Is the Year of the Tiger the year of China’s Bust?

Monday, February 22, 2010 2:33

so, as my first post of substance for the Year of the Tiger, I thought I would make it a bubble post.  Will China’s economy survive the Year of the Tiger in tack, or will it implode.  It is a question that has been debated in many forums, and there are a wide range of “experts” on the topic, but two pieces over the break caught my eye.

The first is the clip below from Tsinghua University professor, rock-and-roller, and blogger Michael Pettis.  Pettis has provided some of the most interesting analysis of the China stimulus over the last 18 months, and why I prefer his analysis over others (UBS in particular) is he tends to look at underlying structures vs. the next two weeks of pricing, and sees through the thin veil that has become statistical measurements of an economy.. i.e.,you can certainly spend a trillion dollars to get to 11% GDP growth in a recession, but that doesn’t mean you can sustain it… and in this clip for Carnegie Endowment, Pettis runs through several important topics that I feel should be considered by anyone betting on China,expanding into China, or developing a “China plan”.

the next piece was Gady Epstein’s piece, also entitled China: Boom Or Bust?, where two prominent Chinese economists (Mao Yushi and Ha Jiming) respond to questions on China’s economy, and the answers are ones that again should make one think about jsut how stable the economic foundations are.. and how the economic stimulus may have only exacerbated the fissures.  Of particular note for me was the following:

Epstein: Some economists worry that the growth in money supply in China–30% in 2009–along with the speculative bubbles and overcapacity problems, have greatly increased the chance of a hard landing for China, though perhaps not for several years. What do you think?

Mao: There will be a hard landing if the bubbles burst. I can’t say. I don’t know how much time China still has.

Ha: Please remember 2015. That is the year when China’s baby boomers start to retire and the share of the working age population begins to fall–a phenomenon seen in Japan in 1990. That is also the year that the number of the baby boomers’ children begins to decline. Asset prices, particularly housing prices, will stop rising, and may even fall, when demand from the baby boomers and their babies shrinks.

Some economists suspect that China’s bubbles will burst in the next one or two years, while some expect that China will maintain fast growth for decades. I disagree with both.

Removing your inner alarmist, and planting an inner planner, there are two things that I feel are worthy of a healthy dialogue.

First, what would cause the bubble to burst?  high property prices? out of control lending?  inflation?  missallocation of resources (particularly those that came through the stimulus)? Chinese banks unable to recover stimulus loans and seizure of Chinese banks?  Some would say that ALL of these conditions exist.  Both Michale PEttis and Victor Shih (Northwestern) have written extensively on the topics, but these are debates that are being had locally.. and VERY publicly.  YOU now see regular, and highly visible, speeches from Zhongnanhai on the issues.  Even Wen Jiabao is out talking inflation and housing prices.  Which leads me to believe that Mao’s statement on timing is shorter than we think.

Second, to Ha’s point on China’s greying.  It cannot be understated, and while I have broached the topic on a few occasions, anyone who has a long term China angle needs to carefully consider the fact that within the next 15-20 years there is going to be a HUGE shift to the grey.  Right now Shanghai’s over 60 population is roughly 20%, and by 2050, China’s over 60 is projected to be a whopping 30% of the population.   Which changes the working to retired equation dramatically (see graphic) from roughly 5.4 workers to over 60 to 1.6 by 2050.

How do you think GM, Nokia, and Starbucks will fare in this environment?  More importantly, while everyone is focused on the fact that China put up a huge number on the scoreboard for this game, the question I have for this year is whether or not its bull pin will be able to sustain the full series.  Or whether, after working through this stimulus round and perhaps the next one that needed, the fissures will grow to wide and the air will be let out of the bubbles.

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21 Responses to “Is the Year of the Tiger the year of China’s Bust?”

  1. bill j says:

    February 22nd, 2010 at 3:06 am

    What Michael Pettis leaves out is profits. UBS have shown that the increase in Chinese savings since 2000 consisted pretty much totally of increased profits in the SOE sector. It is these profits which have enabled the government/banks to fund the lending binge of the last 18 months. Capitalism, a system which runs on profits, is not going to suffer by having too much of a good thing – the profits which drive its investment.
    What’s more there has been a significant shift in the make up of fixed asset investment over the last three years away from manufacturing and into infrastructure projects. Pettis might want to argue that many of these will be wasted capital, that they will not earn the anticipated returns, but in general these type of projects never earn any returns at all. They are usually paid for out of taxation and then written off. The fact that they will earn returns at all, points to the relative strength of the Chinese economy.
    Finally you speak about the issue of aging and the impact it will have around 2050. As Keynes pointed out “in the long run we are all dead”. Who knows what the world will look like then? How about concentrating on the next five years!

