Gary Shilling: China heading for a hard landing

Back in February, I published a video interview with Gary Shilling, president of A. Gary Shilling & Co., Inc. and author of the best selling book The Age of Deleveraging, in which he outlined why China’s economy is headed for a hard landing and what to do in order to profit from the slowdown.

Now Mr Shilling has returned with a five-part series of articles published in Bloomberg, in which he again outlines why China is headed for a ‘hard landing’. Below are some of the key extracts. The entire articles can be accessed from Bloomberg here: Part 1 ; Part 2 ; Part 3 ; Part 4 ; Part 5 .

Few countries are more important to the global economy than China. But its reputation as an unstoppable giant — as a country with an unending supply of cheap labor and limitless capacity for growth — masks some serious and worsening economic problems.

China’s labor force is aging. Its consumers save too much and spend too little. Its political and economic policy tools remain crude. Its state bureaucracy seems likely to curb spending just as exports weaken, and thus risks deflation. As U.S. consumers retrench, and as the global commodity bubble begins to dissipate, these fundamental weaknesses will combine in a way that’s unlikely to end well for China — or for the rest of the world…

…why do so many analysts predict that China can continue its robust growth?

In part because they believe in the misguided concept of global decoupling — the idea that even if the U.S. economy suffers a setback, the rest of the world, especially developing countries such as China and India, will continue to flourish. Recently — after China’s huge $586 billion stimulus program in 2009; massive imports of industrial materials such as iron ore and copper; booms in construction of cement, steel and power plants, and other industrial capacity; and a pickup in economic growth — the decoupling argument has been back in vogue.

This concept is flawed for a simple reason: Almost all developing countries depend on exports for growth, a point underscored by their persistent trade surpluses and the huge size of Asian exports relative to GDP. Further, the majority of exports by Asian countries go directly or indirectly to the U.S. We saw the effects of this starting in 2008: As U.S. consumers retrenched and global recession reigned, China and most other developing Asian countries suffered keenly.

Overconfidence in China’s ability to keep its economy booming is also partly psychological. It reminds me of the admiration and envy (even fear) that many felt toward Japan during its bubble days in the 1980s…

China has become an economic giant because it has so many people who are producing moderate amounts. In most ways, however, China remains an underdeveloped country with political and economic policy tools that are crude by Western standards. Those tools can spur impressive growth –but they also mask some deep structural weaknesses in China’s economy.

It’s relatively easy for developing countries to grow by emulating the technology of advanced nations or, in China’s case, by forcing them to share it as the price of doing business or by simply stealing it.

And a tightly controlled economy can get results quickly. That’s what happened with China’s $586 billion stimulus program introduced in 2009…

[But] this kind of growth is unsustainable, and it won’t be able to cover up China’s underlying vulnerabilities forever.

China’s reliance on exports and a controlled currency for growth, for instance, will no longer work if U.S. consumers are engaged in a chronic saving spree, as I believe they will be. Chinese export growth, which averaged 21 percent per year in the last decade, is bound to suffer.

The country’s seemingly inexhaustible pool of cheap labor is expected to peak in 2014, in part due to its rigid one-child policy. By some estimates, ample labor has boosted GDP growth by 1.8 percentage points annually since the late 1970s, but the contraction of the working-age population will reduce growth by 0.7 percentage points by 2030…

China is hoping to cool its white-hot economy without precipitating a recession. Doing so will be extremely difficult: Inflation fears are growing, the government’s ability to respond is quite limited, and China’s economic model, which leaves bureaucrats guessing about the market effects of their directives, is ultimately untenable.

Inflation worries start with housing. With Chinese exports curtailed by U.S. consumer retrenchment, capital spending threatened by government restraints and excess capacity, and domestic spending less than robust, housing has been China’s big generator of economic growth in recent years. By some estimates, half of Chinese GDP is linked to real-estate activity…

Developers are rushing to build while they try to support faltering prices by delaying completions and creating artificial shortages. Of course, these efforts are difficult to maintain because they tie up capital in uncompleted houses. Houses are now being built at about twice the rate they’re being sold, well above earlier norms…

A report this week by China’s National Audit Office found that a significant chunk of bank loans made to provincial-government financing vehicles were improperly funneled into property investments, contributing to a debt load equal to some 27 percent of GDP. Other huge loans to state-owned enterprises, intended to finance infrastructure, also reportedly went into real estate and may be at risk.

With inventories soaring while demand softens, and the government clamping down on speculation, a collapse of the housing bubble seems increasingly likely.

Housing isn’t the only area where signs of inflation are popping up. In May, consumer prices increased 5.5 percent versus a year earlier. In December, Chinese leaders agreed to “put stabilizing the overall price level in a more prominent position” in their ranking of economic priorities. In a country where many live at or below the poverty level, food costs are obviously a major concern, and they jumped 11.7 percent in May from a year earlier.

