Chinese Economy May Be Heading into an Iceberg

Since China’s fiscal stimulus announcement in November 2008, the Shanghai Composite Index has rallied almost 90 percent, giving hopes that China may lead other countries into a global recovery. However, in this article we raise questions over the sustainability of the biggest emerging market upturn in history because eventually the Chinese stimulus will fade away.

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Indeed, at Trading Economics, we think the unprecedented rebound in the Chinese stock market has been to some extent engineered by the Chinese government and not propelled by a positive change in real economic fundamentals. More importantly, the huge stimulus package has been mostly designated to boost the construction activity rather than provide help to distressed exporters or households. That said, the IPO activity has been mostly in construction industry and shares in property and building companies recorded the biggest increase. For example, the Sichuan Expressway stocks soared 300 percent during its opening trading day on July 27, while China State Construction Engineering Corporation surged 70 percent on July 29.

Furthermore, lower interest rates have increased credit availability and provided resources for extensive stock purchases. It is estimated that lending was up by more than 200% year-on-year in the first six months of the year. To make things even worse, investors desperate to make up previous losses have been supplying the market with a lot of borrowed money, driving the stock prices even higher. These special circumstances combined with crowd behavior and human psychology creates the perfect conditions for a bubble to expand and eventually implode, bringing the global economy into a double-dip recession.

Disclosure: No positions

Comments

[User 353732:]

A year ago, the Chinese economy was heavily dependent on external demand. Moreover it was a producer driven, high fixed investment(including residential urban real estate), high savings, energy -inefficient in assembly - manufacturing, economy.
A year later,we know that external demand has contracted astonishingly, urban real estate is in deep trouble,and rural unemployment has risen sharply while electricity production has declined. Savings are still high because Chinese households with any capacity to save do so furiously. True, auto production and sales are up but not by so much(ie they have not tripled) that they can offset much of the loss of external demand for manufactured goods. Yet, we told by the Chinese Govt and its parrots in Western media that China is again growing at high single digit rates.
This can only be possible if China, in a matter of months, has metamorphosed itself into an internal demand driven, consumer-centric, low household savings(ie high household spending ), energy-efficient manufacturing economy with no real estate overhang and rising real estate prices and rapidly falling rural unemployment. Is this credible?
The fact is that a structural change of this magnitude this quickly and a parallel transformation in employment markets and consumer behavior is simply not credible. The Chinese Communists are adept propagandists and use epic falsehoods as a matter of routine statecraft.
The Chinese would have us believe that they have engineered a second Great Leap Forward, in less than 9 months. In truth they have engineered a Great Bubble, which when it bursts may be their second leap backwards.

Jul 31 07:57 AM

[dybydx:]

dude, what r u talking about.

ya sure there are some doubts about the sustainability of the SSE bublee, but no credible economist echo anything of your magnitude.

besides, u have no idea wat a great leap forward really is.

Jul 31 09:24 AM

[Graham and ...:]

China's not doing badly, but also not well enough to justify a 90% gain in its stock market. It has to be excess liqudity, which is to say, "bubble."

Jul 31 10:13 AM

[Bill L.:]

James Cordier, President of Liberty Trading Group gave an interesting interview and he's been pretty spot on regarding oil.
To summarize, be believes many recipients of the Chinese stimulus (well to do people, factory owners, etc) have actually just been reinvesting it in stocks, oil, speculative real estate etc, instead of building out infrastructure, creating speculative bubbles in many areas. For example you can see a big divergence in demand for oil end products and crude.


I'm looking into new construction rates, but in the meantime, some interesting food for thought.

Jul 31 10:31 AM

[Sober Realist:]

User 353732,
I always enjoy reading your comments.
Bill L makes an excellent point on crude oil demand for end products. not just stockpiling in a strategic reserve.
Indeed, to make the structural changes in such a top-down economy will take drastic measures and a generation to perform. I believe the very controlled, bureaucratic, and corrupt nature of the Chinese regime inhibits the transformation of China into a Western consumption model. Transferring such buying power to the masses would also destabilize the CCP's power base.
The CCP values mammoth state-run institututions/corpora... in order to maintain monopolistic control in key industries (such as energy, transport, banking and communications). Senior and mid-level executives in state controlled enterprises are appointed by the CCP.
Their state-corporatist model favors a relatively small number of well-placed insiders.
Their is a glass ceiling for advancement of those who are not members of the CCP.

