Is China a Bubble?
by cactus
Is China a Bubble?
A friend of mine who does just about all of his business providing a very specific service to selling to companies who do business with China. (And yes, that is as specific as I am willing to be, except to say that right at this moment, the service he provides is extremely tailored toward China.) My friend tells me he believes “China is a bubble” which very much resembles the dot com bubble and the housing bubble. According to him, this is the resemblance – there is no due diligence to speak of on any deal involving China, not from the Chinese and not from the Westerners dealing with them, and all the deals are being done with “other people’s money” and heavily leveraged.
In most instances, on the Chinese side, everyone is in some way connected – that is to say, they are connected to one of a few key organizations, or more likely, key people in the government. The more such people involved in the deal, the more people there are who are used to big payoffs and have the juice to make sure they will get paid. The Chinese government ends up providing its “blessing” to all sorts of crazy operations based on the simple principle that once enough people who have to get paid are involved,a project cannot be stopped. And its not merely that connected people have leverage; in China there is a feeling that this is China’s time, so its not like something can go wrong. Throw in the unlimited pot of money trying to do business in China, and you end up with big projects – half a billion dollars and up – happening simply because they have to happen for the sake of the parties that put them together.
The Westerners also have the sense that it is China’s time. So if you ask them about a particular deal they’re doing and why they’re doing it, if you scratch hard enough, it comes to because “its China.” That includes the very biggest private equity funds in the world.
The end result is that a lot of things are happening that make no financial sense and wouldn’t pass the laugh test if the magic word “China” wasn’t there. Deep down everyone knows it, but nobody cares.
So is my friend planning to get out? Heck no. He simply makes sure on every contract that he gets paid early. Everyone he’s dealing with is very happy to comply since the expectation is that China is going to grow forever. Being shortsighted as far as everyone else is concerned has had some big benefits, and so far he’s done very, very well. Of course, if he’s wrong, he’ll lose out on the gravy that comes in the back end. If he’s right, he’ll move on to servicing the operators of the next bubble when this one bursts, no worse for the wear.
I don’t know enough about doing business with China to say much other than I trust my friend’s judgement, and if he tells me he’s seeing no due diligence on multi-billion dollar projects, it means there are multi-billion dollar projects with no due diligence happening. I do that the demographics are going to get very interesting in China over the coming decade. With my limited knowledge, I’m leaning toward agreeing with my friend. So waddaya think? Is China a bubble?
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by cactus
Well China has stopped most bank lending. They did it rapidly without a lot of controversy, so they are dealing with the problem. I would bet on their success. Unlike the US they don’t just go around in circles. I think we’ve been through these “China is going to collapse” things before. Mainly wishful thinking in the West where China is frightening.
cactus,
If your friend is correct then China is in a bubble. If that is true, what is more interesting is what happens when it pops. Can the gov keep the lid on?
I hope your friend as the ability to make a quick exit and will leave early if he sees things start to unravel. (hope his money is already overseas.)
Personally, I bet the Chinese manage to muddle through…
Islam will change
Maybe the whole thing isn’t a bubble, but it seems to be putting out a lot of froth. If your friend is working in the froth zone and knows it, he’s probably right to be confident he can sit down before the last chair is pulled out from under him. Otherwise, China’s government has no namby-pamby Constitution with rules against wasting the enemy, domestic or foreign, political or economic. It will continue, I think, to keep it together.
Ask yourself this question–what would this administration do if it could to keep its government running? Hard to say, right? Ask the same question about the Bush administration. Any doubt what Cheney would do? The Chinese have Cheney beat three ways to Sunday for “doing what it takes.” They’ll be ok no matter what happens elsewhere.
Big time.
When China’s economy collapses, we’ll yearn for the days of a good ol’ housing bubble.
Caviat: I’ve been out of the China market for several years.
So, my having not been there for a long time can be taken to mean that anything I knew is obsolete. But your friend’s experience speaks to me.
My customers were connected too. They had to be. Not everybody could get an import license. My customers knew how to fix that, but it was hidden from me.
