The China Bubble

[Grimssdur]

http://www.telegraph.co.uk/finance/economics/8261740/Hedge-funds-bet-China-is-a-bubble-close-to-bursting.html

What say ye?

[YHWH]

I SAY DEEP FRIED CHICKEN LEGS

[ACow]

I'd be more surprised if there wasn't a bubble...

[fripping]

real estate is definitely going to pop in the coming several years but the larger economy will likely weather it pretty well thanks to a large manufacturing base. by pretty well i mean go back down to single digit growth.

[C.J.Woolf]

From the article:


There have been academics and analysts who have argued about the dangers of China’s economy overheating for some time. But for many, the fact that hedge funds, particularly those with track records on previous crises, are launching specific funds is the sign that the bubble is close to bursting.
Hmm. So the more people pay attention to the smart money betting on a bubble to pop, the sooner it will pop? And the sooner the smart money will profit from it.


Even the hedge funds concede that their timing might not be perfect. Corriente warns that investors, who are required to put in a minimum of $1m each, should brace themselves for an estimated burn-rate of 20pc a year until the theory pays off. But it’s a risk that plenty seem willing to take.


real estate is definitely going to pop in the coming several years but the larger economy will likely weather it pretty well thanks to a large manufacturing base. by pretty well i mean go back down to single digit growth.

I suppose the hedge funds can profit by betting on anything lower than double-digit growth.

[Tlalocone]

It(, the chinese bubble) is nothing.
At least if you had not met yet with THE Japanese Bubble!!! :=//

http://en.wikipedia.org/wiki/Bubble_Bobble
http://upload.wikimedia.org/wikipedia/en/thumb/e/ed/Bubble_bobble.jpg/256px-Bubble_bobble.jpg

[aelan]

A few dynamics at play.

1) China will bust the way all empires will bust. i.e. after some time. The question is the length of time.

Some stats:

China: Reserves of USD 2.85 trillion, plans to build 150,000 km of railway lines alone in the next five years, FDI of USD 105.7 bn representing a 17.4% increment for 2010. Overseas Chinese investments: USD 43.3bn (2009) - while relatively small vs. US outwards FDI, this represents a doubling from 2007 to 2008 and 14x between 2003 and 2008.

In the capitalism model, it is the man with the most money who wins. I don't think I even need to deliver the US stats - debt of USD 14tn+, housing starts, etc.

2) How do hedgies make money.

They do not make money by betting your money correctly. They make money by betting your money, period. aka, they will always be looking to sell something.

Hedge funds are mainly West-based and West-run. And put simply, they're out of ideas what to invest in their home markets, there're little opportunities for the amounts of money they have to invest, to make a reasonable return to justify their existence.

Now they cannot bet on a US collapse - that'd be a hard sell to the home team, of whom their monies they're investing.

The easier sell is a China bust.

Now whether or not they'll make money depends on how they're placing their bets. Housing for e.g., would face a cooling, but this is not because of economic difficulties the way a "bust" portrays - it is a problem created by excess capital seeking a better return.

and if housing as an avenue of investment is removed, and the stock markets are forced to cool, the money would just move offshore.

the way i see it, if the bets are placed in such a way as to capitalise on the tightening measures onshore, it'd be viable.

but if the bets are placed on china "going bust" in the idea of an Argentinan collapse, I'd sooner take the bet on the USD depreciating, and US firms failing to make money in China because they are not understanding the market.

the marketing is very much hype, and inaccurate in painting a real picture of the complex creature that is China.

[Ferrus]

The main issue in China at present is inflation and asset pricing bubbles - if they burst it could cause some socio-political pain for the Chinese, and possibly for the Communist party whose legitimacy is now defined by stability and growth. But the long run trend of geopolitical, military and economic power points in the Chinese's favourite.
I'd sooner take the bet on the USD depreciating
Although given China's (and indeed Japan's, India's and Brazil's for that matter) whole monetary policy has been based around juicing up their exports by persistently undervaluing the Yuan I could see this as not being mutually exclusive with a Chinese inflationary crisis. A lot really depends on the speed at which China can readjust to a domestic-led consumption growth as US demand wilts.

[nonperson]

You have to weigh increase in Chinese domestic consumption against declines in US consumption. Remember the Chinese middle class is bigger than the entire US population.

[aelan]

The main issue in China at present is inflation and asset pricing bubbles - if they burst it could cause some socio-political pain for the Chinese, and possibly for the Communist party whose legitimacy is now defined by stability and growth. But the long run trend of geopolitical, military and economic power points in the Chinese's favourite.
Although given China's (and indeed Japan's, India's and Brazil's for that matter) whole monetary policy has been based around juicing up their exports by persistently undervaluing the Yuan I could see this as not being mutually exclusive with a Chinese inflationary crisis. A lot really depends on the speed at which China can readjust to a domestic-led consumption growth as US demand wilts.

