Currently, economists in major institution in Australia are still forecasting growth in the Chinese economy. Even the Reserve Bank of Australia (RBA) are pencilling in further boost of the Australian economy because they expect continuing growth of Chinese demand for Australia’s commodities. With such rosy forecasts, the mainstream pundits believe that Australia’s economy will continue to power ahead, which will result in further “skills shortages,” inflation, and for the property spruikers, further growth in property prices. This is the reason why the RBA had the guts to raise interest rates.
But as contrarian investors, this should be the time for you to be more careful. As we warned our readers a few months ago 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.
In other words, the ups and downs of the Australian economy follow the business cycle of China. And yes, the business cycle still exists in China. As we wrote in Will the China boom go in a straight line?,
Put it simply, we do not believe that the rise of China will take on the path of a straight line. Instead, there will be ups and downs, booms and bust and progress and setbacks. Anytime when the path does not look like a straight line upwards and take a temporary dive, the market will flip to the other extreme of this story and project extreme pessimism into the indefinite future. In other words, the market always looks at one side of the boom and completely ignores the flip side.
Contrarian investors like Marc Faber believes that the Chinese economy will “slow down regardless” any time from now on. Whether this slowdown will be a nice soft-landing or a gut-wrenching crash is another matter. This will have implications on the Australian economy, currency, stocks and property market. Make no mistake, this is what he said in an interview:
Mind you, there are massive excess productive capacities in the Chinese economy. As we wrote in Is China going to dump their excess metal stockpiles?, there are eye-witnesses’ reports of ghost cities, vacant office blocks and apartments in China. It had been reported that China’s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined. All these points to a massive mis-allocation of resources in China, which according to the Austrian School of economic thought, a pre-cursor to a bust (see our free report, What causes economic booms and busts?).
That’s why, as we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap, the Chinese government will have to rein in their runaway economy sooner or later (e.g. through administrative means, revaluation of the yuan). The longer they delay, the bigger the inevitable bust will be.
A voluntary reining in of the runaway economy will definitely result in a smaller bust today (the alternative will be an involuntary and bigger bust tomorrow). That’s where the problem lies- the Chinese government lacks credibility in its will to cool down the economy. Within the circles of the Chinese property speculators, there’s an assumption that the Chinese government lack the guts to induce deflation in property prices (which will have negative effects on the rest of the economy). The reason is because once the deflation forces take hold, it will be very difficult to reverse. The same applies to the Australian government. The assumption is that at the end of the day, the government (whether it’s the Chinese or the Australian government) will indulge in moral hazards (e.g. bail out, print money, etc).
But dear readers, make absolutely no mistake about this: even if the government succeeds in avoiding a big bust today at all costs, this very success will result in more severe unintended side-effects and Black Swans. In Australia’s case, it will be a currency crisis (see Will there be an AUD currency crisis?) and/or social breakdown (because a policy of inflation is inherently unfair and widen the rich-poor gap). In China’s case, it will be complete social collapse, which is not uncommon for those who are familiar with China’s long history. Over thousands of years, China endured endless repeated cycles of corruption, dynastic collapse, followed by renewal through the birth of a new dynasty.
Hence, we will not be able to offer our readers the exact time-frame and predictions of what will happen next. No one can. But this is what you can do: be flexible and watch out for the signs and prepare the drills to be activated. So, bear this in mind: the moment the financial markets believe that the Chinese government’s talk about cooling its economy will be real concrete action, things will happen very fast.
