China Bubble: More Bearish Commentary

The holiday season has not stemmed the flow of commentary questioning the strength of the Chinese economy. On Christmas Eve, Australia’s own Karen Maley of Business Spectator wrote a nice summary of the challenges currently facing the Chinese economy. Here’s an extract of what Maley wrote:

As we head into 2011, the biggest cliffhanger for Australia is whether China will be able bring its inflationary threat under control, or whether rising food and energy prices will unleash a fresh wave of social unrest.

Many economists worry that Beijing is showing a dangerous complacency when it comes to tackling their inflation problem, with the country’s consumer price index climbing to a 28-month high of 5.1 per cent in November. This leaves Chinese savers – who earn a paltry interest rate of 2.5 per cent on one-year deposits – facing negative real interest rates. This has prompted Chinese households and businesses to pour their money into physical assets – such as food, real estate, and even commodities – as a hedge against inflation. As a result, we’re seeing commodity prices such as iron ore and the spot coal price continue to inch up day after day.

They argue that it is impossible for a country which has accumulated $US2.65 trillion in foreign currency reserves, and where growth in money supply is running at around 20 per cent a year to keep inflation under control if it persists with maintaining negative real interest rates. Especially since the Chinese economy is growing by about 10 per cent a year.

But the Chinese government is deeply reluctant to combat inflationary pressures by raising interest rates. One reason for this is Beijing’s fear that a sharp rise in interest rates would push up the borrowing costs for many Chinese businesses, and spark widespread business failures. A rash of business collapses would exacerbate the existing problems that Chinese banks have with bad debts.

Beijing’s fear that rising interest rates could cause widespread business failures is consistent with arguments recently put forward by Jim Chanos and  Vitaliy Katsenelson, who claim that China’s high fixed costs, emanating from its massive manufacturing overcapacity, means that China’s manufacturing margins are razor thin and it cannot afford a slowdown of economic growth or a rise in costs, such as wages.

Whilst criticism’s of China’s growth model are gaining prominence internationally, few commentators within China have dared ring the alarm bell. That is, until now. Yu Yongding is president of the China Society of World Economics, and is a former member of the monetary policy committee of the People’s Bank of China and a former Director of the Chinese Academy of Sciences Institute of World Economics and Finance. On 23 December, Mr Yongding published a scathing attack on China’s growth story in the state-run ChinaDaily. Here is some of what Mr Yongding had to say:

China’s progress over the past three decades is a successful variation on the East Asian growth model that stems from the initial conditions created by a planned socialist economy. That growth pattern has now almost exhausted its potential. So China has reached a crucial juncture: without painful structural adjustments, the momentum of its economic growth could suddenly be lost.

China’s rapid growth has been achieved at an extremely high cost. Only future generations will know the true price. The country’s investment rate now stands at more than 50 percent – a clear reflection of China’s low capital efficiency.

There are two worrying aspects of this high rate. First, local governments influence a large proportion of investment decisions. Second, investment in real estate development accounts for nearly a quarter of the total.

Some local governments are literally digging holes and then filling them in to ratchet up the GDP.

Consequently, there are simply too many luxurious condominiums, magnificent government office buildings and soaring skyscrapers. Hotels in China’s provincial cities make five-star establishments in Western capitals looked shabby.

China has become one of the world’s most polluted countries. Dust and smog choke its cities. All of the country’s major rivers are contaminated. Although progress has been made, deforestation and desertification remain rampant.

Drought, floods and landslides have become commonplace. Relentless extraction is quickly depleting China’s resource deposits.

With China’s trade-to-GDP ratio and exports-to-GDP ratio already respectively exceeding 60 percent and 30 percent, the economy cannot continue to depend on external demand to sustain growth.

Unfortunately, with a large export sector that employs scores of millions of workers, this dependence has become structural. That means reducing China’s trade dependency and trade surplus is much more than a matter of adjusting macroeconomic policy.

After decades of rapid expansion, China has become the workshop of the global economy. The problem is that it is no more than a workshop. A lack of innovation and creation are the economy’s Achilles’ heel… Without a strong capacity for innovation and creativity, even a giant has feet of clay. And when a giant falls, many get hurt…

If China fails to tackle its structural problems in time, growth is unlikely to be sustainable. Any structural adjustment is painful. But the longer the delay, the more painful it will be…

What the public resents most is the collusion between government officials and businesspeople, described by the respected Chinese economist Wu Jinglian as “capitalism of the rich and powerful”.

Breaking this unholy alliance will be the big test for China’s leadership in 2011 and beyond. Under China’s current institutional arrangements, meritocracy is a prerequisite for good governance.

What makes Mr Yongding’s criticisms so special is not what he said – since these issues have been raised previously by external commentators – but the fact that such a prominent economist within the Chinese establishment has raised these issues in the state-controlled media. If anything, I believe this adds weight to the arguments put forward previously by Jim ChanosVitaliy Katsenelson, and other external observers.

2011 is looking like it could be a make-or-break year for China which, by extension, will determine the fortunes of the Australian economy (see here and here for analysis of Australia’s dependence on China).

Happy Holidays

Cheers Leith 

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.


  1. Oh but Australia property will increase 20% next year. The Australia banks are the envy of the world.

    Oh and the other one the Chinese build then move in as they did this in the 90s…… So I guess after some of those cities that have been empty for 5 to 10 years then maybe they'll move in. LOL

    What a crock of S$%T all this is. It goes to show a correction has always happened in every economy. It cant boom forever. Bring it on things need to cool off for a while.

    Thank God for blogs like this.


  2. For Australia it is starting to look rather like 2006 did for the Americans. When someone pops up claiming that we're all Chicken Littles then I will know the end is nigh for the Australian housing bubble.

    What really amazes me about all of this is the psychological nature of booms and busts. If we didn't have the spruikers declaring a new paradigm we wouldn't have the bubbles in the first place. People need to learn to be a bit more skeptical.

  3. Hi there

    I am from Germany. Most people just laugh when I tell them about the China bubble. All I hear is: "You are wrong, wrong, wrong. China gets it. China knows how to handle this. China is not the USA." "There might be a tiny bubble but the regime will do anything against it. Don't worry."

    Actually, I am deeply worried about this.