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China Risks Repeating US Mistakes

Despite clear evidence that housing has rebounded significantly in China (see graph at and that the stock market has jumped dramatically, China recently proclaimed that it would continue the stimulus.
            This can be viewed in a couple of ways. First, this is a clearly inflationary policy that stimulates domestic demand which could be helpful for China. It would increase employment, increase wages for the lower tier of society, and provide goods for local Chinese. The policy would also increase costs for Chinese exporters and make the current exchange rate more appropriate. In fact, this is another way of doing what I suggested earlier; the Chinese will seek improvement of their domestic situation at the expense of exporting cheap goods to the US.
            Second, this policy risks further inflating the bubble in China. China behaves that, without a minimum 6-7% growth, it can not survive. In other words, a significant part of the economy is tied to the economy growing. Obviously this can not continue indefinitely. In fact, the change from high growth to stagnation is exactly what caused much of the drop in the US economy (once home builders stopped building, they stopped buying lumber and building materials, which meant that companies that make these were hurt in turn etc.) The choice to reinflate prices instead of allow them to continue to fall slowly has meant that prices now have further to fall. In fact some warn that prices may halve by 2011. Significant inflation could stop this by increasing income available to average Chinese (the cost of housing represents ~60% of income for many), but the distance the housing prices need to come down make this somewhat unlikely.
            The outcome of a housing price crash could be just as dramatic as it was in the US and the rest of the world. With dramatically dropping prices for existing construction, development will virtually cease. Without growth and construction related employment to help prop up the economy, income to purchase housing will decrease and the entire viscous circle will be in full force. What the current situation teaches us is that governments and their banks who try to inflate a bubble (the Fed since the late 1990’s) to get out of a short term problem (LTCM or 9/11) just delay the problem until a few years later.
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