I'd beg to differ on the issue actually:

Chinese inflation has a different driver vs. US inflation:

In China's case, inflation is caused by growth generating excess savings and reserves, seeking a better return. That's your USD 2.85tn of reserves. As the stock markets in China are limited, property becomes the next best means of preserving and growing wealth - traditional mindset also holds that physical assets (land, gold), are more "real" vs. equity and paper money.

The way I see it, the issue is more places for the money to go to. Another outlet possible is investments overseas, which were the FDI numbers I'd given earlier - that would ease the pressure in the home market for the Chinese, and from the way they've been purchasing US and global assets, I'd think they've figured that out too.

in US' case, inflation is caused by the increase in money supply and being supported by printing more paper and issuing more debt, to put things simplistically. In other words, the dollar's simply worth less and less. If you look to where the USD departed from Bretton-Woods in the 1970s, at the time, the gold was pegged at USD 35 per troy ounce, on a controlled SDR programme, it went to about USD 44+. currently at a float, it is at USD 1368 per troy ounce.

To flip the coin around, the issue can also be perceived as not the RMB, JPY, BRL being undervalued, but the USD being over-valued.

And i think this is why the other countries are reluctant to revalue - in a way, the other countries are being "punished" for growing better than the US, and requested to take a measure which does not reflect their real position.

[composer]

Yes China is definitely in a bubble. It's pretty well known they goose their numbers anyhow (command economy) and they don't have the tools and experience in managing a pseudo-capitalistic economy, too long to go into the analysis and data here, but yes I've been studying this for the last five years. Bubbles usually go on longer than you expect, but pop they do, so I wouldn't be surprised if we're close in China.

Speaking of which we're in another mini bubble here in the West again (compared to the great credit bubble which finally popped in 2008.) Stupid govt. can't leave well enough alone.

[composer]

I'd beg to differ on the issue actually:

Chinese inflation has a different driver vs. US inflation:

In China's case, inflation is caused by growth generating excess savings and reserves, seeking a better return...

A lot of misunderstandings in this post I think. That excess savings canard isn't worth your time - China doesn't have excess savings, it's simply trade deficit which has to be recycled back on US soil. And excess savings doesn't really cause inflation, more commonly it causes asset bubbles as you have too much hot money seeking a return. Additionally with a fractional reserve system there's nearly infinite 'excess savings' in the wings waiting to cause all sorts of inflation by that definition.

Much more ... really the inflation in China is due to the command economy and some real economic growth, which is necessary to take the peasants out of poverty (they need a real GDP of > 6% to keep the present regime in power). For example, take a look at the excess steel producing capacity in China, and ask yourself how well that would survive in the West (demand, not command economy), while contemplating how much materials went into creating that capacity ...

[aelan]

to simplify what i'm trying to say - the asset inflations are caused by money seeking return. in there, i agree with your point. i do agree on a bubble, but i disagree on the way the media's marketing a China "bust", being that everything goes to bust after a time, it is a nature of cycles.

i think a distinction also has to be made as to what is domestic money seeking return, and foreign monies seeking return. ergo my point as to how the hedgies express their bet on a "bust" is important.

the bubble isn't caused by a depreciating yuan. that's the crux of the difference vs. the US - the term "inflation" is being bandied around too loosely.

regarding hot money: my understanding of hot money is foreign funds flowing into a country to obtain higher returns.

in this case, a lot of chinese asset demand is domestic, i.e. the driver is still the high savings rate - this is cultural, economists have estimated it at 30-40% of income, accumulated over the last 30+ years. Certainly a lot of it is govt generated too - the 150,000 km of railway planned being a case in point. "command economy" as you've said.

the issue for the govt is not as simple as allowing the yuan to appreciate to resolve the bubble. that will not resolve the US overspending and heavy reliance on debt that is making other currencies appreciate in comparison. the chinese govt has the heavy task of trying to ensure their own people get to participate in growth (as you said, this required 6% growth).

at the heart of everything is also the mindset - trying to get a chinese to spend a dollar on something that will not generate a return is tougher than trying to get a us person to spend money.