The government appears increasingly worried about social unrest. In November, it said it was ready to impose price controls to reduce inflation, especially on food and energy, and said it would help the poor with higher welfare payments. The unrest continues and, significantly, has moved from rural areas to the cities…

China’s ability to respond to these worries is extremely limited. The central bank relies on adjusting reserve requirements and limits on bank lending to implement monetary policy. Since January 2010, it has raised reserve requirements 12 times (to 21.5 percent), while only increasing the one-year lending rate four times (to 6.31 percent), to accommodate inefficient state-enterprise borrowers, which provide a lot of jobs.

Finally, implementing any policy in an economy that is partly government-controlled, partly market-driven is very difficult. In a completely controlled economy, as China’s used to be, government leaders might have made economically inefficient decisions, but their authority wasn’t disputed. In an open economy, as in Singapore, the markets make the decisions, and politicians have little involvement.

But under China’s current arrangement, officials making major decisions have to guess what market reactions will result, then try to mitigate the unintended consequences of their actions…

I suspect that such a hybrid market system is too unwieldy to allow the Chinese government to manage a soft landing for its economy. By my reckoning, the Federal Reserve has tried 12 times in the post-World War II era to cool an overheating economy without precipitating a recession. It succeeded only once. Can the politically controlled Chinese central bank, and the government leaders who really call the shots, be more successful than the independent Fed?

That seems unlikely. And the consequences, for China and the world economy, could be unfortunate…

Growth in the broadest measure of China’s money supply has declined from 30 percent year-over-year in December 2009 to 15 percent year-over-year at the end of May. Bank loans fell 25 percent in May from April. Excavator sales fell 10 percent in May from a year earlier, possibly foreshadowing a construction bust. The 14.3 percent decline in the Shanghai Composite Index last year and the 10 percent drop since mid-April also don’t bode well for growth.

Despite all these negatives, with recent data showing first-quarter GDP expanding by a still-healthy 9.7 percent, and consumer inflation at its highest levels since July 2008, China has continued to tighten its economic policy. The government raised banks’ reserve requirements to 21.5 percent in June, the ninth such increase since November. And it will probably continue to tighten until it sees decisive results — that is, a hard landing.

What will happen next?

…China’s most likely reaction — to focus still more on exports — will exacerbate its hard landing. If consumer spending doesn’t increase substantially in the next few years, China will have a serious problem using all the industrial capacity it has built, partly to keep people employed. Capacity is mushrooming so rapidly that even in China’s booming economy, most manufacturers are still seeing flat or falling utilization rates.

This unused capacity portends weak profits and trouble for the loans that financed it. My judgment is that it will once again be used for exports aimed at the U.S. and Europe. And once again, this will add to global excess supply and put downward pressure on prices.

Then China, along with other export-dependent emerging economies, will be competing fiercely in a world of slow growth and deflation…

The hard landing that I foresee for China will probably prick the global commodity bubble, which is already showing signs of topping out… Much of the leap in commodity prices was due to investors and other speculators…

The confidence that China would continue to buy huge quantities of almost all commodities has been the bedrock belief of speculators. For example, there were rumors that China was again building its emergency petroleum reserve in the first half of this year.

I’ve studied many bubbles over the years, and concentrated on predicting their demises. Commodities show every sign of being in one…

Speculators are starting to take stock of the evidence of a hard landing in China, and industrial commodity prices, including copper, are swooning. As in the past, warnings about shortages in key industrial inputs are magically being contradicted as unaccounted-for stockpiles materialize…

The bursting of the commodities bubble will be bad news for developing-country producers such as Brazil, which has thus far largely escaped recent global economic and financial woes but is a major exporter of iron ore and other commodities to China. Developed commodity exporters — Canada, New Zealand and Australia — as well as their currencies, may also suffer.

I’ve long believed that a hard landing in China would be preceded by a price collapse in copper and other industrial commodities. Copper prices peaked in February, and Barrick Gold Corp. (ABX)’s agreement on April 25 to acquire copper producer Equinox Minerals Ltd. to gain mineral resources outside its area of specialization is a classic sign of a peak.

Another classic sign of a speculative price peak was the sudden appearance of copper inventories where none were thought to exist. As prices start to break, hoarded commodities suddenly become available for sale by highly leveraged owners. Copper in China was so abundant that bonded warehouses were full. In January and February, extra copper was sold abroad as Chinese exports were eight times the year-earlier total…

…there is so much leverage money floating around the world that regardless of how it’s managed –by fundamental, momentum or technical strategies — it tends to end up on the same side of the same trades at the same time. So, when one of these positions reverses, the effects spread rapidly as speculators bail out of their positions to reduce risk and preserve their capital. Keep in mind that the prices of the wide variety of commodities continue to move in lockstep.

Many commodity bulls see this trend as a short-lived midcourse price correction and have maintained their long positions in copper, crude oil, corn and even silver. But markets anticipate, and it now appears the declines in commodities are foreshadowing a hard landing in China, with the effects spreading globally.