China was the fastest changing market I knew. And the most risky. Not that I was ever in (much) danger of not being paid. Everything was L/C. No ticky, no laundry. There were other risks. Not just the inability to do due dilegence. There are other places like that. Developing a new customer was very expensive to me. I always felt I had an investment in each of them. I suppose today we would say that is a poor business model. In China every deal was as hard as the first one. No continuity. And noplace were people so ready to jump at a fad. If Hop Son had made a little money on something you had sold him everybody in China wanted to buy the same thing he had – at a lower price. In my industry it’s hard to produce for that. But I watched other guys (especially Germans) gear up for it only to see styles change and be left with inventory that they maybe never did clear. I wasn’t doing billion dollar deals, but you can take that for what it’s worth.
Caviat: I’ve been out of the China market for several years.
So, my having not been there for a long time can be taken to mean that anything I knew is obsolete. But your friend’s experience speaks to me.
My customers were connected too. They had to be. Not everybody could get an import license. My customers knew how to fix that, but it was hidden from me.
China was the fastest changing market I knew. And the most risky. Not that I was ever in (much) danger of not being paid. Everything was L/C. No ticky, no laundry. There were other risks. Not just the inability to do due dilegence. There are other places like that. Developing a new customer was very expensive to me. I always felt I had an investment in each of them. I suppose today we would say that is a poor business model. In China every deal was as hard as the first one. No continuity. And noplace were people so ready to jump at a fad. If Hop Son had made a little money on something you had sold him everybody in China wanted to buy the same thing he had – at a lower price. In my industry it’s hard to produce for that. But I watched other guys (especially Germans) gear up for it only to see styles change and be left with inventory that they maybe never did clear. I wasn’t doing billion dollar deals, but you can take that for what it’s worth.
Somehow China seems to keep on growing and not collapsing as its non-friends wish…I tend to see success begetting success. I wonder if the British thought the US economy would collapse in the late 1890s or early 1900s? We were rising then and they were falling but didn’t fully realize that. There may be a few bumps in China’s road to world dominiation, but I doubt they will derail the process.
warprofiteers=warmongers
Chinese budget deficits:
http://www.hangseng.com/ermt/eng/fxmv/pdf/ecof_e_20090513.pdf
Cf: to US deficits of 3.24% in 2008, 12.93% in 2009 and 8.54% in 2010.
Then let us compare public debt as % of GDP.
US in 2008 was 70.49%; in 2010 projected to be 98.15%
China in 2008 15.6%; figure for 2010 I haven’t found.
China has lots more wiggle room to increase the debt I think.
The goals of the Chinese economic policies may be different from those of American or European policies. China primarily wants to expand its industrial capacity and infrastructure and the Chinese government isn’t mesmerized by high finance. Their bubble primarily is creating tangible goods (e.g., factories, infrastructure, buildings) rather than paper wealth (e.g., higher prices for stocks and real estate) as with U.S. bubbles. They’ll still have the infrastructure and factories after their bubble collapses.
Hi Cactus,
I work in fixed income – last week a Chinese (name to left out) company came out for a meeting in order to entice investors with their fantastic business plans, and plans to urbanize China. I looked at these lofty hotels and apartment buildings with one thing in mind…property bubble. We asked them about the prospects of a decline in housing values, and they told us that they saw this as an opportunity to acquire land at lower cost (as their competitors exited the market). It’s all relative. But could it be, that the housing market is set for an imminent crash? Perhaps, but I suspect that the bubble will not hit for a couple years more.
My point is, is that the bubble that we speak of is probably less imminently popped that many imply. It takes a long time for property markets to collapse – and China, I suspect, will be no different. The banking industry, too. Before non-performing loans start to work their way through, the economy must start heading down (for real). And that’s not part of any forecast for at least another year or two.
Interesting anecdote. Thanks! Rebecca
Hi Cactus,
I work in fixed income – last week a Chinese (name to left out) company came out for a meeting in order to entice investors with their fantastic business plans, and plans to urbanize China. I looked at these lofty hotels and apartment buildings with one thing in mind…property bubble. We asked them about the prospects of a decline in housing values, and they told us that they saw this as an opportunity to acquire land at lower cost (as their competitors exited the market). It’s all relative. But could it be, that the housing market is set for an imminent crash? Perhaps, but I suspect that the bubble will not hit for a couple years more.