US overspending and heavy reliance on debt are equally in play. It's somehow more convenient to have another country as the bogey man though. and the hedge funds are basically playing on this to market another new fund - in the end, no one wins except the hedgies.

i'd think the chinese challenge in their minds currently is more of how to ensure the wealth filters down to more people and levels. and to do that, they may choose to hold down the yuan, vs. help the US resolve their debt.

as is, they are cooling the property markets down currently, and there're already several restrictions on overseas ownership and ability to hold the RMB. but all that's doing is driving the chinese to neighbouring countries like HK and Singapore, where they're buying up many of the properties here at starter prices of a million each, and permanent residencies at USD 5-10mn a piece, a chinese FDI exodus that's just beginning.

my main beef is: economics has been a socioscience and seeks trends based on past data; but correlation does not equal causation, and economics is a descriptive, but not always a good predictive, science. in this case, I'm not certain applying the traditional western-based economic theories hold, given the circumstances are different, as china is not motivated towards the same goals as the US.

so we could study and analyse as we wish, but if china does not want to conform to the theory, they simply will not.

[Ferrus]

I'd beg to differ on the issue actually:

Chinese inflation has a different driver vs. US inflation:

In China's case, inflation is caused by growth generating excess savings and reserves, seeking a better return. That's your USD 2.85tn of reserves. As the stock markets in China are limited, property becomes the next best means of preserving and growing wealth - traditional mindset also holds that physical assets (land, gold), are more "real" vs. equity and paper money.

The way I see it, the issue is more places for the money to go to. Another outlet possible is investments overseas, which were the FDI numbers I'd given earlier - that would ease the pressure in the home market for the Chinese, and from the way they've been purchasing US and global assets, I'd think they've figured that out too.
Yes, but this still doesn't foreclose the possibility of a large drop in the value of assets due to exogenous economic shocks - including a dramatic fall in the value of the USD.

Also much of the inflation is driven by food prices, to wit (from the Economist):


About 75% of China’s inflation is the result of higher food prices, as in 2008 when costly food pushed inflation past 8%. But in 2010, unlike 2008, disruptions to food supplies have been modest. China experienced harsh weather early in the year and floods in the summer. But it suffered nothing like the blue-ear disease that took such a toll on the country’s pigs in 2007-08.

Food inflation may, therefore, reflect stronger demand rather than weaker supply. As China’s households grow richer, meat, poultry and milk are claiming a bigger share of their budgets, according to Wenlang Zhang and Daniel Law of the Hong Kong Monetary Authority. If the share of spending on other things were to shrink, this need not be inflationary. But the rejuggling will cause what Kaushik Basu of India’s Ministry of Finance has called “skewflation”, a rise in one set of prices relative to others.

If China is suffering from skewflation, or temporary dips in supply, its inflation problem should soon resolve itself. Food prices will settle at a higher level, or fall back. The central bank’s only job is to make sure higher food costs do not translate into higher pay demands, which might start a wage-price spiral.

But many economists now worry that the problem runs deeper than food. If the prices of vegetables, fruit and other crops are more flexible than other prices, food inflation may be an early warning of an overheating economy. Perhaps China’s monetary policymakers have let the economy slip their grasp again. They have allowed the money supply to grow by half since January 2009, real interest rates to plunge and bank lending to breach government quotas. The central bank’s own survey of households shows inflationary expectations at their highest for over a decade.

...

The People’s Bank of China (PBOC) did raise interest rates by a quarter of a percentage point over Christmas, following a similar move in October. The hikes mean that banks cannot now lend at less than 5.81%. But in an economy growing by 15% a year (in nominal terms), that floor is unlikely to deter borrowers. Deposit rates were raised to 2.75%, but in real terms savers get back less than they put in.

...

Besides interest rates and reserve requirements the PBOC still relies on non-market tools such as loan quotas and “window guidance” to banks. Window guidance is not a relic of socialism so much as a throwback to Japan’s clubable capitalism of the post-war era. The central bank convenes a meeting of bank heads and offers some friendly advice on how to do their jobs. In 2010, for example, it prodded banks to back China’s outsourcing, logistics and culture industries, as well as a drive to encourage university graduates to fill civil-service jobs at “grassroots level”.

If “window guidance” influences the direction of lending, China’s credit quotas regulate the amount. Or they are supposed to. The government set a limit of 7.5 trillion yuan for new lending for 2010 but banks exhausted a quarter of that quota in the first two months and over 99% of it by the end of November (see chart). The government may not bother to set a quota for 2011, preferring to police the bigger banks month by month and one by one. Policymakers have decided they can live with somewhat higher inflation, raising their target from 3% in 2010 to 4% in 2011.