  2. Uln says:

    February 22nd, 2010 at 4:49 am

    I don’t see why the greying is such a big problem in China, and in any case it is not comparable to Japan in the 90s, which was far more developed than China is today. There are still masses of workers here eager to take the place of the retired ones and contribute to the growth of that internal market that China seeks to develop.

    Besides, the baby boomers retiring is not necessarily such a bad thing. They have the culture of socialism and I suspect they are not precisely the most productive sector of the workforce. Their retirement will provide working places for young people. Their health expenses may finally force their families to open the purse and start spending their savings in areas like healthcare and pharma (in which China is investing a lot).

    Sure, I see the greying problem can be important in the long term, but in 2015? IMO, there are many more critical factors that will play before this laolinghua seriously becomes a problem.

  3. Bill Rich says:

    February 22nd, 2010 at 7:38 am

    I am glad that Chinese don’t consider greying of the population is a problem, at least not a problem for many years. This is the kind of optimism that will drive the economy, to get it to bloom again and again. I think the best assumption is that the greying will not have any effect in consumption at all. When people retire, they will spend more and more money, on their non-existing grandchildren.

    And assuming the SOE’s are profitable is also a good way to deal with the problem. And as SOE’s continue to profit from expanding their capacity paid by taxation, it shows the real advantage of the Chinese approach to stimulation over those of the western countries. And since there is no limit on China’s capacity on taxation, the stimulus packages can continue forever.

  4. Rich says:

    February 22nd, 2010 at 8:10 am

    @Bill J

    Acutally, and I am not sure if you read Pettis’s blog, he has addressed the savings that you mention in detail. Basically, as part of a debunking the myth of household savings will save China piece… and I think he has put forward some compelling posts on the question of infrastructure investment as well.

    On the issue of greying, the effects will be felt at different times depending on the place. Right now, the “oldest” city statistically is Shanghai with over 20% of its population above 60. There is a lot of concern here for how to take care of this group, as contrary to popular belief, many of them do not live with their families and are in fact living on their own. A lot of effort and money has gone into bringing services online, but there is a HUGE gap.

    It will be a problem well before 2050 for Shanghai, and for many areas where the able bodied men have left to work in the city, it is often already a problem in the fields as well.

  5. Rich says:

    February 22nd, 2010 at 8:18 am


    Actually, I would say that one could look at Japan and see why China should rightfully be concerned. There are massive structural differences (inefficiencies) here, that are compounded by the sheer numbers, that are going to put much more pressure on the system here than Japan felt.


  6. Rich says:

    February 22nd, 2010 at 8:24 am

    @Bill R

    Interesting comments, but where I would lean the other way is the fact that much of the group that has recently retired invested much of their savings into their children and are reliant upon them and the state for monthly payments.. many of the above 70 simply do not have deep pockets. They live very frugally and are not the online dating, world traveling, RV buying elders snow birds that have become one of America’s biggest growth sectors.

    As for stimulus packages lasting forever.. I honestly hope it never comes to that. To think that China would spend its national wealth on roads, bridges, and office parks that will never been used is (regardless of the short term economic impact) a bad idea.


  7. bill j says:

    February 22nd, 2010 at 9:56 am

    I do occasionally dip into it, but I think he is basically wrong about the results of the reflationary package, and I find his use of terms like “households” to be pretty unsophisticated, bordering on plain misleading and wrong. Behind that term lies a whole gamut of social content.
    Do we mean the small peasant farmers in the countryside? I’m guessing not, as they don’t have much savings at all. Do we mean the migrant workers in the factory barracks who send what savings they have home? I’m guessing we don’t either, for while they save something, their income is not too high in the first place. Or do we mean capitalist manufacturers who have seen strongly rising profitability over the last few years? In other words massively rising savings in the form of profits. I’m guessing we do.
    This seems to me to be the strength of the UBS analysis. When they discuss over capacity, they ask the question over capacity relative to what? If profits are still rising relative to investment, that is if returns are still on the up, then there is no real over capacity. You could talk of reserve capacity, but that’s a whole different thing now isn’t it?
    Its also important to note I think that the decline in exports as a proportion of GDP has been qualitative in the last 12 months, falling by around 10% in a single year. The idea that China was pretty much exclusively dependent on exports was always a myth, as it ignored the imported and value added component of exports and focussed instead on sales relative to GDP. Another UBS point that’s been confirmed over the course of the recession if you don’t mind me saying!

