Evaluating the Likelihood of China Crashing

The overall question of China’s economic situation remains enigmatic. Earlier this year several leading experts expressed grave concerns related to the distinct possibility that China would crash. Renowned short-seller James Chanos was the first to publicly state that his company was actively analyzing methodologies to prosper from an anticipated Chinese economic crash. He considers China to be “on a treadmill to hell” because of its addiction to pushing growth through property development. A point belied by the fact that as much as 60% of the country’s GDP is now contingent upon construction related activities.

In February, Ken Rogoff -Harvard Professor, former chief economist at the IMF, and author of the critically received historical economic analysis ‘This Time it is Different’- warned of a collapse of China’s debt-fuelled bubble. Rogoff refutes the conventional arguments offered over the past decade that China cannot have a crash. History he insists provides no example where an emerging market nation did not succumb to a crisis that sent growth plummeting and markets crash. “You’re starting to see that collapse in property and it’s going to hit the banking system,” states Rogoff in Bloomberg BusinessWeek.

In the past couple of months, a tidal-wave of fund managers have turned on China. Marc Faber, publisher of the Doom, Boom, and Gloom report, anticipates that China will have a hard landing by the first half of 2011. Whereas Hugh Hendry, a UK based hedge fund manager, is developing a stand-alone fund that will exploit the upcoming failures of the Chinese economy.

As of this month, the Shanghai stock market remains at its lowest point in sixteen months. Much of China’s GDP growth can be directly correlated to the value of property, which has soared 40% in the past 18 months alone. Despite attempts by the communist government to quietly reign in excessive speculation and overleveraging in the housing and commercial real estate market, unsustainable growth patterns persist. According to Bloomberg, property prices in 70 Chinese cities rose 12.4% in May; the second-fastest pace on record.

A number of analysts are predicting that any correction will not harm the overall Chinese economy. Optimists point to the fact that “Shanghai’s sales of new homes fell 57 percent in the first six months of the year,” implying that an orderly correction shall occur. Bloomberg news posts the assertion of one analyst that China’s property boom is “cash-driven” rather than “leverage-fuelled,” and as a result, the same dynamics that occurred in the US housing market would not be replicated in China.

On the other hand, a report by Fitch rating agency issued earlier this month and discussed in the NY Times,

Said Chinese banks were increasingly engaging in complex deals that hid the size and nature of their lending, obscuring hundreds of billions of dollars in loans and possibly even masking a coming wave of bad real estate and infrastructure loans.

The report also highlights that Chinese regulators have understated loan growth “in the first half of the year, by 28 percent, or about $190 billion.” The level of deception and fraud occurring in the Chinese banking industry, coupled with the financial innovations created to explicitly conceal risk, are the hallmark attributes of an economic system that is in the early spasms of crashing.

Overall, given the inherent conflict of interests of local governments, who have a vested interest in property speculation, infrastructure expansion, and show projects necessary to enhance their reputations and meet growth quotas, it is unreasonable to assume that these same persons and/or entities would voluntarily halt their long established and until now profitable practices. Established corruption, currency manipulation, a lack of transparent legal rights, collusion of state banks with local businessmen, revolting masses, and an ever growing list of skeptics of the “Chinese miracle” portend that even if the property bubble does not crash the economy, there resides many unstable and troubling fault lines that can.