If China cannot tame its headstrong banking system and quell inflationary expectations, its reputation for macroeconomic management will suffer. But Chinese inflation still need not inflict too much damage on the rest of the world’s economy. China makes a big contribution to world growth: it is, after all, 9% of global GDP and it is growing at 10% a year. But it does not make such a big contribution to the rest of the world’s growth: whatever its growing imports add to the GDP of its trading partners, its burgeoning exports tend to subtract. Inflation in China may even help its rivals. As prices rise in China, its goods become less competitive abroad. China’s trade surplus should shrink, contributing to growth elsewhere. If Chinese inflation is one of the big worries for the world economy in 2011, it should be a decent year.


Indeed the point made about the low deposit rates is indicative - I think the real cultural driver is that Far Eastern investers are typically far more risk averse than their Western equivalents. That said, demand for debt, even once cultural variables are omitted, is directly linked the aggregate demand as a whole. The relative cheapness of Chinese goods was a major drive behind domestic and commercial debt accumulation.

in US' case, inflation is caused by the increase in money supply and being supported by printing more paper and issuing more debt, to put things simplistically. In other words, the dollar's simply worth less and less. If you look to where the USD departed from Bretton-Woods in the 1970s, at the time, the gold was pegged at USD 35 per troy ounce, on a controlled SDR programme, it went to about USD 44+. currently at a float, it is at USD 1368 per troy ounce.
This is true, but it should be noted demand in gold reflects a variety of economic utility seeking (i.e. stability, as you hint at). All commodities and metals have seen rises in underlying demand and prices (not only in USD), caused not least by the fact that the world population and world economic growth has risen far faster than increases in extraction.

And i think this is why the other countries are reluctant to revalue - in a way, the other countries are being "punished" for growing better than the US, and requested to take a measure which does not reflect their real position.
They don't want to revalue because it is not in their interest to, simply. There is no point bringing morality plays into international economics.

in this case, a lot of chinese asset demand is domestic, i.e. the driver is still the high savings rate - this is cultural, economists have estimated it at 30-40% of income, accumulated over the last 30+ years. Certainly a lot of it is govt generated too - the 150,000 km of railway planned being a case in point. "command economy" as you've said.
More ominously for countries such as Taiwan, Korea and Japan and the US military expenditure has been increasing rapidly too. In fact there was a leak recently which suggests Taiwan may become indefensible by 2020.

[composer]

i think a distinction also has to be made as to what is domestic money seeking return, and foreign monies seeking return. ergo my point as to how the hedgies express their bet on a "bust" is important.

...

regarding hot money: my understanding of hot money is foreign funds flowing into a country to obtain higher returns.

Maybe in the 1800's, in the present day hot money (a loose term) flows around the globe in a millisecond. One reason why asset classes are mostly correlated these days is because of this, a fund hedges corn futures against Oil spot, and when one of them goes bad has to unload the other to cover, which creates a correlation. Additionally there's little distinction between foreign and local money, unless your interested in looking at a carry trade.

You may be making a valid point, but for the life of me I can't see it :shrug:

[nonperson]

And i think this is why the other countries are reluctant to revalue - in a way, the other countries are being "punished" for growing better than the US, and requested to take a measure which does not reflect their real position.

The big winner in the new Chinese Revolution has been balance sheet of corporate America. The state of America may be in a bad shape and her people out of work but her corporations are doing OK. China is going through an accelerated 19th century. Let us see if China's internal pressures don't destroy the state before we get too carried away.

[Ferrus]

I should also add for all you gold bugs:

China should not be running trade surpluses either in a gold standard or in a system of floating currencies. Read old David Hume. Under a gold standard the huge influx of gold would increase prices in China to the point where the current levels of trade would never be possible. The trade surplus in China has only been possible with a continual compulsory purchase of imported Dollars by the Chinese central bank. There may well be cultural differences of spending and saving but these should, under uninfluenced market conditions, equalise into a stable pattern of trade determined by currency inflows and outflows adjusting prices. Japan actually mastered this a long time ago about the time China was mired in the Cultural Revolution.

The so called 'Western theories' of economics are actually the ones China are using to great effect and against the US's interest - whilst the US has lost economic competence under the weight of increasingly assertive and economically illiterate voters.

[Henry]

According to an article (http://www.telegraph.co.uk/finance/china-business/8272388/SocGen-crafts-strategy-for-China-hard-landing.html) in today's Torygraph, Société Générale is telling clients to hedge against a hard landing in China. Some hand wringing in another piece (http://www.telegraph.co.uk/finance/china-business/8271203/Strong-China-growth-boosted-by-near-1-trillion-of-loans.html) from the same day says that the Chinese banks have pumped out nearly £1 trillion in loans.