When I was an investment associate at a hedge fund in New York I had access to all sorts of outside economic reports (they sprung for a lot of good stuff!).  That was back in year 2000.  What I remember very clearly from that period was that the China story was featured prominently in so many of those regular reports.  While China began its rapid economic trajectory some 20 years earlier, it was only around Y2K that the broad investing public began to pay attention to China's rise.  China was accepted into the WTO in November 2001....its trade surplus began to grow rapidly following WTO accession and this drove more news cycle China stories over time.

In the two decades prior to WTO membership, China rode its demographic dividend.  Economic growth was maintained in the high single digits.  There were hiccups along the way - the Asian financial crisis and Tiananmen square negatively impacted growth and were real and difficult crises.  However, the Chinese communist party was able to contain these crises and adjust, returning growth quickly to a high trajectory.

WTO membership helped China continue high economic growth.  Actually, it increased slightly - since 2001 there have been several years of above 10% growth, a truly remarkable achievement. The buildup of China's heavy industrial capacity, consumer manufacturing industry and road, tunnel, bridge, rail, airport and port infrastructure is unprecedented in such a short time span.  The rapid transformation of its urban landscape is amazing.

However, the growth model derived since WTO accession laid the seeds of a potential Chinese economic crisis.  The global financial crisis (GFC) and its impact to date on China may merely be a prelude.  While China was and remains America's dance partner for the chorus of causes of the GFC, China now has homegrown economic issues that it will have to face soon - China's GDP growth is reliant on an unsustainable level of investment.  There is overcapacity in many economic sectors and the communist party's response to the GFC, huge stimulus and crazy amounts of liquidity injection (loans, loans loans!) is inflating a bubble.

There's a few people that have done good work on the China bubble theme.  Satyajit Das has given a great overview in a series of articles (see links below).  Also, Naked Capitalism blog picked up on the bubble story, and it refrenced a detailed article by Hung Ho-Fung....I've attached both for those of you want to get the details directly.

Satyajit Das "China Syndrome" Part 1

Satyajit Das "China Syndrome" Part 2

Satyajit Das "China Syndrome" Part 3

Naked Capitalism:  China Decoupling Myth

Hung Ho-Fung:  PRC's Dilemma in GFC

The Hung piece makes a particularly compelling case that

(a) China cannot continue to maintain investment spend near 50% of GDP (declining profits and aging population mean that savings, the counterpart to I, must face downward pressure);

(b) the high investment spend during last several years reached levels unprecedented compared to any other hypergrowth economy and it was sustained for longer

(c) the Chinese goverment's stimulus measures favored investment, particularly on the lending side, and cannot be sustained at current levels (the increase in 2009 lending vs 2008 represented a mind-blowing percentage of GDP growth - perhaps 90% via investment expenditure).

(d) the recent investment has not been efficient (hence declining profitability)

(e) contrary to what many China bulls would have you believe, the Chinese economy does not have significant unfulfilled need for additional infrastructure or industrial capacity; in fact, there is significant overcapacity

(f) implicitly......even prior to the stimulus measures in response to the GFC, the Chinese banking sector had significant non-performing loans (anyone's gues 5%-25% or higher....the data is crap!); the new lending is sure to make matters worse.

If all anyone did was pay attention to the mainstream media you would not hear much consideration of the China bubble theme.  Now I'm not saying we're going to see this bubble collapse immediately....we know from the last 15-20 years that it is notoriously difficult to predict when a bubble might pop...but more attention should be paid to the fact that we may have a bubble on our hands.  They come in threes I think.

Agree with'em or not, lik'em or not, the Chinese communist party (CCP) leaders are no dummies.  They know very well that the Chinese economy hit a wall in 2008 Q4 - that's why they threw up a near $600 billion fiscal stimulus and monetary measures (lending through state owned banks forced down the gullet of every SOE whether it wanted it/needed it or not) that totaled about 25% of GDP.  The CCP did what it had to do in the face of a stalled economy - they pumped it and primed it hard.  Added to the worldwide stimulus measures, that bought the CCP time to figure out what to do next.

Detour back to my hedge fund days.   After 9/11 General Motors came out with its "Keep America Rolling" marketing plan.  The other automakers joined in with variations on 0%, low interest rate, or employee pricing plans.    The campaign was hailed for its patriotism.  GM and the other automakers contributed to the post 9/11 recovery, but they were not making money for themselves.  As a short term measure, the financing wars seemed to make sense on some level - the automakers were trying to  keep factories humming and avoid costly layoffs/restructuring.  But then the crazy cheap financing deals kept coming.  In our investment discussions of the American automakers I took to labeling this the "Madman Strategy" - it was increasingly obvious over time that the automakers were pushing on a string, robbing future sales, destroying residual values; but the alternative of closing plants/layoffs/restructuring was even more unpalatable (because of union contracts they had to keep paying laid off employees a substantial portion of their full wage, plus layoffs could make their pension and healthcare liabilities worse).  On a hope and a prayer, management of American automakers were hoping that demand would somehow come back or that perhaps they could grow their way out through growth in emerging markets.

I raise the example of the automakers because it seems that China is faced now with similar circumstances.  It's unclear whether the CCP will be able to navigate through this difficult period.  The statistics don't look good.  As I said, the CCP recognizes fully the grave situation facing the economy....they will do everything in their power to keep the growth momentum going for as long as they can.  The automakers limped along for6-7 years under their Madman Strategy, until the GFC came and the charade could no longer be maintained.  The difficulty for China is that the GFC is already upon us, and they cannot export their way out!

Here's more reading on the China bubble and risk of collapse:  www.gordanchang.com.  Gordon Chang is a columnist for Forbes, a close China watcher, and decidedly not a China story bull at the moment.

P.S. The number of links for articles here seems to be limited to three, so I've had to remove some of my hyperlinks.  You can recover those by going to the article direct on my blog.

BaliRand

http://trivcap.wordpress.com