Jul 31 12:51 PM

[HardwoodFlo...:]

Friend of ours in the lumber business say that 405 of the factories in the south of china are closed. Don't hear that from their governement.

Jul 31 01:29 PM

[HardwoodFlo...:]

that's 40%

Jul 31 01:29 PM

[Tony Daltorio:]

Quit listening to Wall Street propaganda. Wall Street still thinks China is the few large coastal cities that export a lot to the US.

China started making moves toward a more consumer-driven economy years ago. Their middle class is already 330 million - larger than the entire US - and still growing rapidly.


On Jul 31 07:57 AM User 353732 wrote:

> A year ago, the Chinese economy was heavily dependent on external
> demand. Moreover it was a producer driven, high fixed investment(including
> residential urban real estate), high savings, energy -inefficient
> in assembly - manufacturing, economy.
> A year later,we know that external demand has contracted astonishingly,
> urban real estate is in deep trouble,and rural unemployment has risen
> sharply while electricity production has declined. Savings are still
> high because Chinese households with any capacity to save do so furiously.
> True, auto production and sales are up but not by so much(ie they
> have not tripled) that they can offset much of the loss of external
> demand for manufactured goods. Yet, we told by the Chinese Govt and
> its parrots in Western media that China is again growing at high
> single digit rates.
> This can only be possible if China, in a matter of months, has metamorphosed
> itself into an internal demand driven, consumer-centric, low household
> savings(ie high household spending ), energy-efficient manufacturing
> economy with no real estate overhang and rising real estate prices
> and rapidly falling rural unemployment. Is this credible?
> The fact is that a structural change of this magnitude this quickly
> and a parallel transformation in employment markets and consumer
> behavior is simply not credible. The Chinese Communists are adept
> propagandists and use epic falsehoods as a matter of routine statecraft.
>
> The Chinese would have us believe that they have engineered a second
> Great Leap Forward, in less than 9 months. In truth they have engineered
> a Great Bubble, which when it bursts may be their second leap backwards.

Jul 31 02:11 PM

[notsosmart:]

yes-i saw a middle class chinese woman on a car assembly line interviewed.she said she earns $120 a month.now thats buying power.

Jul 31 02:34 PM

[johnqh:]

notsosmart:

Give me a break. That's "middle class"? Manufacturering workers and service workers are never considered middle class in China.

Jul 31 03:46 PM

[Mad Hedge F...:]

An ice berg called the USA. ) Legendary investor and former George Soros partner Jim Rogers gave a great interview to Bloomberg TV. Although he is a long term bull on China, he wouldn’t be adding to positions here because, having doubled in six months, you’d be jumping on moving train. China’s stimulus program is larger and better working than ours, as it is being entirely domestically spent. No subsidies for foreign car imports. Many industries are booming there, and real estate is going crazy again. The better play here is commodities, which the Chinese absolutely have to buy, especially the grains (see my call to buy wheat at www.madhedgefundtrader...). Jim is sop wedded to his china play that he has moved to Singapore to get closer to it. He has always been very public with his ideas, getting people to buy what he already owns, and widely propagates YouTube with his interviews. Take a look at his personal investment website at www.allthingsjimrogers.../.

Jul 31 05:03 PM

[Locked Out:]

Hello Sober,
www.youtube.com/watch?...

Jul 31 05:33 PM

[Teutonic Kn...:]

User 353732 has a point. It does look quite Bubbling and I am skeptical as well.

However, I think it takes more than just the Chinese propaganda itself alone to engender this so-called "Second Great Bubble".

Look at all the financial media's hype on China in the past 11 months since the Lehman fall. I suspect both the U.S. government and Wall Street would be partly encouraging it as it would help draw voters and investors attention from the dire economy, respectively.

Wall Street in particular would like to cook up a frenzy like "The Grass is Greener on the Other Side". The said part is, however, few Americans investors have first-hand knowledge of Chinese language, culture, and economic drivers, and political landscape.

Even on a Safari trip you would need a local guide, not a 24 something year old guy or gal broker brought up in an all-white American suburban neighborhood.

