There's No Bubble in China

 |  Includes: FXI, PGJ
by: Jeff Nielson

I find it utterly amazing how the same group of commentators who could not “see” the U.S. housing bubble – the largest asset-bubble in human history, can suddenly see “bubbles” everywhere (except in the U.S. economy).

The most frequent target of these “bubble sightings” is China, where the simplistic reasoning of these “experts” seems to be that if China's economy is growing much faster than anywhere else, then this must be where the next “bubble” will occur.

However, much as these “experts” were all wrong in failing to see the massive U.S. bubble, they are wrong again in imagining bubbles where none exist. For the benefit of those who need assistance in understanding what an asset bubble is, the definition is very simple. There are two components: over-valued assets, and an excessive amount of leveraged debt. While both conditions are necessary, neither is sufficient by itself.

The mere presence of over-valued assets does not represent a “bubble”. Assets become mis-priced in markets all the time – sometimes under-valued and sometimes excessively valued. When this happens in normal market conditions, markets “correct”; whereas with a bubble, there is inevitably a subsequent “debt implosion” of varying degrees of magnitude.

The reason why a true asset-bubble always ends in some manner of debt-implosion is because of the second (necessary) component of a bubble – excessive, leveraged debt. Again, even too much leverage (by itself) does not indicate a “bubble” if the underlying assets are not mis-priced.

It is over-valued assets which inevitably lead to a market “correction” at some point in the future, and it is the addition of leveraged debt which turns a “correction” into a “debt-implosion” - because of vast numbers of defaults on that debt. Corrections alone do not imply defaults, because if the debtors have not taken on excessive debt, then they can withstand a correction without defaulting.

Having dealt with definition of terms, let's look at the facts of the Chinese economy. First, there are vast levels of savings in the Chinese economy. It was because of the vast amount of savings in the Japanese economy that an economic downturn of well over a decade resulted in relatively few bankruptcies and defaults – despite the fact that all the other ingredients of a huge asset-bubble were present.

China's economy is growing much more rapidly than other economies. A growing economy generates real increases in wealth. Rising wealth supports higher asset prices, thus a rapidly growing economy can sustain a much more rapid rate of asset-appreciation.

However, the China-bashers still insist that there is one ingredient of a “bubble” in China: too much leveraged debt, they claim. Given that these same “experts” were totally incapable of spotting excessive leveraged debt in the U.S. economy, it should be of little surprise that once again the experts are totally wrong.

China's four largest banks, which account for nearly half of new loans originated in China this year, have seen their total deposits quadruple while lending has only tripled. It should be obvious even to the inept, China-bashers that if China's biggest banks are taking in $4 of deposits for every $3 dollars that they lend, that they have been getting steadily less-leveraged all year. This is in contrast to the behavior of U.S. banks during the housing bubble (and Wall Street Ponzi-scheme) – where U.S. banks were lending out $30 of debt for every $1 they took in, in deposits. Can you spot a slight difference here in the degree of leverage?

To provide even further assistance in educating the experts, let me introduce them to a real “bubble”: the U.S. bond market. At a time when the U.S. is dumping more supply onto the market than at any time in history, bond prices remain near all-time highs. It is straight out of Economics 101 (presumably the experts managed to pass that course) that when you increase the supply of any good that you depress the price. An extreme increase in supply should result in an extreme decline in price. Thus, the first condition for a bubble is satisfied: a grossly over-valued market.

It is even easier to point out the excessive leverage, because it exists in so many ways. To begin with, the U.S. debt-to-GDP ratio is increasing exponentially – a sure sign of excessive leverage of the U.S. government, by itself. However, there is an even more obvious indicator of excessive leverage: the need for the U.S. government to “buy” much of its own bonds to prop-up the prices. Without any possible doubt, this is the most blatant example of an over-leveraged market on the planet – yet it remains “invisible” to most of the experts (and all the China-bashers).

As a further note, we are seeing very similar behavior in U.S. equity markets, where the Plunge Protection Team permanently pumps-up valuations of U.S. equities through buying-up shares, and in the U.S. housing market – where U.S. banks have also artificially (and radically) reduced supply, through simply holding millions of foreclosed U.S. properties off of the market (see “Fantasy Housing Numbers a Prelude to NEXT U.S. Crash”).

You don't suppose the same group of experts who already totally over-looked one, enormous U.S. asset-bubble could fail to see several more, do you?