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China Won’t End in Tears Just Yet

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The Economist has an excellent response up to Jim Chanos’ shorting of China. Basically The Economist acknowledges that there are developments that would signal a bubble in developed countries, but argues that:

1)      China’s bubble, if there is one, will not burst for some time;

2)      Its developing nation status makes 80’s Japan-style infrastructure spending a sensible long-term investment, which will lead to a V-shaped recovery afterward.

 

To this, I would respond:

1)      Yes there is, and no, it won’t;

2)      See Keynes's description of what happens in the long term, and no.

 

I don’t disagree that good infrastructure is a great platform for growth. But The Economist overlooks a few factors that are driving Chinese growth right now, that will help precipitate a crash, and that will be a long-term drag on growth afterwards.

1)      The sliding dollar. Despite the warnings of an imminent dollar crash that have been going on as long as I can remember, the dollar is simply too big to fail. One of the biggest trends of this business cycle will be the slow secular dollar decline accelerating and perhaps reaching an inflection point.

2)      Rising commodities. The age of oil isn’t over, but the age of cheap oil is. The price of oil will rise with global recovery, and so will the raw materials that depend on it for extraction and transportation.

3)      Demographics. Although he’s prone to hyperbole, and has made some disastrously poor predictions lately, Harry S. Dent’s core technique of correlating birth waves and economic expansion (see Strauss and Howe) works very well for predicting the timing, if not the size, of expansions and contractions. A glance at China’s population pyramid shows one age-wave reaching its peak-productivity years (around age 45) right around now. China had a birthrate surge in the early 60’s with the main peak in 1963 and a smaller, second peak in 1968. Another age-wave starts around1980, and births peaked around 1987. The Economist says that China’s labor force will start shrinking in 2016.

 

From these, we can make a rough sketch of the next several years:

1)      Rising Chinese demand will cause commodities to trend steadily upward, similar to the early 2000’s. This will cause a lot more pain in developed countries than in China, where new infrastructure can and will be designed around the reality of expensive oil.

2)      The US, heavily leveraged to oil, will stagnate or double-dip. The dollar slide will continue.

3)      China will be stuck between trying to keep commodity import prices down and export prices low. China will not free the yuan yet, but re-peg it higher increasingly often in an attempt to smoothly transition away from export-led growth.

4)      The explosive economic growth this cohort has created is starting to taper off, but not end just yet. The dragon will start to chase its own tail and the Chinese government will continue to pump stimulus into the economy throughout this business cycle in an attempt to re-create the 2000’s. Foreign investors will rush in to help.

5)      By 2016, the Chinese that were born during the Cultural Revolution, came of age under Deng Xiaoping, and built the Chinese economic miracle will be past their peak earnings and productivity years. The working-age population will begin a long-term decline. The Chinese economic miracle, and any bubbles it blew, will be over.

6)      How the crash/recession/soft landing plays out is anyone’s guess, but the demographic and resource drags will pull Chinese growth rates in a recovery back down to earth from the last 20 years, even if absolute GDP growth increases.

 

The moral of this story is that although there may be bubbles in China, they can keep growing for a long, long time. The final pop will be precipitated by high oil prices if it happens sooner, and demographics if it happens later.




Disclosure: No positions