My point is, is that the bubble we speak of is probably less imminently popped that many imply. It takes a long time for property markets to collapse – and China, I suspect, will be no different. The banking industry, too. Before non-performing loans start to work their way through, the economy must start heading down (for real). And that’s not part of any forecast for at least another year or two.
Interesting anecdote. Thanks! Rebecca
Hi Cactus,
I work in fixed income – last week a Chinese (name to left out) company came out for a meeting in order to entice investors with their fantastic business plans, and plans to urbanize China. I looked at these lofty hotels and apartment buildings with one thing in mind…property bubble. We asked them about the prospects of a decline in housing values, and they told us that they saw this as an opportunity to acquire land at lower cost (as their competitors exited the market). It’s all relative. But could it be, that the housing market is set for an imminent crash? Perhaps, but I suspect that the bubble will not hit for a couple years more.
My point is, is that the bubble we speak of is probably less imminently popped that many imply. It takes a long time for property bubbles – and China, I suspect, will be no different. The banking industry, too. Before non-performing loans start to work their way through, the economy must start heading down (for real). And that’s not part of any forecast for at least another year or two.
It seems like China does have some time to enact precautionary policy – the question is whether they will. Interesting anecdote. Thanks! Rebecca
I think the Chinese will do okay. They and their leaders are more intelligent than Americans. Sorry to be so trutyful.
warprofiteers=warmongers
Cactus,
You could narrow down which of China’s bubbles you wish to discuss.
11 Big Surprises for the Next Decade
China Bluff Exposed, Regime Overthrown– China’s communist regime continued to print money, lending it to everybody that wanted and didn’t want it. The giant housing, infrastructure, and manufacturing bubble came to a violent crash when the debts where not paid and inflation forced the authorities to tighten despite massive unemployment. The combination of high inflation and high unemployment in the urban centers took the people to the streets. The Chinese citizens refused to accept state intervention in the economy and their personal life demanding more personal and economic freedom resulting in prolonged civil unrest which almost reached a full scaled civil war. The collapse of the Chinese regime and economy resulted in a colossal bust for commodity prices, albeit temporarily and caused a severe recession in Australia, Brazil, Russia, Argentina, and the Gulf States.
My friend doesn’t by any stretch fall into the “caucasian westerner” category. If he’s suffering from wishful thinking, its not the, er, typical Weterner wishful thinking.
I’m not worried for him. I believe he has gotten himself into a position where he is set for life.
That said, from what I can tell, my friend doesn’t have more than loose change in China. He makes sure of that. If he’s wrong, he won’t make quite as much money (but he’s still sitting pretty) as everyone else he’s dealing with, but he thinks China = Pets.com.
Some of that sounds like the conversation I had this weekend, stated a little better than I was able to convey.
MM,
The difference between the US and Australia 100 years ago and China today is the amount of empty space. There’s no frontier in China. And the demographics are about to go down the tubes.
There’s something else. I think while the US managed to piss off most of the Americas by being a bully, much of the developed world viewed the US as an ally or potential ally. Name a country outside of Africa who views China as an ally or potential ally. You might have a few marriages of convenience (e.., Iran) but that’s the best I can do.
That sounds like a trivial issue, but that’s how you get immigrants.
H-Bob,
Yes and no. My guess is that in 2005, one could have said the difference between the dot com bubble and the housing bubble is that if the housing bubble popped, we’d still have physical houses sitting around.
And someone in the dot com world would have defended that bubble (had he seen it coming) by pointing out that all the networks would be built as a result of the bubble, unlike, say, the S&L mess before it. And so on and so forth.
Rebecca,
I asked my friend about timing. He (like you) doesn’t think its imminent. He thinks there are easily a few years to go. China’s a big place, after all.