The extracts provided above are the sections that I believed are most pertinent and comprise only around one-third of the detail provided in the Bloomberg articles. Readers seeking more detail are encouraged to read the articles in full for themselves (available here: Part 1 ; Part 2 ; Part 3 ; Part 4 ; Part 5 ).

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Leith van Onselen

Comments

  1. I have been reading about Ordos , the ghost city in Inner Mongolia, it is starting to fill due to the rare earth boom, I would not underestimate the chinese ability to mask the truth or to act with a wisdom of foresight that is miles ahead of the west. They will have no hestitaion in writing off debt and reissuance. They have watched Japan, and the west gorge upon themselves and will not make the same mistakes, maybe different ones though.

    • Agree Jack.

      I find it interesting when people write that China will not repeat the mistakes of X and Y (where X and Y are Japan, the US, the west, other developing asian economies etc etc).

      The Chinese are attempting mass urbanization utilizing elements of both a command and capitalist system on a scale that’s unprecedented in human history. They may avoid the mistakes of lots of other places, but at the same time I’m sure they’re more than capable of making their own unique, but no less damaging mistakes…I liked the point of bureaucrats having to make decisions and then dealing with the unintended market reactions of these decisions.

      In regards to rare earths – there’s scope for that whole game to change if Japan can successfully mine this deposit – http://www.reuters.com/article/2011/07/04/us-rareearth-japan-idUSTRE76300320110704

      • Rare earths: very unlikely to devise a cash-positive extraction technique so deep in the ocean.
        If people can’t be bothered processing similar concentrations up on land, they will be even less interested it it under the water.

        This is “mud”, not “ore”.

      • The Austrian Business Cycle Theory works in China too!

        I think we give China’s politburo too much credit… they are after all as fallible as you and I.

        First of all China does not have rule of law, second, there is no protection of property rights. Whenever these fundamental institutions are missing or lacking the nations long term future can never be too bright. In the long term India will be the one to watch as they at least have better rule of law, and better protection of private property.

    • We are actually designing a large Convention Centre for Ordos right now… An iconic piece of Architecture!

    • MontagueCapulet

      “They have watched Japan, and the west gorge upon themselves and will not make the same mistakes”

      Why do you say that? The main lesson of history is that human beings do not learn from history. They certainly do not seem to learn from bubbles in other countries – it’s always “different here”.
      China may well manage to make ALL the mistakes of both the USA, Japan and the USSR, plus a few new ones with Chinese Characteristics.

      Read up on some of the insane things they did during the Great Leap Forward and the ensuing famine. And I use “insane” in the technical sense. As in totally divorced from reality. Refusing to recogise factual truth even when many millions of people were dying around them as a result of their madness.

      Why on earth would you think that the Chinese have “wisdom or foresight that is miles ahead of the west”. Is there any actual evidence to support this? Sounds like wishful thinking to me.

      Not for one moment would I want to minimise the foolishness, corruption or treasonous nature of the powers in the West. But from what I can see the Chinese are just as corrupt and foolish.
      It seems to me that corruption and foolishness is a global problem – you can see it in Greece, Ireland, the UK, the USA, Germany, Canada, Australia, Japan, Russia – and China and India and Brazil too. You just have to look.

      The same mistakes have been made EVERYWHERE. It’s a global problem.

      • MontagueCapulet

        It’s particularly ironic that you think China has some special wisdom that will help them avoid the pitfalls that other nations suffered, when their whole game plan for the last 30 years has been to copy what Japan did on their way up.
        .
        .
        So they are going to do exactly what Japan did and somehow get different results?

  2. Read these last week. Shilling does raise the usual (and valid) points. All we can hope for is that China experiences a soft landing, for the sake of the resources sector here in Australia and the citizens of China.

    I’ll go with soft landing (thought Andrew Sheng link I posted last week was an interesting perspective, mainly that China would experience difficulties certainly, but would navigate them in unexpected ways). Who knows.

    On a purely selfish level, Australia must hope for a soft landing in order for this country to get on with what it does best – resources. Truth is, we have little else to offer.

    Deep philosophical musing: It ain’t over, until it’s over.

      • It will only be a terrible outcome because we’ve racked up so much personal debt and allowed ourselves to become so leveraged to the China construction boom. Besides, it won’t be the end of the world. Australia was doing just fine before the commodities boom, and it will be fine again, but with some much needed balance restored to our economy.

        Was Australia an economic wasteland in the mid 1990s before the rivers of gold were flowing in from China? Of course not.

        Yes there will be lots of pain for the over-indebted and over-invested miners, but that’s not a bad thing IMO.

        • The only difference that we had a government in the 90’s willing to make structural reforms to bolster the economy. The galahs we have today are unable to make a hard decision that is not focus group orientated or fit the 24hr media cycle mould. I reckon Australia will struggle immensely post commodities correction. Our R&D and manufacturing industries are all but decimated and the adjustment period will not be easy. In saying this, if China does crash, the rest of the world goes with it so it really won’t matter too much cause there’ll be nobody to export to.