  8. silly things says:

    February 22nd, 2010 at 11:46 am

    There is a key question on China’s overcapacity issue and that is: how should overcapacity in an economy be measured? I suspect many got this wrong.

    30 years ago China’s productive capacity was lockup and dormant due to bad political structure. China’s _potential capacity_ was not part of the world’s productive capacity. In that old world, China’s production capacity was underutilized. At the same time the rest of the world’s production capacity was in balance with demand and was supported by an old price. That old price was based on an under utilized global production capacity (China’s capacity isn’t being used). Therefore, the old price is neccessary higher. This is a really important point.

    Today, more and more of China’s production capacity are coming online every year. The existing productive capacity of the rest of the world that were supported by yesterday’s price is now unsustainable. However, China’s current productive capacity is supported by today’s price. Viewed this way, it is the rest of the world that has an over capacity problem. It is also interesting to note that because of lowered price, demand changed. People every where are able to afford more at a lowered price.

    Everything I said above applies to all the emerging markets (not just China) today and upcoming emerging markets in the future. Each time the production capacity of a new emerging market comes online, it is the rest of the world that has a over capacity problem!

    Unfortunately, many discussions of overcapacity are framed from the view of “excess over what is produced and what is consumed domestically”.

    Unfortunately, this view really butchers the #1 sacred cow in economics: efficiency.

    Consider what the consequence is if a country, any country not just China, holds back production even through it has the capacity to profitably produce more? The end result are:

    – Foreign corporations, that otherwise would be uncompetitive, will continue production due to reduced competition.
    – All consumers in the world will necessary pay a higher price for goods and services due to reduced competition. Consumers are forced to subsidize the uncompetitive businesses.
    – Global economic growth (GDP growth) will necessary be lower.
    – Resource will be severely mis-allocated. This is especially serious for the mis-allocation of human resource in the world.

    Everyone looses in the long run.

    In the short run, major changes do have a very real human cost dimension. Therefore it is understandable and correct for governments of developed nations to soften the shock. However, viewing overcapacity from “excess over what is produced and what is consumed domestically” misleads the analysis and will lead to significant inefficiencies.

    A country is an economic actor like a business enterprise. I think the measure of overcapacity for a country should be the same as a business. Overcapacity should be measured by price and profitability of production.

    Considering half of the world’s 6 billion population are still living in poverty, the road ahead is still very long! Also considering the hundreds of million that were lifted out of the misery of poverty in the last few decades, this is a good road to travel on!

  9. gregorylent says:

    February 22nd, 2010 at 6:19 pm

    ah, the obligatory bubble post … there have been so very many lately, almost all from the western world …

    one question, was the usa in a bubble in, say, 1910? that is about where china is, relative to its development …

  10. silly things says:

    February 22nd, 2010 at 6:58 pm

    Here is my take on the original question:

    Is the Year of the Tiger the year of China’s Bust?

    1. Yes, China is ahead of the world in recovery. It is still nonetheless only 1 year into the recovery process. Bubble blowing needs more time.

    2. The whole world has learn a lesson of the harm bubbles can cause from the US subprime mess. Today, various government and not just China, are yelling bubble any time asset prices appreciate quickly. We probably now live in an environment that has a predisposition to pricking bubbles! In this kind of environment, there maybe many little bubbles that burst. However, nothing can get too big.

    This is most likely an uninteresting year!

  11. Rich says:

    February 22nd, 2010 at 8:22 pm

    @bill j.

    all fair points – and I think do a great service to the idea that it is all about the context. For me, I have always enjoyed the research that UBS has put out, but I found it too focused on short term for me.. keeping in mind that I am not a big trader, their targeted client, that is not a knock on UBS’s work, but just a reflection of my context was different than theirs. Pettis for me has been equally interesting, and added a different sense of context as he has (on the whole) presented a more long term vision.

    Back to the topic – and towards your last point. Personally, I think that China was reliant upon exports in many ways, and I think the massive need for the stimulus (which fueled the recent investments) is proof of their dependence. I would agree that they were not dependent in the sense of they had no other options, and the economy was going to collapse as a result of the drop, but I think that (back to the greater context), the economy has simply replaced its fuel.. from exports to infrastructure. Question is – is this the right balance? Can it be sustain? If not, what then?



