2011 May 17 Tuesday
Jim Chanos Sees Cracks In China Investment Bubble

With over half the Chinese GDP going to investment, bubble-level real estate prices, and debts rising to unsustainable levels hedge fund manager Jim Chanos sees cracks in China's bubble.

The Chinese Communist Party played a strategy of funneling most economic output back into investment during a time when the country had little capital. They could get away with it because they had great growth potential for exports and because they had so little capital to start with. A new steel plant's output could be used for exports and factories and rail to haul exports to ports. The output of a new concrete plant could be used to make factories and roads and port facilities. No great finesse was needed to cause growth.

Mercantilism combined with state-subsidized capital expenditures worked well for China for a few decades. But China can't sustain this strategy. They've gradually run out of productive ways to use large amounts of capital. As a result their return on capital has gone down and, has Chanos has pointed out previously, China is hit by the law of diminishing returns. At the same time, costs of raw materials inputs have soared as long term extraction costs are trending upward.

Whether China's policy makers can even make the shifts needed is debatable. The interests inside of China dependent on the current status quo (e.g. construction firms, real estate spectators, steel mills) work against the needed shift toward greater internal consumption.

Mish Shedlock says China is headed for a correction. Also see Vitaliy Katsenelson's China The Mother of All Gray Swans. Katsenelson believes China's measures to avoid recession when the rest of the world contracted in 2008 have severe global consequences.

My questions: How severe a correction will hit China? Also, on the other side of that correction what will be China's new (lower) long term growth rate? Will Peak Oil prevent resumption of growth? Or will China's Communist Party manage to shift transportation to electric power fast enough to avoid stagnation due to Peak Oil? Also, can the Chinese Communist Party maintain sufficient legitimacy during a downturn to prevent regime-threatening mass protests?

For the next year or two put this in a global context. Every major region has serious economic problems and these problems will interact. The US economy is weak and hard hit by high oil prices. Japan's economy is down for 2 quarters and is in a double dip recession. Popular opposition to austerity measures in the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) seem likely to force sovereign debt defaults in the PIIGS. The resulting German bank losses will increase German popular dissatisfaction with the Euro. Will the currency zone survive without defections?

Share |      By Randall Parker at 2011 May 17 07:23 PM  China Economy


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