        • Mid 90s. Fifteen or so years ago. In that time economic globalisation has accelerated and Australia’s position in many areas has changed considerably.

          Think of the number of manufacturing processes that have relocated to Asia – they’re not coming back. Property prices have multiplied. Financial markets have undergone a revolution of sorts. Oil prices have rocketed. The world of online shopping is real. Major development of regional emerging nations with population in the billions is inevitable.

          No matter what, we’re unlikely to see those days again.

          And if all goes well, those miners will have invested very nicely thank-you.

          • Fanboy, D’ya reckon massively over-investing in iron ore capacity (not exactly a rare mineral) will look smart when demand collapses?

          • I did say ‘if all goes well’. And if it does, I stick by it! A very good investment indeed.

            Even given your apocalyptic fantasies and demand collapse, at some point it will resume. That is just a demographic reality.

    • What’s amazing to me is that our economic masters are ONLY focusing on the returns, not the risk of the China trade.

      This goes across all parts of economic life: the RBA, the regulators, the politicians/legislators.

      Has anyone come up with a Plan B if China/India have soft (likely) or hard (unlikely, but still possible) landings?

      No they haven’t. Like financial planners who just repeat the “stock market doubles every 7 years” mantra, no one is looking at the potential downsides and preparing thereof.

      This is the debate that should have occurred years ago – its too late now. We just have to ride it out and hope FutureBoom can provide a savings buffer from here on in….

      • I think you’re right Prince. We have to ride this out, because it could be huge. We have little alternative due to structural changes required to support the boom. Doing it by halves rather defeats the purpose.

        As H&H as pointed out many times, we have binged on foreign debt fueled property, built up large imbalances in a non-productive sector. Presented with the only opportunity for respite via Futureboom! – Yes, you run with it. What alternatives are there.

        Plan B is for losers! Well, not really, but can be cobbled together (like most other government policy) post Futureboom! At least this time, RBA and Treasury appear to have a plan.

        It is an optimistic vision in the midst of all the gloom.

        My one concern is exactly how structural changes will leave Australia with a vibrant and ongoing globally valued economy. Just what sectors or industries are going to fill the gap resources will leave when they’re depleted. No SWF to assist transition and a history of fairly poor governments (of which the current one reigns supreme – if for the carbon tax issue and no other – introduction an ineffective cost intensive overly complicated scheme at the very time the economy can least withstand it) which generally lack any future vision. Dictated by short term interests and now muddied further by the rise of the economically illiterate Greens and (mostly) extraordinarily uninspiring independents. In that light, even my optimism fades a little.

          • Actually, probably not the current government either – evidenced by the carbon tax debacle, the wish to tax the hell out of resources and spend billions on the NBN.

          • FWIW, I would say the Greens are vastly more economically literate than Tony Abbott.

            The best of a bad lot are probably Turnbull and Wong, but sadly neither of those are likely to lead their respective parties for the foreseeable future.

          • I think the Greens are hopeless, and Bob Brown’s crowing on the weekend as to their being the future second party, replacing Labor was frightening.

            Not a fan of Abbott, but think there is enough economic literacy in the party as a whole (Turnbull is the star) to compensate.

            I know it’s nothing new, but I think the legacy of Labor politicians either being union sourced former officials or lawyers does blinker vision. Complicates it really – look at Ferguson and Combet stuck in the middle of the carbon tax fallout. Assuring industry whilst imposing additional taxes at the behest of the Greens. Reality dawns and they find themselves in an ideologically uncomfortable place – further complicated by the fact they have come to enjoy the good life and the prospects of financial reward. The old days are well behind them, alas some allegiances are not.

          • Montgomery Burns

            The libs would be better served with a shop window mannequin or a crash test dummy as their leader.

            Abbott hasn’t seemed to figure out that he is the only thing Labor has got going for it.

          • At least the Greens have a heart. They might be naive and idealistic, but at least they have a heart. All Abbott has is scare campaigns.

          • Not much of a heart when it comes to wanting to close the coal and other high emitting industries. Not enough of a heart to consider the livelihoods of families affected, communities damaged…probably just think stick them on welfare, after all they misguidedly think they can run an overly generous welfare system whilst at the same time as destroying chunks of the taxpaying economy.

            Economic illiterates with not much heart at all.

          • >Economic illiterates with not much heart at all.

            Sounds like the Coalition.

            For full and frank disclosure, I do not support any party, and do not vote.

            If I had to, I would vote Independent.

            I think like most major institutions in this country, that competition (the lifeblood of evolution) has been completely destroyed by our democratic process.

            i.e the monolith parties provide an illusion of choice, just like going to the bank or getting any type of insurance.

            A topic for weekend musing perhaps…..

          • How has the coalition demonstrated little heart?

            And what is ‘heart’?

            Perhaps a Weekend Musings is in order.

