More Investors Convinced China will Crash

There has been a number of articles in the past few weeks outlining the distinct possibility that the Chinese economy, due to inherent corruption, an unstable credit bubble driven by housing speculation, and a poorly regulated financial system, is posed, at the very least, to have a hard crash that will spill over into the rest of the global economy.

According to the NY Times, "Mr. James Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc."  Chanos' hedge fund, Kynikos Associates based in New York, foresaw the demise of Enron and a number of other high-flying companies whose profits were too good to believe.  As is frequently stated by the financial industry, "Past performance is not indicative of future earnings."  So how valid is Mr. Chanos' opinion on this subject?

The nation’s huge stimulus program and record bank lending, estimated to have doubled last year from 2008, pumped billions of dollars into the economy, reigniting growth.  But many analysts now say that money, along with huge foreign inflows of speculative capital, has been funneled into the stock and real estate markets.  A result, they say, has been soaring prices and a resumption of the building boom that was under way in early 2008 one that Mr. Chanos and others have called wasteful and overdone.

The implication is that the great illusion of growth and prosperity that continues to be exalted by investors and politicians alike, will not last.   As they also say in business, it's a matter of simple "mean reversion."

Thomas Friedman in yesterday's NY Times OP-ED pages, will not accept any such arguments about declining Chinese supremacy.  He retorts that China is sitting on two trillion dollars worth of foreign currency reserves, the country is finally finding its stride by finding efficiencies in its vast transportation infrastructure, capable managers and entrepreneurs are returning to the country in droves, and vast numbers of students are enrolled in college and university programs.  Collectively, China's best days, in his opinion, are still in front of it and we in the West best get used to it.

That argument is fine and in the long-term, China may well do better than woeful and stagnating Japan or the once heralded Asian-tigers of the Pacific south-east.  However, Friedman fails to address the central premise of his opponents, in that there is obviously a credit bubble brought on by massive state stimuli to mostly state owned and inefficient businesses.  How long is this affair supposed to continue, in which the central government keeps pouring capital into questionable economic endeavors with equally limited return?  Three of the top five banks in the world (by capitalization) are now Chinese.  Does anyone really know what is on their books and how confident we should be about their debts?

The Washington Post, elaborates on lending practices by Chinese banks:

The government has helped pump up the property market by keeping interest rates low, the currency undervalued and the fiscal spigots open. Standards for bank lending have been lax, with lending rising at a 30 percent annual pace in 2009, according to a report by the Los Angeles-based bond investment firm Pimco.

Recent housing bubbles, that were created elsewhere, also have had similar attributes: rampant speculation, apartment and home prices doubling over the period of months, loan applicants lying about income, regular people with average incomes being priced out of the market due to geometric growth patterns, and officials and real estate agents boasting that price corrections were not probable given regional dynamics.

Some economists and bankers fear that they have read this script before. In Japan at the end of the 1980s and in the United States in 2008, residential real estate bubbles ended in big crashes, battered banks and slow recoveries. With China acting as a key engine of global growth, a bursting of the Chinese real estate bubble could be a pop heard round the world.

Enough data has been seen by this blogger, that I can confidently state that those banking on gossamer winged dreams of future growth derived from corrupt plutocrats, are probably the same persons who learned nothing from the past economic catastrophe and are thus bound to repeat the follies of their predecessors.