will include additional "break-out" groups.

For speaker bios, please check out Wine Country Conference Speakers.

This Year's Cause: Autism

$100,000 of the money raised last year came from a generous matching grant from the John P. Hussman Foundation.

Some of us in the industry who have done well are making an effort to help others. John Hussman is at the very top of that list.

One of John's kids has severe autism. This year, all net proceeds will go to support autism programs.

Conference Details

For further details about the 2014 conference, please see Wine Country Conference May 1st & 2nd, 2014

Nothing Like It!

This event is not just another "come and hear someone talk" kind of thing. Attendees and their significant others can expect an educational, fun, and relaxed time.

Last conference, we arranged wine tours. They were a big hit. We will do so again. One of the wine estates we visited had a Bocce Ball court. On a couple of miracle shots, I won both games I played.

Stay an extra day and golf or travel. I did. The conference hotel is a fun place in and of itself.

Unlike many other conferences, you will have easy access to speakers.

Want to chat with me, Steen, John, or anyone else at the conference? You will have an easy chance.

Not only do we have an excellent lineup of speakers, you will have an opportunity to meet with them, have intimate discussions on important investment topics, with a lot of fun on the side, including wine tours and great wine.

There's nothing like it in the investment business. And your money goes to a great cause! What can be better?

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2014 Mike Shedlock, All Rights Reserved.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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