            I don’t know your electorate, but would you have voted for Oakeshott or Windsor? Seriously?

          • ‘I think like most major institutions in this country, that competition (the lifeblood of evolution) has been completely destroyed by our democratic process.’

            Because on many issues they have morphed into each other. However, I am not sure that democracy is enhanced when so much power falls into the hands of a few – Independents and a Green or two. Voted for by a minuscule proportion of the population exercising influence out of all reasonableness to their vote.

            We may as well adopt proportional representation and be done with it. Would sort the monolithic parties out too.

          • 3d1K – the fact that the Coalition had “stop the boats” as No.4 on a list of priorities at the last election (and I assume still do) shows they have no heart, nor any brains.

            Further, they provide billions in unneeded welfare to the middle class without providing any additional support to those who should get it – carers.

            That’s heartless (and economic madness).

            As I said, if I had to vote, I’d consider an independent.

            But lets leave that for a weekend muse….

          • Montgomery Burns

            the prime objective of welfare from both parties is to cultivate a dependency in the electorate. Whether or not it reaches the right people is irrelevant.

          • Prince, will all due respect, you’re stuck in an ideological muddle.

            Labor don’t want the boats. Labor are actively seeking to process people offshore. Labor is the current government and has a very generous middle class welfare program i.e. Labor wants to unnecessarily reward well remunerated teachers to the tune of billions. Labor is in the process of imposing a carbon tax that apart from glaring opportunistic political inconsistencies will threaten a number of industries. Carers are in the process of receiving improved conditions (not paying adequately was probably sensible if not fair in economic terms). Taxpayers pay for carers, hence whilst often a worthy role, the degree of care varies enormously and therefore payment criteria difficult to determine. Labor continues to deploy forces in foreign lands, despite rising death toll. Not Labor, Not Coalition, Not Greens (definitely not Greens) have a claim to being the only party with heart. And you said you WOULD vote independent!

            Probably won’t need to muse now…

          • Not much of a heart when it comes to wanting to close the coal and other high emitting industries

            Jeez, that’s a bit rich Fanboy. When have you shown any sympathy for the much larger number of people who work in manufacturing or other trade exposed industries? You cry crocodile tears for people who dig up the enemy-of-the-human-race, but you don’t give a damn about the millions having their life torn apart by the Dutch Disease.

          • I have always expressed a concern for the manufacturing sector, which I have a particular belief in, and a more general concern for other areas.

            If you recall, I have consistently maintained that I don’t want to see collapse anywhere, in any sector and view the current difficulties in some sectors are part of the economic cycle. Unlike you, I do not wish to see the demise of mining, nor China.

            I have a heart…whereas I question that in others when they rather gleefully advocate collapse in sectors that are not their own…no heart at all – like the Greens.

          • Unlike you, I do not wish to see the demise of mining, nor China

            I wish for China to rebalance its economy, raise incomes, and stop funneling easy money to SOEs to build things they don’t need. That scenario just happens to be terrible news for Australian miners, so you would prefer it doesn’t happen.

            I wish for Australia to become a more balanced economy which isn’t completely dominated by one sector that has become all powerful politically and economically.

            The Greens are deeply concerned about the long term health of the planet that sustains us — which is the ultimate collapse! But of course, you conveniently deny the consensus climate science so you don’t even accept this as a debating point.

            Denial is such a cop out. I can respect your arguments about the mining boom raising Australia’s national incomes etc, but denial is an escape clause for the intellectually lazy. You can’t deal with the problem so deny it away.

            Pathetic.

          • I don’t deny, I’m on the fence. Think the planet will survive and have great faith in human ingenuity and enterprise. Was invited to a talk hosted by Lord Monckton here in Perth last week. Interesting. If you get the chance, go have a listen.

            And yes, I probably am intellectually lazy. Probably pathetic at times too. I’m human.

        • I would suggest that, at the moment, the only side of politics with any sort of economic literacy, credibility and vision is the Greens.

          Never thought I’d say that.

        • Montgomery Burns

          Given that we run current account deficits how do you propose to finance a SWF?

          Other nations that have SWF have current account surpluses so accumulation of wealth in those funds does not smash the private sector.

          • To be honest, I’m not sure. I like the idea of any take being on a similar basis to royalties but recognise it may not even be constitutional. Alternatively, a modest SWF impost on taxable earnings applicable to all resource extraction companies, to be directed credited to the SWF. Anyway, I’d happily give the task to this bloke:
            http://www.malcolmturnbull.com.au/uncategorized/4487/

            Brains far better than mine can work this one out! But it surely must be preferable to simply imposing additional taxes that get lost in the mire of general revenue and are subsequently spent on various pork-barrelling exercises.

          • Montgomery Burns

            By way of accounting Norway runs a current account surplus so the sum of its government and private sectors are in surplus. In principle it can therefore set aside part of that surplus into a SWF.

