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Chinese Stimulus Superiority or Just Another Bubble?

Posted by Larry Doyle on July 27, 2009 8:48 AM |

Is China leading the global economy out of the severe economic recession or is it setting the table for another leg down by creating another bubble? Is the United States economy beholden to developments in the People’s Republic of China? Let’s look eastward and navigate the Chinese economic landscape.

Recall that China has recently become our largest creditor. Additionally, China’s economic stimulus enacted and largely disbursed is already three to four times the size of the United States stimulus as a percentage of GDP. (U.S. stimulus of $700 billion is approximately 5% of GDP. China’s stimulus of approximately $600 billion is the equivalent of 20% of their overall GDP of $3 trillion) From China’s perspective, it is nice to have an enormous surplus and a government controlled economy.

Let’s review some of the inner workings within the Chinese stimulus and the current view of the Chinese economy and markets. From Stratfor Global Intelligence, we learn:

1. fully one fourth of the Chinese stimulus is targeted at helping the province of Sichuan recover from a massive earthquake in May 2008.

2. the bulk of the Chinese stimulus is focused on infrastructure with little assistance for faltering export based industries.

3. loan growth has exploded in the first half of the year. This has to be a positive, correct? Stratfor is very concerned and writes:

China is more concerned about maintaining employment than about ensuring that money is used efficiently. And the result of such a sudden surge in loan-granting will inevitably be a mounting of nonperforming loans that will eat at the very heart of the Chinese financial system (a similar problem is what brought down Japan in 1991).

And that is the good news. Much of this loan surge — by some reports, perhaps as much as half — is being lost to scams, corruption and simply using the money to play the various Chinese stock markets. The Shanghai Composite Index, for example, is up 50 percent since its lows in November 2008 — an otherwise inexplicable development considering the steady stream of bad economic news that has trickled out of Beijing in recent months.

As I think of this analysis, I immediately wonder if China is creating a semblance of a bubble in their economy and in their stock market. Arjun Divecha, portfolio manager of Berkeley, CA based GMO, holds similar concerns. In an interview published in Barron’s this weekend, Divecha was aksed about his concerns in China and specifically Chinese lending. He asserts:

“I believe a lot of the money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.

We know they are buying real estate, and they are doing all kinds of things we don’t think in the long run is particularly productive investment.

Barron’s asks Divecha what will be the consequences in China of this stimulus plan? He responds:

“Two things are likely to happen. First, longer term, if the banks don’t have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on the money. I don’t know when that will be. But I worry that it is coming.

A fair amount of the stimulus money has found its way into the real estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.

Is the United States likely to suffer a similar consequence? I am very concerned.

For further analysis of China and all the emerging markets, please review my interview last evening with Dr. Paulo Vieira da Cunha on No Quarter Radio’s Sense on Cents with Larry Doyle. Dr. Vieira da Cunha is a former Brazilian central banker and currently works at Tandem Global Partners in New York. He is also a visiting scholar at Columbia and serves as a consultant to the International Monetary Fund. He provided riveting insights and perspectives not commonly found in financial periodicals or the financial media.

LD

Related Commentary

Rise of Emerging Markets Triggers Alarms
by Dominic Elliott and Elizabeth Pfeuti
Wall Street Journal; July 27, 2009

  • Aaron kramer

    The Chinese stimulus plan is based on holding up the economy long enough for the US and Europe to recover. Loan origination has increased 3 fold and bad loans have increased at a greater rate. There are still numerous empty building in every major city and mainland stocks are on an unsustainable path. It is funny but central planners always think it is so easy to build a complex economic system, but you frequently end up with empty building, under utilized infrastructure and over capacity. China is dealing with these problems and our advice is for China to increase the social safety net so individuals spend their savings and rely on government handouts. Is it any wonder why we are in trouble? When the Chinese economy falters and it because obvious to everyone else in the world, the final leg will fall and we will deal with the global imbalances that led us to the point we are at. Watch Chinese energy consumption for an indication of economic development it will lead the way. (Down over 20% this year)






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