And he’s putting his money where his mouth is, so to speak. What he does takes a couple years, at a minimum, from the beginning until he gets his first dime. And he’s looking for more projects in China. Of course, he keeps one foot out the door just in case, but he thinks there’s time to for him make a lot more money.
And he did give me the old Keynes quote – “markets can remain irrational for longer than you can remain solvent.”
As to the precautionary policy… out of curiosity – what would you suggest China do?
MG,
Nope. The statement from my friend is “China is a bubble.” That is to say, the whole kit and kaboodle. Not just Chinese real estate or Chinese tech or Chinese demand for raw materials or Chinese tennis players. Everything.
That part I don’t know. My friend is not expecting the end of the regime. He’s not not expecting it either. Whatever happens, if the regime falls, it will be a case of “meet the new boss, same as the old boss.” Sure, the outfits will be different. And the lingo will change. But from a practical perspective, no change.
I guess we are going to get to see how well the eastern approach to life can resist universal temtation of easy money. Japan’s did not do so well.
For me, the question is whether China will loosen its grip on the peoples minds enough to let their economy grow while the rest of the world’s developed economies shrink. As nations like us be come less of a market, where is China going to export to? South America is still working to grow their exports, so who are they all going to export to? Of course, the United Nation of Global will just keep moving capital where ever, so they’ll be fine.
Hi divorcedone,
Isn’t that the point? The rebalancing of trade? US imports less, China imports more. It’s the physics of economics….or is it.
Rebecca
Cactus,
I am impressed with your diligence in replying to comments!
I digress. As to the precatiouary policy – let’s just say a complete 180-degrees from what China is doing now. I must admit, that I have spent some time this week thinking about how “things are not going to change”. You know, Congress is pushing the banks to lend – why wouldn’t they? We are in the wake of a financial crisis – more consumer lending is exactly what we need. And you have China on the other side of the Pacific – beefing up their export industry as if there was external demand to support 9-10% growth for the next decade.
If the government does not turn policy inward – i.e, convince its population that there is a safety net to support it by allocating all wasted resources (or at least some of the $2.4 trillino plus unmeasurable amount of FX reserves) away from exports and toward domestic production – I imagine that these “bubbles” will leave the economy standing naked in front of an audience. The US is not innocent here, but we are talking about China.
Rebecca
Well, that is the formula they write all over the chalk board. Only they never include that elusive force of economic gravity: United Corporations (as I mistyped above) of Global.
Silly China, thinks it can defy gravity.
Cactus,
I am impressed with your diligence in replying to comments!
I digress. As to the precatiouary policy – let’s just say a complete 180-degrees from what China is doing now. I must admit, that I have spent some time this week thinking about how “things are not going to change”. You know, Congress is pushing the banks to lend – why wouldn’t they? We are in the wake of a financial crisis – more consumer lending is exactly what we need. And you have China on the other side of the Pacific – beefing up their export industry as if there was external demand to support 9-10% growth for the next decade.
If the government does not turn policy inward – i.e, convince its population that there is a safety net to support it by allocating all wasted resources (or at least some of the $2.4 trillion plus unmeasurable amount in the banking system of FX reserves) away from exports and toward domestic production – I imagine that these “bubbles” will leave the economy standing naked in front of an audience. The US is not innocent here, but we are talking about China.
Rebecca
I know, I’ve seen this formula glowing for about a decade now. I think in academics they call it a “current account puzzle”, or something of the sort.
Rebecca
Rebecca,
But how much of a safety net is there in China? My understanding is that for any given family, the safety net is what savings they’ve put away and whatever it is the children can earn above and beyond what they themselves will need to survive. I could be wrong about this and I probably should do a bit of digging.
(BTW – the diligence in responding depends on time. Sometimes my replying is more diligent, sometimes less. This post is an exception… but I generally try to write about things that tie in some way with something I have reason to believe I will have to have a bit of info about in the near future, so I can justify the time in my mind.)
divorced & Rebecca,
Japan, Inc. had the same issue, plus there’s one more major problem related to their strategy. As you succeed at exporting, there are pressures on the currency to rise. China has a real peg to the dollar – Japan had a not so real peg. That causes its own pressures.