            We run current account deficits so by way of accounting the sum of the government and private sectors are in deficit (which also means that if the government runs a budget surplus the private sector will go further into deficit). It follows that wealth put aside into a SWF would not in our case be funded from surpluses but must come from sectors already in net deficit.

            On that basis Turnbull and/or others must explain the impact of a SWF on the private sector. Given that most of these blokes call for a budget surplus without understanding it means a greater private sector deficit it is hard to have much faith in their concepts and ideas.

          • Montgomery Burns

            By way of accounting Norway runs a current account surplus so the sum of its government and private sectors are in surplus. In principle it can therefore set aside part of that surplus into a SWF.

            We run current account deficits so by way of accounting the sum of the government and private sectors are in deficit (which also means that if the government runs a budget surplus the private sector will go further into deficit). It follows that wealth put aside into a SWF would not in our case be funded from surpluses but must come from sectors already in net deficit.

            On that basis Turnbull and/or others must explain the impact of a SWF on the private sector. Given that most of these blokes call for a budget surplus without understanding it means a greater private sector deficit it is hard to have much faith in their concepts and ideas.

          • Montgomery Burns

            sorry about that. I liked it so nice I posted it twice.

            But actually a better way to think of it is that if we are running current account deficits then where is the wealth that is to be stored in a SWF?

      • Worst part is that the CBs/pollies of China and India recognise the risks and are gearing up their policies to aim for a soft landing.
        .
        i.e. our establishment is more bullish on China/India than the establishment in China/India themselves !!

      • It amazes me as well. McKibbin, to his credit, has frequently said that policy needs to be based on uncertain forecasts rather than best case scenario. ie. don’t just bank on China. The problem is that managing our China exposure can only really be done through fiscal policy. And the government is just incredibly bad. I don’t even think they understand the basic issues.

      • China Watcher

        @ The Prince. I think a big part of the plan if China goes under will include AUD at 0.60-0.70 and RBA slashing interest rates. Same mechanisms that got us through the tech wreck and associated belting of household financial wealth.
        One could argue a more holistic strategy might be helpful, but if written by current governments in this country, it might equally be unhelpful too…

  3. Shilling’s a smart guy. And he’s right, the Chinese economy makes no sense at all. Either the average Chinese persons income is going to grow at unprecedented rates over the next few years, or their economy will be sucked into a deflationary spiral.

    • Inflated land prices represent a BRAKE on productivity and income growth. There is NO WAY out of this cleft stick.

  4. Leith Van O is turning into easily the world’s best “bubble commentator” blogger.
    I say China is definitely going to have a hard landing. The big factor that economists always miss, is the role of urban land price inflation and successful rent-seeking in “new development”, in all of history’s volatile economic cycles.
    Focusing on the Asian crisis of the 1980’s and ’90’s, it is bleedin’ obvious that there would have been no crisis without urban land price inflation. Why people can’t see exactly the same process occurring today in China and India, is beyond me. Or the same process in California, Ireland, and Spain.
    “Building booms” accompanied by successful rent-seeking, are just as bad as outright building shortages for creating bubbles in the price of ALL urban land. A building boom with a minimum of successful rent-seeking is always of far more benefit than cost to an economy, because low urban land prices cause numerous gains in productivity in the urban economy.

    • Actually, successful rent-seeking in urban development is the historical “norm”. The period following WW2 in the USA especially, but also in Australia and France and Germany, involved a providential mix of circumstances which actually IS a kind of magic bullet for eliminating cyclical volatility in economies, and enabling sustained growth in real wealth. This was the era of Levittowns, fair priced new healthy homes for returned servicemen, marriage and baby booms, roads and infrastructure building, increased home ownership and car ownership and “mobility”.
      There was NO “crash” following THIS “boom”, because “rent seekers” were disempowered, urban land prices stayed low, and massive productivity gains occurred in urban economies because of this. In most of the USA, this situation still applies. It is the rent-seekers making a comeback on the back of the politics of “growth constraint”, that have wrecked the “stable growth” paradigm in California and a few other States – without this, there would have been no crash in “the USA” in 2008.
      The cities and States of the USA that stay with the “no rent seeking gains from development” paradigm, will OWN the future of civilisation. Developing nations will NOT replicate the growth of the USA and France and Germany and Australia 1946-1990 odd without a similar free market urban “sprawl”, low and stable urban land prices, and “automobility”. It CAN be done better; i.e. more efficient cars, no “minimum lot sizes”. But when all “development” is accompanied by massive rent-seeking gains, the “boom” will definitely end in tears.
      If China’s developments were being done at fair, competitive, free market prices, the homes and apartments would be getting filled as fast as they are built, by low income earners getting out of the slums – and the whole process would be as successful and sustainable as the USA 1946-1990. But poor Chinese cannot afford the prices after the rent seekers have inflated them 5-fold or 10-fold.
      If inventive “credit” is used to bridge the gap, this will end in tears also. The only time that easy credit and demand-side incentives for home ownership are NOT ultimately destructive to an economy, is when “supply” is perfectly elastic. It hardly matters how many young couples take out 1% interest no deposit loans, if the houses are 2X average annual income. It is when the houses are 10X average annual incomes, and “8X” has been pocketed by incumbent land owners, local governmments, speculators, lawyers, consultants, bureaucratic fiefdoms, etc etc; that you have a problem – and a big one.
      Check out “planning gain” on Wikipedia and decide whether you like it. The whole process has long since become explicit in Britain – all the various parties now openly and blatantly negotiate for YEARS for “their share”, before any development happens.
      One of the most basic lessons that needs to be understood about all this, is that the prices of “new developed” land, sets the prices for ALL urban land, representing a century or more of past development. It is NOT just about “making developers pay”; the inflation in land prices affects literally hundreds and thousands of times as much land as what the planners and activists are myopically focusing on out at the fringe.
      One of the worst disasters that can befall a society is to have economically ignorant and brutish people determining their economic destiny without even realising it.