Take Care!

On Jul 31 07:57 AM User 353732 wrote:

> A year ago, the Chinese economy was heavily dependent on external
> demand. Moreover it was a producer driven, high fixed investment(including
> residential urban real estate), high savings, energy -inefficient
> in assembly - manufacturing, economy.
> A year later,we know that external demand has contracted astonishingly,
> urban real estate is in deep trouble,and rural unemployment has
> risen sharply while electricity production has declined. Savings
> are still high because Chinese households with any capacity to save
> do so furiously. True, auto production and sales are up but not by
> so much(ie they have not tripled) that they can offset much of the
> loss of external demand for manufactured goods. Yet, we told by the
> Chinese Govt and its parrots in Western media that China is again
> growing at high single digit rates.
> This can only be possible if China, in a matter of months, has metamorphosed
> itself into an internal demand driven, consumer-centric, low household
> savings(ie high household spending ), energy-efficient manufacturing
> economy with no real estate overhang and rising real estate prices
> and rapidly falling rural unemployment. Is this credible?
> The fact is that a structural change of this magnitude this quickly
> and a parallel transformation in employment markets and consumer
> behavior is simply not credible. The Chinese Communists are adept
> propagandists and use epic falsehoods as a matter of routine statecraft.
>
> The Chinese would have us believe that they have engineered a second
> Great Leap Forward, in less than 9 months. In truth they have engineered
> a Great Bubble, which when it bursts may be their second leap backwards.

Jul 31 10:40 PM

[HaavBline:]

After the Chinese market is up 90% it is easy to be sour grape if you missed the huge rally and try to talk it down. The question is what was the author's position 9 months ago?

Certainly there are bound to be some excess when a gigantic stimulus program is executed in such fast pace, but the results are very clear. You don;t have to believe Chinese statistics alone, it can be collaborated by other Asian economoies that export to China, all of them are doing far better than G7 economies, boosted by Chinese demand and confidance. Even Japan counted on booming export to China to avoid a deep depression.

Of cause major correction is likely, the Chinese goverment is already taking action to control excess. If only out Fed and Wall Street is this discipline, we wouldn;t be bringing the world, and ourselves, to this deep mess in the first place.

Aug 01 02:41 AM

[Big Mouse:]

"Indeed, at Trading Economics, we think the unprecedented rebound in the Chinese stock market has been to some extent engineered by the Chinese government and not propelled by a positive change in real economic fundamentals."

---- I would like to explain the Chinese stock market in another way. Neither government manipulations nor a positive economy signal. The industry funds give up their factories due to weak demand from overseas. These funds went to coal mines in 2H08 and then transferred from coal mines to the stock market in 1H09. Now they move from the stock market to porperties. The index boom has nothing to do with economy. The Chinese stock market is merely a way for capital to make money in the weak time - just like the oil price in developed countries.
---- An analyst in Shanghai

Aug 01 10:12 AM

[johnqh:]

Why don't we look at the graph over the last 10 years? It doubled since 2000. Only 100% gain over 10 years, when the economy averaged 10%+ growth/day - the economy is about 4X of 2000.

Does it still look like a bubble?

The Chinese stock market is immature. Maybe the problem is not the recent gain, but how undervalued it was in 2006.

Aug 01 10:51 AM

[Alphameister:]

Maybe it's time for you "macro" analysts to check things out from the bottom up!! johnqh is on the right track with his above comment, though I'd add "and 2008" to his last sentence. I've watched my diversified portfolio of Chinese stocks climb by well over 100% since the lows as their P/Es climbed from a range of 2 to 6 (with most priced below book) to a range of 4 to 12 times rapidly growing earnings (actually, the lowest current P/E among my current Chinese stocks is still 2). I've seen bubbles, and this surge by Chinese stocks doesn't come close to qualifying.

Aug 01 11:30 AM

[huangthomas:]

The Chinese stock exchanges started in 1991 by Deng Xiaoping. The market is young and Chinese investors are inexperienced. They "invest" as though they are gambling.

Aug 01 11:49 AM

[nmelendez:]

I wonder about the chinese exchange. If China had 40% invested in it and did a massive sell off, how many dollars would they take from the US banks?

Aug 01 11:10 PM