If the currency rises in value, you almost have to move up the value chain (i.e., start producing higher end goods a la Germany and the US as examples, as Japan has done). But it is harder to keep quite as many people employed if you’ve moved from making gee-gaws to making bleeding edge stuff… and its harder to be able to make the bleeding edge stuff competitively, plus you have to figure out to continuously develop new bleeding edge tech. Countries that follow that approach seem to have a hiccough as they try to transition from big exporters of gee gaws who can copy technology developed elsewhere to developers of bleeding edge. None seem to be bleeding edge on quite as many areas as they were able to dominate back in the days they focused on low tech.
Cactus,
When I said “convince”, I should have said “continue to build and convince”. From what I understand, the Chinese government is aware of its need to supplant some of the household’s saving out of necessity through improved social programs – and they are actively engaged in this process (again, from what I understand). However, that unmeasurable amount of reserves could certainly be funnelled into education, healthcare, insurance, etc, more so than it is now.
Rebecca
Bubble and froth, bubble and froth. Look, those terms have been used so many time to mean so many things that just saying one more situation may or may not be a bubble doesn’t get us very far. What, in this instance, do the participants in the discussion mean by “bubble”? I’d be willing to bet that, if each participant were to define bubble, we’d find that we aren’t all talking about the same thing, in anything but the broadest terms.
I understand the claim that a particular market is in a bubble, though I think even when the claim is just that a particular market is in a bubble, we ought to ask for a definition. Way too often (such as with claims that the Treasury market is the latest bubble), what seems to be meant is that prices have gotten so high they have to fall. That seems a pretty sloppy definition for “Bubble”. The question posed here is whether a whole country is a bubble. I’m not sure how that works. Does that mean every aspect of China’s economy is overpriced? Like labor for instance, or the yuan? If labor isn’t overpriced and the currency isn’t overpriced, then an odd definition of “China” is being employed in the claim that “China is a bubble”.
There is a good chance that sloppy expression reflects sloppy thought, and calling a whole country a bubble strikes me as pretty sloppy.
Cactus,
Nice article in the WSJ today: U.S. Keeps Foreign Ph.D.s
Part of the article suggests that foreign Ph.D.’s earning their degree in the U.S. (there is a espsecially with a 92% retention rate currently among Chinese Ph.D.s in the U.S.) are expected to return to their native countries at an increasing pace. Life is better there, and the job market is relatively stronger, in some cases. This trend would definitely help to push some of the development along the path of new technologies rather than copied technologies (at the cost of some technical advancement in the U.S., of course).
Rebecca
http://www.econbrowser.com/archives/2010/01/chinese_trade_e.html On re-valuation, profit margins in China, and such
http://www.nakedcapitalism.com/2010/01/on-chinas-overinvestment.html Where are the bubbles or the stats?
If I had some loose change or change at all I’d be happy to put it in China.
The Chinese West looks pretty empty to me. Have you ever used Google Earth to get a good look at China? And of course Japan didn’t have any “empty space” either and now is the second largest economy in the world.
Well Pakistan is usually seen as a Chinese ally. And China and Iran seem on good terms as well as China and Russia. I am not aware of Canada disliking China at all nor Brazil, etc., etc. Nations for whom China is a big market tend to like it. I don’t think nations like each other for their looks or smiles. Shared interests are what usually create friendships.
Oh gee, let’s just agree that China has no future and all go and sing Yankee Doodle Dandy. It’s such a drag to have to imagine China being a success. Really gets your goat and disturbs your rest. Now, let’s all make some China dolls and stick pins in them. That should do the trick.
MM,
No. Think 1985. Japan, Inc. was going to take over the world. Everyone knew it – it was on the cover of Time Magazine. Heck, I saw Rising Sun with Sean Connery… and for weeks I couldn’t go to sleep without checking for a Japanese salaryman hiding under the bed or inside the closet.
It turns out that Japan didn’t take over the world. They are a major power, and despite a long recession, exert a bigger influence on world affairs than they did in 1985. I haven’t read anything in this comment thread above in which anyone is saying things are incompatible with China following Japan’s trajectory.
