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I am a longtime China bear. The basic reasons for my skepticism are (a) an economy that relies on extensive government intervention and direct and indirect control of prices will inevitably experience massive misallocations of resources that will eventually require substantial rebalancing (“recalculation” in Austrian terms), and (b) the financial sector is particularly distorted, and myriad credit losses have been papered over in schemes that would make Enron’s Andy Fastow blush. Massive fixed investment can generate remarkable increases in GDP, but there is reason to be skeptical about the efficiency of these investments.

Initial signs of cracking include an evident imminent collapse in the housing bubble, a steep selloff in the stock market, and growing problems in the vast shadow banking sector and municipal finance.

A couple of pieces that discuss this include this article and an interview with Jim Chanos. From the article:

An alarming report from Schroders said Chinese banking operates in a “twilight zone” of phony accounting and shadow money and it’s all coming apart. “Almost half of all credit creation in China is off balance sheet,” wrote the team at Schroders.

They think this situation could unravel “over the next three to six months,” producing a huge crisis with international implications. Most Chinese banks, they predict, will end up as “zombie banks.”

. . . .

Albert Edwards at SG Securities warned that China’s long-running investment boom has no precedent and is bound to burst. “China is a ‘freak’ economy,” he wrote. “To my knowledge no other economy in history has experienced such high investment/GDP ratios and seen so many sequential years of strong investment growth.” The Asian tigers in the 1990s? Japan? Nothing comes close, says Edwards.

The Chanos interview is definitely worth watching. The interviewer does her best to push the China case, but Chanos smacks her down pretty effectively. And there’s a bonus line in the interview. When asked about China helping Europe, Chanos responds that Sarkozy is the worst possible person to send to ask them for money. And from initial reports, it appears that he’s right. Although methinks that anybody the Euros could have sent would have been received just as coldly. What could they possibly offer?

What happens in China definitely bears watching (sorry–couldn’t resist). Financial steroids and narcotics help maintain appearances for a while, a la Michael Jackson, but eventually it all falls apart. And in a place as big as China, with its seething social undercurrents, that would not be pretty.

Source: China: Initial Signs Of Cracking