China or Bust

When Dubai’s debt bubble burst a few weeks ago, few expected that it would precipitate, by itself, a complete collapse of the global economy. Even those who foresaw the mounting and crippling debt loads there weren’t that imaginative. After all, the Swarovski-clad emirate’s portfolio, packed with high-end New York retailers and Las Vegas casino projects, represented, in many ways, more super speculative hedge fund than measured, robust investment stratagem.

Likewise, when Greece, laboring under a deficit not dissimilar to that in the United States, fell prey to the ratings agencies’ wrath, few investors conjured up apocalyptic scenarios of mile-long soup lines around the world. The government there had a “poor history” of debt management, the agencies observed. What did we expect?

These two debt-addled sovereigns are far from out of the woods, of course. Abu Dhabi might have thrown its meretricious cousin a $10 billion lifeline, for instance, but the emirate’s leader must still find a way to meet up to $80 billion in additional debts and liabilities. With soaring interest rates on bonds issued by the emirate and shattered investor confidence, that won’t be easy. The Greeks face similar problems, and already their fate weighs heavily on both the Eurozone and its currency.

But in any high stakes game, it is always the weakest hands that fold first. That is to be expected.

The same casual indifference cannot, however, be indulged when one considers the possibility of a China bust-up. And with investors like Jim Chanos employing – possibly hyperbolic – descriptions like “Dubai times a thousand” to describe the Middle Kingdom’s economy, the possibility that we may see a spectacular collapse there is worth, at the very least, a moment of contemplation.

Prima facie, China appears to be nursing along the world’s nascent recovery rather well. Forecasts of GDP growth around 10-10.5% for 2010 are not infrequent and, judging by the inflow of liquidity into the Asian region as a whole, most investors expect nothing less.

According to Nomura Holdings Inc., persistently low interest rates in the US, coupled with the perception that Asian economic growth is a one-way bet, is driving a “tsunami” of capital into the region. Data compiled by the Japan-based financial group show a half-trillion dollar reversal in foreign cash flows over the past year alone as investors pile their bets on a China-led economic resurgence. In the three quarters leading up to March of 2009, widespread economic meltdowns in the west saw some $262 billion vacuumed out of Asia’s red hot “tiger” economies as beleaguered funds in The City, Wall Street and elsewhere repatriated capital to meet crushing margin calls closer to home. However, over the past six months, almost all of that cash ($241 billion) has found its way back to Asian shores.

Even in a region as populous as this one, that kind of cash does not stay inconspicuous for long. Coupled with ample stimulus spending by local governments, those funds have helped inflate prices from equities through to the local property markets.

The MSCI Asia-Pacific index (which excludes Japan) is up 62% for the year, en route to its best twelve-month performance in over a decade and a half. China’s own Shanghai CSI 300 measure is higher by more than 65% for the same period. Again, such a strong market performance one year does by no means guarantee a retracement the next, much less a total collapse. But in and of itself, a past rally does not support unbridled optimism for future rallies.

Indeed, some fissures are already starting to appear. The same Shanghai index that boasts such impressive year to date numbers slid over 4% last week, and several components of the China Stocks and ADRs Index have slipped by 10% over the same period.

Real estate prices in China are also looking rather frothy. A recent editorial that appeared in China Daily ought to inspire at least some skepticism amongst once-bitten investors:

“If there is anything more spectacular than the amazing V-shaped recovery of the Chinese economy this year,” the paper reads, “it must be the jump in its housing prices which, after dipping for a while, are breaking records in many cities.”

Statistics cited by the paper indicate prices in 70 major cities (yes, they have 70 major cities) are rising at an incredible pace, outstripping even their parabolic climb in 2008, before the last “dip.”

“It has been reported that prices for commercially built new residential units in Beijing, Shanghai and Shenzhen have jumped above 50 percent so far this year, outpacing the growth of local economies by more than 5 times,” the paper continues.

On Friday, Zhang Xin, chief executive officer of property developer SOHO China Ltd, warned that prices in the red hot real estate market may already be overheated.

“The government needs to realize how serious the asset bubble is,” Zhang told newswire, Reuters. “It cannot control the asset bubble by just saying a few words. The most fundamental solution is to tighten credit.”

“There is a bubble in every city,” Zhang added.

That’s the problem with central governments’ stimulus spending, of course: one never knows when enough is enough.

According to Forbes, “More than 1.6 trillion yuan, or about one-sixth of China’s new loans, went to the property sector in the first 11 months, including mortgage loans to home buyers and lending to developers.”

All this is not to say that China will implode, of course, only that it might. Any recovery the world may or may not be experiencing is, at best, embryonic and, therefore, extremely fragile. In an era where Nassim Taleb-style Black Swans darken the skies and “six-sigma” events seem to defy conventional mathematics, it would be foolish to expect only the expected.