Nor is there much evidence that folks on this thread are disturbed by China. I’m pretty happy that a few hundred million people who would otherwise go hungry can get something to eat.
And BTW, a decade before that the Europeans were worried the US was going to take over the world. That hasn’t happened either. We exert a lot of influence – one can even say we function as first among equals on the world stage – but we are not a dominant power.
What would it mean for “China” to be a bubble? There could be bubbles in Chinese markets, but I don’t see how the whole country could be a bubble so long as it continues to run a trade surplus. Now you might rightly ask whether China is a scam, or a kind of sovereign RICO, but that’s another question entirely.
This idea that a dictatorship can control its economy no matter what is nuts. Ever heard of the Great Leap Forward or the Cultural Revolution?
Like the eye drop guy said: something which can not continue indefinately must at some point end.
China has so far made a classic transformation from a behind the curve economy to a rapidly catching up economy. They aren’t the first and they won’t be the last. China is going to level out in the same way that Russia, Japan, Mexico, Korea, Canada and many more countries have, including the good old USA. Everyone except for jolly old England was playing catchup in industry at some point. The million dollar question is when do they level off.
Well human capital is said to be any nation greatest asset, especially China’s. Let’s say China keeps moving the 40% of people in agriculture into services and industry where per capita output is about 5.4 times higher. That allows for another 50% increase in output if no one is farming at the end.
The other source of growth is increase in productivity. And all the underlying factors that we would expect to sustain long term productivity are absent: no higher education, no social safety net, no efficient regulations. China does not look like an economy that can rapidly transition to a high tech economy like the Korea or Ireland did, none of the building blocks are there. True, they do continue to have a very high investment rate but that is not in the social capital needed to be a modern economy, that’s simply giving them the tools for the same relatively low value industry they are doing right now. Raise China’s industrial productivity to something like Mexico’s and you are still adding another 50% room for growth.
So China can roughly double before their current course remains sustainable, even in the abscence of trade wars, etc. At their current growth rate, that gives them about 7 years. Do people’s current expectations account for China’s growth plummeting after 7 years? No? Then they’re in a bubble.
The next 7 years for China will be a good thing of course. Millions will be lifted out of poverty. But the expectations are higher then 7 years of very good growth, the expectations are for a socialital transformation. And when that fails to materialize… well for starters, there will be some unhappy investors. China and the rest of the world should be very concerned about what happens after those 7 years.
What is the difference between a bubble and a boom? Do bubbles pop while booms jerk to a halt? Is there something else discernable before the change in pace?
China is growing apace, but that growth is based on rapid urbanization, ecological degradation, imported technology and mercantilist policy. There are obvious constraints on such growth, including the political risks of allowing businesses to get big and rising worker expectations.
My guess is that there has already been a phase change in China’s economy, but we aren’t going to see what happened for another two or three years, and then only if we are looking for it.
Ummmm, no one lives in the west because its pretty much unlivable. I mean, its either desert, or barren wastes of mountains. Ever wonder why there is really only one moderate sized city in the entire western half of china? It’s Lhasa in tibet. And it’s not that big. The US had the entire lucrative west coast, the entire pacific northwest, basically everywhere except in the rockies and new mexico/arizona. China is packed to the brim, with no dish to catch the overflow.
Few western nations like china. The mercantilistic ways of the chinese government piss off foreign companies. In how, china will greatly hinder foreign companies to make ones at home grow. Western nations do not like china. China does have quite a large bubble. There is a growing divide between the rich coastals, and the poor masses of the inland. Not to mention the fact that china is pretty much imitating Japan
The US is the biggest market in the world. I don’t think they are that well liked by the europeans…
Everyone hates china. They really have no friends at all. The US has Europe (politically), any western nation, and pretty much the better half of the world as an ally. China has….. itself i guess. Just because the pakistani and chinese aren’t cutting at each others throat doesn’t make em allies. I don’t see chinese bases in pakistan.
wait wait wait. Are you saying that a typical chinese person is better off? You mean the typical chinese person who makes less then 5000$ a year? compared to 50,000$ in the US?