In our previous article (Is the coming ?crash? in China not a real crash?), one of our readers sent us a link to a very good article (Trapped Inside a Property Bubble) written by a former Morgan Stanley economist named Andy Xie. He is a very contrarian and provocative analyst who called China’s economy as a “Panda Economy” (named after the cartoon movie,? “Kung Fu Panda”). His bearish call on the Chinese economy attracted a fair amount of criticism from Chinese government officials.
One of our readers, Pete, had highlighted sections of Andy’s article, with some good questions and comments…
Once a country loses export market share on rising costs, it stagnates because property bubbles during high growth periods deter consumption while overwhelming the middle class with housing expenses.
As property bubble grows further, debt servicing burden will grow as well. That in turn will deter consumption further as more and more of income will be spent on repaying debts. The only way to increase consumption whilst debt servicing burden is increasing is to increase debt further. Obviously, if a consumption-based economy is dependent on increasing debt to sustain consumption, then it is an economy that is addicted to debt. Once credit growth stalls, the die is cast for the economy. Back in January 2007, we wrote in Myth of asset-driven growth,
… asset-driven growth magnifies the consumption debts of the economy, which will have to be serviced in the future. By deferring the burden of debt servicing to the indefinite future, it can only mean that the nation?s wealth will shrink in the future. Hence, asset prices cannot rise in perpetuity. Eventually, the weight of future debt servicing burdens dooms the bubble to collapse under its own weight.
Since the Chinese economy is still dependent on cheap labour to achieve low cost production, labour costs increase will kill its competitiveness. As a result, exports will decline. If at that point in time, citizens are burdened heavily with debt, there is no way they can increase their consumption to replace the lost exports.
Similarly, Australia is already a highly indebted nation. The only thing preventing the Australian economy from falling into deflation is Chinese demand for Australian resources. As we wrote before in Hazard ahead for Australia- interim crash in China,
Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.
There are some signs that Australian consumers are binging on debt once again. Should this translate into a resumption of increasing credit growth, it will mean that Australia is increasing its vulnerability to any slowdown in the Chinese economy. Worse still, Australia is selling more and more of its businesses, capital and resource companies to China, which means that more and more future economic growth will no longer benefit the next generation.
Enough about Australia. Let’s look at Andy Xie’s article further,
The dollar has bottomed. The Fed will begin raising interest rates in 2010.
Andy Xie reckons that the US dollar has bottomed and that the interest rate cycle has bottomed as well. What are our views?
As we wrote in Permanently low interest rates for Uncle Sam?, the more indebted the US government is, the harder it is for them to raise interest rates. According to Marc Faber, currently, 12 percent of US government’s tax receipts goes to interest payment on their debt. In 5 years time, it could be at 35 percent. Should the US raise interest rates to combat any potential price inflation, that will increase the debt burden of the US government unless the US economy can put on a miraculous feat of super-turbo-charged growth. This means that the higher interest rates goes, the higher the risk of the US government becomes insolvent sooner.
Next, Andy Xie wrote,
One possible way to prolong the bubble is to appreciate the currency, as Japan did after the Plaza Accord, to contain inflation and attract hot money. Such a strategy will not work in China. Japan’s businesses were already at the cutting edge in production technologies and had pricing power during currency appreciation. They could raise export prices to partly offset currency appreciation. Chinese companies don’t have such advantages but rely on low costs to compete.
That’s a reason why China cannot let the yuan appreciate too much too soon. Next, Andy wrote,
China has been trying to promote consumption for a decade. However, consumption’s share of GDP has declined annually. The reason is the policy environment has been squeezing China’s nascent middle class through high property and auto prices along with high income tax rates.
Recently, there’s a Chinese soap opera titled “Dwelling Narrowness.” That was a very highly popular show because it strikes a cord with the Chinese middle-class, who are burdened with taxes, corruption, high property prices, inflation and so on. Unfortunately, that soap opera was terminated early by the Chinese government.
As we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap,
In other words, the paradox is that the further the Chinese government delay in tackling inflation, the more reliant they will have to rely on American consumers, which means it is harder for them to let the yuan appreciate.
The inflationary policies of the Chinese government are hurting Chinese consumption more and more.
Andy wrote further,
China’s property market is creating winners and losers based on timing. All other factors ? including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.
Our reader, Pete was wondering how could it be that China can have labour shortage. Our take is that it is skilled labour shortage that China is increasingly short of. Anyway, as we wrote in Harmful effects of inflation, an economy based on inflation and asset price bubble to sustain growth is an economy that rewards speculation instead of hard work.
Finally, Andy wrote,
The killer is inflation driven by a surge in money printing. The average lag between currency creation and inflation is 18 months in the United States. China’s lag could be two years since the government uses subsidies to suppress inflation. By 2012, China could experience 1990s-like inflation. And that’s when the property bubble will probably burst.
We will add this: in a highly indebted society, price inflation without adequate wage inflation will contribute to the bursting of the asset price bubble.
Many of what Andy Xie wrote also applies to Australia. When the Chinese bubble burst, Australia’s bubble will burst too. Marc Faber, while he agrees with Jim Chanos that China is in a bubble, believes that the implosion of the Chinese economy will not happen soon (see China bubble will not burst right away: Marc Faber). If this is true, it means that many Australians will be suckered into more debt (property prices may even be inflated further), which is akin to a turkey being fattened for the day of slaughter. The difference between 2008 and that day of reckoning is that more Australian businesses, mines and capital will be under Chinese control by then.