  12. Rich says:

    February 22nd, 2010 at 8:29 pm

    @ silly things

    Thanks for the comments. No disagreement on the role/ threat of what believe are over capacity issues, and I your view that the supply will eventually be taken up is a very valid one.

    questions for me would be – are there industries (and if so, which ones) where the shelf life of the goals cannot afford to wait? Like real estate perhaps – how much is the building worth if it is 10 years old and only at 10% occupancy? … and to your point, was that investment the most efficient allocation of resources? Because if not, then there is a mismatch that eventually will be accounted for (short or long term) depending on whose balance sheet the assets rest on.

    To your second set of comments – your #2 seems interesting to me, and I guess the only reservation I have is on the implementation end of the equation. Yes, there is growing risk aversion at the policy level, but at the local branch level the story may be different.


  13. Rich says:

    February 22nd, 2010 at 8:37 pm


    I know. it was a cheap post, but I have a long history of cheap bubble posts to rest my reputation (and viewership) on… and yes, there is a lot of coverage from the western perspective now (primarily from the investment side), which is why I found Gady’s article interesting. There is more and more discussion occurring locally (even my inlaws were trying to draw a line between the lack of fireworks this year and real estate prices), and for me that is the real discussion that people should be paying attention to at the end of the day.

    Is China different than 1910 US. I would say that outside of being a developing economy trying to move away from an east coast export base, it is vastly different. I have always said that it is like the expansion of the US meets the integration of the EU. there are both dynamics occurring at the same time, and at a speed that makes 1910 look like…. well, 1910. the economies of the world are more tightly integrated and dependent on each other than they were in 1910, and unlike in 1910, the average Zhou is leading a very different life that is increasingly leading to the city. Main question for me… is China’s systems really ready to support the move away from fragmentation. I know that this is the trend, and that it is a good trend, but where are the fissures in that equation that we should be on the lookout for?


  14. silly things says:

    February 23rd, 2010 at 7:30 pm


    Regarding China’s real estate market, I don’t have any good answers. However, I do have the following question.

    1. Who is over leveraged in China? In the last 10 years, the US went through 2 recessions. The tech bubble was not caused by over leverage and the current one is. It is crystal clear which one hurts a whole lot more. Therefore I think figuring out who is over leveraged and by how much is really important. I don’t know the answer but the cast of characters are: central government, local government, banks, businesses and consumers.

    2. What is driving the demand? Low interest rate is one factor. However, home ownership in China is suppose to be over 80% and down payment for 2nd home is 40%! It is definitely not the central government policy. I don’t think it is the local government either since they can only sell land. They cannot force people to buy houses. What is driving the buyers to buy? Is it as simply as irrational exuberance? Very puzzling.

    I only have one potential reason for the demand but probably a weak one. There aren’t many investment options in China for the average citizens. Stock market is too wild. The safe stuff like banks offer very little return and probably lower than inflation. So, people put their money in houses. Perhaps when China opens up it’s financial system is when house prices fall. Actually, a diversify portfolio of global investment is much safer than the Chinese stock market.

    3. I suspect the central government knew about the leaks at the branch level very well. The central government probably figures that while they can’t stop the leaks they can definitely compensate, maybe even over compensate. The government over tightening is a real risk too.

    Anyway, please let me know your thoughts.

  15. Edward Eng says:

    February 23rd, 2010 at 8:42 pm

    China is on its way up. Be positive. Simple.

  16. Rich says:

    February 23rd, 2010 at 11:40 pm

    @Silly Things

    Some important questions, and hopefully I can answer in part.. but hopefuly the usefulness of All Roads will be in that others will also be able to answer as well.

    1) This is a question that I think is critical to the real estate and financial markets in China, but moreso on the real estate side from the following angle. In the US, part of the problem with the subprime mess was that millions of loans were being rolledup and sold as a single package, while at the same time you had major developers who were over leveraged and expanding through the use of short term financial instruments.

    In China the equation is different, and I think that is partly what insulates it. That, because the vast majority of properties in China are sold strata title, the risk to the banks is ultimately diversified. they are not waiting on baited breath to see if a single REIT will be able to hold on, or whether it will have to begin spinning off properties (like Morgan Stanley did) because there is a secutiry in knowing that (without a complete meltdown) are going to be able to keep up their payments.