  5. This is gold, and I am a massive China bear…

    “Finally, implementing any policy in an economy that is partly government-controlled, partly market-driven is very difficult. In a completely controlled economy, as China’s used to be, government leaders might have made economically inefficient decisions, but their authority wasn’t disputed. In an open economy, as in Singapore, the markets make the decisions, and politicians have little involvement.

    But under China’s current arrangement, officials making major decisions have to guess what market reactions will result, then try to mitigate the unintended consequences of their actions…

    I suspect that such a hybrid market system is too unwieldy to allow the Chinese government to manage a soft landing for its economy.”

    When you look at where the US economy and Euro economies have gone wrong, its where Governments got involved and messed things up.

    China’s success from late 70s has been due to willingness to embrace market principles. Their downfall will stem for a belief that the market forcea that brough them prosperity can/should be tamed by a small group of supposedly all knowing corrupt officials.

    China is back on the road to serfdom

    • Montgomery Burns

      When you look at where the US economy and Euro economies have gone wrong, its where Governments got involved and messed things up.

      thanks for that clarity. I had previously thought that wall street banks and monolithic insurers had played a part but I now see that as private companies they are by definition, virtuous.

      • MB:

        I’m always amused by the hard core free market economists who place the entire blame for the financial crisis on government interference. And then on the other side you have the hard-core lefties who place the entire blame on Wall St bankers, gung-ho mortgage brokers, and poor regulation.

        This truth is somewhere in the middle, but neither side will give an inch on their (highly ideological) position.

        • The revolving door between government/regulators and Wall Street banks means that it does not matter which side is to be blamed.
          .
          It is just a set of individuals who profited enormously at the expense of the taxpayers.

          • i.e. in case of the financial crisis, you have to play the man/men and not the ball (systems/institutions).

        • Lorax, I agree. Regulators failed to regulate, financiers exploited, consumers splurged, governments complied and/or capitulated.

        • Montgomery Burns

          This truth is somewhere in the middle

          …which is why I said “played a part”

          doubtful any of it could have happened without regulatory capture and Geitner asleep at the wheel at the NY Fed etc. I think Bailout Nation gives the best description of events.

      • It’s a combination of three factors in my opinion:

        1. Private companies cultivating favour with politicians to bring in regulations that benifit them and not the people.

        2. Politicians themselves that allow themselves to be so easily corrupted.

        3. A complicit media that either have a financial interest in ignoring the goings on in 1 and 2 (thus making #2 easier for politicians to be corrupted). Or the media are just incompetent morons pandering to todays 24-hour instant gratification, celebrity centric culture.

        • The media one is a goodie. An intelligent, informed, investigative media performs a watchdog role in keeping check on governments and corporations.

          Our media largely abandoned this task in recent times (curiously I suspect since the rise of journalism as a Uni Course…perhaps the need to please the lecturer transfers to pleasing the employer and limits the ability to think independently, largely reliant on groupthink and press release).

          Is it any wonder the rise of blogs has been so rapid and that this is gradually giving rise to a rebirth of the role of journalist, as both reporter and critic.

          We’ve still a way to go.

          • Interesting point, I never really cared to ponder on the effect of centralised education on budding journalists thinking processes.

            The effect of poor quality journalism is quite dramatic though. Without a watchdog to “keep the bastards honest”, how can the average joe watching 4-5 hours a day of TV possibly be well informed?

            I’m skeptical of the ability of blogs to fill the gap however, as the responsibility to produce evidence is pretty much non-existent and digital data is quite easy to falsify. But perhaps the “peer-reviewing” that bloggers on the same topic do of each other helps to stop this though. It only takes one conscientious reader to find mistakes.

        • Alex Heyworth

          Re your point 2: politicians in the US are owned even before they take office. They usually owe so many favors that it will be impossible for them to repay them all, even if they stay in office for 50 years.

