Is China Going Boom Or Bust?

First let me confess that I have not been to China. Some folks think that handicaps me. They are woefully mistaken. I make it a pretty steadfast rule not to go to Washington, either, but I can give you a good idea of what’s going on there.

Since I have no desire to go to China, I am thankful for my contacts who do! (To paraphrase Chris Farley from the movie Tommy Boy, you can stick your head up the backside of a cow to see a good steak, but why not just take the butcher’s word for it?)

The nice thing about currencies is that the categories of information and the pricing structures vary little around the globe. For instance, if you were looking to add a retail stock to your portfolio, the numbers you’d look for in an American company may not be the numbers you’d think important in China.

Instead, the numbers that we care about when looking at currencies are bigger and easier to compare.  Is an economy expanding or contracting? More importantly, why is it doing so? Is it expanding because of government stimulus? What is the ratio of new stimulus to new growth? What likelihood is there that growth will continue if stimulus is removed? Is the stimulus about to be removed? Are rates falling or rising? What is the government policy toward the currency? How about debt ratios to GDP?

All of these are important considerations in the forecast of a currency. And we will consider some of them today in relation to China.

Now let me begin by saying that like with all good stories, China has two sides, a boom side and a bust side. There are those who are bullish on China, and those who are bearish. If I do a good job today, you’ll have a decent idea of the arguments from both sides.

Let’s begin with the headline figures.

China’s most recent numbers for growth as measured by GDP and posted by Trading Economics come in at 10.7%. But we also know that China’s growth has been based upon sizeable stimulus  — $586 billion at last count. It’s pretty remarkable, even if it comes nowhere close to U.S. stimulus spending. We spent 25% more in our first round of stimulus alone, and as much as $1.5 trillion (in various forms) altogether.

As a ratio to population, that makes the U.S. stimulus 10 times the size of the Chinese stimulus. So why aren’t we seeing 10% growth rates like the Chinese? Actually, if we’re spending 10 times per capita as much, why aren’t we seeing 100% growth rates? Seems like a straightforward equation, doesn’t it? It would be, if it weren’t for other “mitigating” factors. (Perhaps the most outstanding is debt, but more on that another time.)

China’s interest rate is 5.31%. Its inflation rate, 2.7%. Jobless rate, 4.3%. All told, some very nice numbers. But let’s continue: exports are reportedly up 45%; imports of crude oil nearly 60%. (Although, please bear in mind, China is no more free of number manipulation than any other country. And in this recession, we’ve learned a lot about number manipulation…)

So let’s summarize. China’s interest rate, while not as low as the rest of the world, is still low by recent standards. There was a time, only 20 years ago, that rates under 8% were considered absolutely bullish for equities. (Seems hard to imagine now.) So at just over 5%, that’s not too bad. Official inflation is not yet out of control… still below the 3% level, and most folks in the United States (especially the administration) would be doing cartwheels in the street for a jobless rate below 5%.

And yet all is not well.


The problem is, China has a bubble, which is inflating even as we speak, although the government is trying very hard to keep a lid on it. The bubble is similar to what ours was… real estate and housing.

Across much of the country, housing prices rose 10% last year. But in the special economic zone of Hainan (largely comprised of an island off the southeast corner of the mainland), house prices rose 50%! The geography and designation of Hainan is important. It is the largest of the special economic zones, where free enterprise is blossoming. But a 50% rise in housing prices is not “under control” by any definition. If houses are skyrocketing in the prosperous zones, it’s evident that the People’s Bank of China has no more clue on controlling price inflation than the Fed does. Also, how much more difficult does it become to translate the positive economic changes of Hainan to other less fortunate parts of the country without creating the same problems?

Also consider what has really been taking place. The Chinese government hasn’t really had to face how to export these changes to poorer, rural areas, since many of the peasants have flooded into the cities in search of the new jobs. After 1,000 years as an agrarian society, the country estimates it will be majority urban in just five years.


The Western media continues to perpetuate a popular myth — the myth of the Chinese consumer. In the United States and Europe, the average savings rate is very low. One reason is because the American and European consumer doesn’t need to save. If something happens to his job, he doesn’t need a rainy day fund. He has a myriad of social programs that he will eventually qualify for.

So while I personally have no desire to live in a country with a welfare “safety net,” one of the upsides is this: When the bureaucracy fumbles the ball and drops the economy on its ear, the unemployed just collect their benefits… and maybe eventually food stamps or heating assistance or whatever the government may dole out.

But up until relatively recently, China was not the same. You lost your job, you lost your income. Period. The government didn’t provide unemployment insurance. There weren’t any food stamps. Bills come in you can’t pay? Too bad. You lost your house. You went hungry.

Even now things aren’t much improved. The welfare that exists is inefficient and rife with corruption. So the Chinese are more inclined to put some money away for a rainy day instead of spending.

Here in the West, our GDP is 70% direct consumerism. In China, it is only 30%.

But do you think it is likely that the Chinese will undo generations of spending and saving habits overnight? No way. The American consumer is paying off the debt form his “big party”… I guess his European counterpart is as well. We will not continue to buy exports. And for the reasons just stipulated, the Chinese won’t be picking up their own slack domestically either.


All that being said, China is still able to fund more stimulus if it should so desire. But as King Solomon asked, “Can a man take fire into his bosom and not be burned?”

In other words, while China may be able to keep the illusion of growth going for some time yet, it has bought into the same failed model of Keynesianism that the West has used. It is already combating bubbles, even though its official inflation rate is not in the red zone. If it continues to put the brakes on its red-hot economy, we can certainly look for a second dip into recession.

Its first round of stimulus was equal to just under 15% of GDP. With the stimulus funds they created jobs. It can afford to keep going it from a treasury standpoint. It has to afford it from a social unrest and upheaval standpoint. But the big questions remain can they afford it — and can they control it — from an economic standpoint.

My vote is obviously, no. And there has already been some evidence of it. China used its last round of stimulus to build the largest shopping mall in entire world. It now sits 99% vacant. The Chinese government is not very proficient at allocating capital.

So they may be able to manipulate it for some years yet. But NO central bank, dealing with a FIAT CURRENCY, has ever won at this game.

Bill Jenkins
Whiskey & Gunpowder

March 22, 2010

The Daily Reckoning