    So, in China, while I would say the leverage is held by consumers and industrialists alike, the fragmentation of China’s markets does provide a safety net.

    How that applies to the big SOEs though is a different question. Those are loan decisions made in part by policy, and my guess is that the top 1000 SOEs do provide a significant amount of risk to the banking system. particularly if a single SOE holds a large amount of a local branches portfolio.

    2) your demand driver question is also important, and the answer you have is quite valid if you are speaking about the Average Zhou in China. the market here does not off the options of a US market, so that does drive a lot of the demand… and flow of hot money..

    However, from a foreign investment perspective, that does not answer the question. Foreigners have options, and thus my conclusion is tht they are flowing into real estate and other China based assets for a whole different reason.

    Some may see the upside of the market, or feel that they need to “be there”. however, there are some that are pure currency speculating, and the more assets they hold in China, the higher the return there… like printing money.

    What I find interesting, and this is unrelated, is that the Chinese money seems to be flowing offshore at a rate faster than the reverse. Some of that is going into “safe” investments as a hedge against implosion here.

    Different investors.. different motivations

    3. they certainly know about the leaks, and I am not sure they can do much but over steer the policies in hoping that 50% of it sticks.. but the problems are big enough that they have a negative impact on the plans of Beijing, and every once in a while you will see that play out in the press.

    Anyone else?



  17. Rich says:

    February 23rd, 2010 at 11:41 pm


    Care to share your Koolaid?


  18. Edward Eng says:

    February 23rd, 2010 at 11:45 pm


    Ice or no ice?

    -Eddie from getchee

  19. Anders says:

    February 24th, 2010 at 7:50 am

    Pettis’ thing besides the imbalance is the Chinese consumer. The Chinese consumer is the joker here, because we really don’t know how to figure them out. Pettis argue that a low interest rate will not lead to a raise in consumption it will in fact lead to more saving. The argument is based on the assumption that the Chinese consumer needs to save more, because his/her savings get eaten by inflation or he/she simply fears for future expenses. An alternative to this is (as mentioned) buying real estate, but that still looks a lot like saving and it surely is if Chinese banks don’t put their profits to good use (if they subsidize the SOEs to produce overcapacity for the world market. Can you say steel?). All this could mean that consumer demand in China is held artificially low. Pettis could be wrong and the Chinese consumer could just be getting started, if so then all his arguments would be proved wrong, because then the bet on infrastructure will pay off and the tax base will grow.

    So if anyone could map the consumer pattern of the average Chinese consumer in the 1st and 2nd tier cites, then we might find out what’s really happening. I am not sure that this is possible simply because the numbers are just not there, there is no one in China who would ever really tell how much or how little they have.

    The point, about exports not being as an important part of the GDP as we think, is all good and fair, but export companies (and FDI) are extremely important as a tax base for the national and local governments. Building roads, railroads or other infrastructure is not a tax creating move (ok you get a one time lump sum for the land in real estate deals, but it’s not a solid tax base for years to come). The leading of free money to SOEs is also not a tax creating move.
    The government relies on import taxes and foreign companies for good part of it’s tax base.

  20. Edward Eng says:

    February 24th, 2010 at 7:49 pm

    Everything will be fine. Really.

    -Eddie from getchee

  21. Chris Devonshire-Ellis says:

    March 5th, 2010 at 7:53 am

    China’s growth will slow. It has too, its unsustainable to expect 10% year on year forever. I’m also hesitant about the expected growth and how much of that (and 2009) was actually built on debt. China’s mantra of 8% is going to start to look silly in a decade from now, the question is going to be how they expect to manage the reduction to a more likely 3-4%. The government seem preoccupied with ‘social order’ and maintaining power rather than a longer term strategy of continuing, but sustainable growth. China has hit a socialist, one
    party system glass ceiling. Being – you can’t have indefinately
    sustained growth without domestic political democracy and intercourse.

    We live, (cursed or not) in interesting times. The rise of India, which I expect will outpace China in GDP growth (from a far smaller base it has too) from this year onwards. The writing is on the wall. India’s previously moribund system has been rebooted, and their take on growth, economic and social, will start to make an impact.

    Which system wins, China’s totalitarian model, or India’s (USA) democratic one is the most fascinating development – and question – of this century. The contest, I should suggest, has only just reached the first quarter.

    But where to invest, dear reader? Both. Its a no brainer. – Chris