  6. A commentator I watch is Michael Pettis for his take on the macro effects of Chinese economy. The major takeaways from Pettis were, for me:

    – China saving is a direct result of its current account, not necessarily indicative of cultural biases.
    – There is too much capital investment and too little spending on services. Service industries are starved of capital at the expense of construction and real estate.
    – Savers are transferring wealth to speculators.
    – Because real lending rates are so low, lending is based on quotas and preference, not on interest rate auctions.
    – Small and medium-sized enterprises that generally concentrate on services were being deprived of access to funds, though this may be slowly changing.
    – The central government likely does not fully understand the ramifications of continuing to starve service-based parts of the economy and lavish capital-intensive ones.
    – China is wholly to blame for its inflation problems.

  7. The Chinese government will most likely loosen monetary policy and build more infrastructure to prevent a ‘hard landing’ for now. 2012 will see a changeover of the leadership, and it is impossible to predict what the new government may do. This is China we’re talking about, and they can do crazy things like banning all future private real estate development to prevent house prices from falling.

    On another notes : “In an open economy, as in Singapore, the markets make the decisions, and politicians have little involvement.”. Are they being serious?? I know that it pays to suck up to Singapore Inc, but isn’t this a bit too blantant?

    • All in all a great article by Leith and also all of the comments.

      Ronin, saw a programme interview with Lee Kwan Yew and how he took the English model of public housing and then turned over ownership to occupants, for a price.

      Maggie Thatcher then followed the Singapore model. Learning from each other.

      China studies both its own history and the history of others of glorious and inglorious policy decisions and outcomes.

      I agree with you on monetary policy and infrastrucure.

      Somewhere out the curve, something big will change. The communists are in control.

      “Although gold and silver are not by nature money, money is by nature gold and silver.” Karl Marx. The communists know this.

      “All the perplexities, confusion and distress in America arise not from defects in their constitution or confederation, not from a want of honour or virtue so much as from downright ignorance of the nature of coin, credit, and circulation.” John Adams. The communists know this.

      He who does not drink from the poisoned chalice of derivatives wins. It’s that simple.

      • “All in all a great article by Leith…”

        With all the greatest due respect to Leith, he didn’t write this article. In fact, he wrote very little in this post.

  8. El Zorro Dorado

    We seem to be looking at the China issue from within a time umbrella ( what is happening now) and accordingly are giving events and trends, and policies, much more direct causal weight and potential effect. Our assessments suffer from our imaginations, and from a tendency to accord ‘Chinese economics’ our own western imperatives and values. China’s history is strewn with upheavals and dramatic social change, but with the exception of 19th century revolutions, broad-based change has taken years or decades to fester and mature. And all of its history has been characterised by re-making the power mould within the ( relatively consistent) confines of “historiography”. The same basic channels of exercise of power continue in today’s China although they are exercised by a different collective dicatorship…one which in the fullness of time will meet its waterloo. The key aspect is the “fullness of time”. Don’t expect rapid changes, even if such may seem in accord with modern global interaction and technology. More probelematic for the ROW is that the integration of China into the global economy will have reached far greater levels than that of today when the reckoning finally occurs. Governments ruling by edict can sustain power and status quo for far longer than we can perceive from within the equation. Hopefully , by the time economic comeuppance occurs, the west or ROW may be strong and insulated enough from the Chinese economy to remain with values and wealth intact.

  9. China’s currency markets are not subject to the volatilty of a free market, because of this lack of transparency, we have very little idea of how much monetising or debt cleansing occurs via the Chinese Central Bank.

    So what if 25% or 75 of their municipal debt goes belly up. It will be purchased by the CCB, written off, and replaced and the malefactors maybe given the 9mm sleeping injection.

  10. Interesting quote:

    “Another classic sign of a speculative price peak was the sudden appearance of copper inventories where none were thought to exist. As prices start to break, hoarded commodities suddenly become available for sale by highly leveraged owners. Copper in China was so abundant that bonded warehouses were full. In January and February, extra copper was sold abroad as Chinese exports were eight times the year-earlier total…”

    So, as the bubble peaks, inventories begin to appear…

    …re: the Aussie housing bubble, I wonder if this is what we seeing in rental and housing listings, WRT the “shortage” of both?

    Interesting times.

    • Slow down in their construction sector will kill their economy. It doesnt matter whether you had to put 30% 50% or 80% down on your property. If you dont have a job to support yourself and cant sell your properties then you are screwed.

  11. I just love Aussies who point the finger of blame at the stupid, greedy finance industry in the USA; but who will not be persuaded that Australia has the same problem with different names on the various players.
    Here is the question I pose to the “the finance sector is to blame” pundits. IF the finance sector, in the USA or in Australia, HAD “acted responsibly” and kept a house price bubble from inflating; HOW would they have done this without having the anti-trust authorities down on them like a ton of bricks? And the “disadvantaged communities” watchdogs?
    What are banks SUPPOSED to do when urban planners force the price of urban land up? Are they supposed to compete with each other for business, or “collude” to second-guess what the urban planners have done to the market conditions under which they operate?