Tuesday, July 28, 2009 2 comments ++[ CLICK TO COMMENT ]++

Are bubbles building in China?

Honestly, it's difficult to say what is happenning in China. Usually it's hard to discern the reality for any developing (or undeveloped) country but it's even more confusing given how China runs a totalitarian state and there is only one media (technically, they do permit other sources but they are tightly controlled.)

The big question being raised these days is whether China's stimulus programs are setting the stage for massive bubble formation. China is spending around 25% of GDP to stem the credit bust and the subsequent collapse in world trade. Bears like me already think there may be bubbles in fixed-assets like real estate, factories, malls, and so forth. But even if you didn't believe bubbles exist now, are they being created?

Vitaliy Katnelson recently wrote an article for Foreign Policy painting a negative picture that some of you may find interesting. Admittedly, Vitaliy has been bearish on China for a while and been completely wrong (like me) so don't blindly make any investment decisions based on that.

I also ran across an article in The Globe & Mail questioning the situation:

Loan growth exploded in the first six months, totalling a record 7.4 trillion yuan. That's nearly a quarter of China's gross domestic product and well in excess of the government's own projected quota of five trillion yuan for the entire year.

There is little doubt much of this cash has found its way into booming urban property markets and red-hot equities. The Chinese stock market has soared 88 per cent so far this year. On Monday, when Sichuan Expressway Co. became the first new listing on the Shanghai Stock Exchange's main board in almost a year, trading was so frenzied that officials had to twice call halts [the stock rose 203% on the first day—did the investment bankers misprice the stock or is it a mania?].

In Beijing, house prices soared an average of 27 per cent in the first six months of the year, and Hong Kong property loans are at their highest level on record.

Analysts estimate that at least a third of all new bank lending is being funnelled into stocks or real estate speculation. Another third is going just to keep struggling businesses running day to day in a tough economy, rather than for infrastructure or other economic improvements.

Who knows if the analysts are right but going with their estimates... spending 1/3 propping up failing businesses is neither very capitalist nor is it benefitial in the long run. But I can live with that. At least it is creating jobs. But the real worry is the 1/3 going into stocks and real estate.

One thing that is working in China's favour is the fact that their reserves are very large (something like $2 trillion). Most of the banks are owned by the government so any loan losses will accrue to the government and can probably be absorbed by the government. So I am not so concerned about the losses per se.

Instead, my worry is that bubbles distort the free market, not that it ever is free anywhere, and provides incorrect signals to consumers and businesses. Investors are also vulnerable but I don't care about them*.


* Sounds weird but I usually don't care what happens to the so-called 'capitalists', which includes me as an investor, because it's our job to price things properly and if it blows up, well, that's our problem. This is why it's so painful for me to see those who made mistakes be rewarded so lavishly. In fact, many executives who ran American banks into the ground are still at the firms (CEOs may be gone but many don't realize how the chief risk officers are still around.) Even worse are the incompetent board of directors, who didn't know what they were doing the first time, still around the second time, hoping to fix problems they clearly know little about. Even companies I am a shareholder of, like Ambac, should replace its entire board because they were all incompetent (there have been some minor changes.)


2 Response to Are bubbles building in China?

John Y
July 28, 2009 at 11:07 PM

I'm a follower of Vitaliy Katnelson's blog. Maybe you will be interested in his last blog entry on 28th July: http://contrarianedge.com/2009/07/28/the-simple-math-of-staggering-chinese-growth/

Besides, you can see my comment on Vitaliy's article on his blog: http://contrarianedge.com/2009/07/25/the-china-bubbles-coming-but-not-the-one-you-think/

Sivaram Velauthapillai
July 29, 2009 at 10:45 AM

Thanks for pointing out your comments. I didn't see those comments before, although I saw that article before.

I read Vitaliy's latest comments and even sent an e-mail about his latest comment (no response yet; I wondered if he is consistent with his numbers. He may be doing it properly but it's not clear to me if some of the numbers are nominal while others are real. I don't think this matters much but I just wonder about the actual numbers.)

Anyway, it's all murky...

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