Sunday, February 21, 2010

China: The Mother of All Black Swans?

Commenter Manolo pointed to this presentation from Vitaliy Katsenelson on the possibility of an over-inflated China crashing. I haven't been able to come to a conclusion on how seriously to take this risk, but this seems a good summary of the case for it.

China - The Mother of All Black Swans - By Vitaliy Katsenelson


rks said...

Boils down to "...ignores liabilities –government-backed loans which are in trillions of dollars as well.". But the assets are external and the liabilities internal. It is sort of the reverse of Japan where the government has borrowed from its own people. Do these internal money-go-rounds really matter??

On the other hand we notice that China is cashing in its bonds. People say this is based on sentiment, but maybe they just need the money. When the Aussie dollar crashed after mid 2008 people said it was negative sentiment, but actually it was just people with bills to pay needing to cash in their Aussie assets. All claims that commercial activity is speculation need to be looked at carefully.

Stuart Staniford said...

rks - yeah, that strikes me as the key point too. It seems like the government is the key actor in China - as long as the government is solvent, the rest of the system will continue to function in one way or another. I didn't see a strong enough quantitative argument in Katsenelson's presentation that there is really any threat to govt solvency. OTOH, I don't really know enough to rule it out either.

Burk Braun said...

Thanks, Stuart-

That was quite interesting. However, I'd take the attitude that China's stimulus, at several times that of the US in proportional terms, was very intelligently done on a macro basis- much was wasted, but it showed that China cares about maintaining employment, which is a lot more than can be said for our own fine country.

That stimulus is leading to some inflation now, with additional risks from a shaky and politicized banking system. But overall, my take is that the Chinese internal consumer is well-poised to take up the slack of export decline, thanks again to the smart stimulus above. It was part of a big pivot to reduce dependence on exports, improve internal infrastructure, and maintain employment.

China has plenty of problems, but their development path remains strong, with a huge backlog of peasants and a state terrified of holding them back or seeing them unemployed.

Stuart Staniford said...

One argument I'm toying with: the idea that there's overcapacity seems to be pretty clearly true (I've read extensive discussion of this in the steel context). Eg see the European Chamber paper. If you think a) the Chinese system has created major overcapacity in key industrial commodity processing areas, but also b) will do whatever it takes to maintain growth, and c) US/Euro demand in key export markets for China will slow down due to deleveraging, THEN, it creates incentives for the Chinese state to promote aggressive expansion into new export markets that China doesn't currently dominate in order to take up the slack. Eg, one mitigation of the overcapacity in steel production would be an aggressive push into exporting cars.

This would tend to worsen the position of manufacturing industries in the west.

KLR said...

Everyone should read up about Ordos and the South China Mall. Has any economy sported such Potemkin villages and come out unscathed?

The spikes in electricity demand on Slide 7 are striking, too.

Electricity output up 30 pct during Chinese Lunar New Year holidays
BEIJING, Feb 20, 2010 (Xinhua via COMTEX) --

China's electricity output during the 7-day Chinese Lunar New Year holidays surged almost by 30 percent on year

According to the National Electrical Power Dispatching and Communication Center, daily average electricity output during February 12 to 18 stood at 8.235 billion kilowatt hours, up 28.49 percent on year.

And of course the fact that power demand has gone through the floor is a strong signal too.

Manolo said...

Stuart- thanks for putting it on the table !
I've been trying to get my head around this: we are obviously dealing with a very complex situation. I am quite a bit sceptical of the "Chinese bubble about to burst" theme, after all, it's a totalitarian regime: totalitarianism has helped them achieve their economic success. In a totalitarian society the party in power can say and do anything to maintain their control. 6% GDP growth, or heck, lets make it 9% or 15% or whatever they want.
Nevertheless, China is building an infrastructure that will allow them to leverage and grow the capabilities of their population. With a more modern infrastructure for food, energy, education and communication, they can expand the productivity of each individual tremendously.
Chinese banks, whether at the national, provincial or municipal level, are all state-owned (although some of the larger financial institutions have sold minority interests to foreign banks).
China, as the US, "will never default" because it finances its own debt, in RMB. The US does the same in $. China has no foreign debt. What will probably happen in China is inflation from overheating. Who controls a fractional reserve fiat currency banking system has no effect on the timing or results of a bubble. To the extent they act in a more intelligent manner the end will come sooner rather than later since only by inflating the supply of money and credit at ever increasing rates can the bubble be prolonged. Since they're already showing signs of putting on the brakes (Increasing reserve requirements) the odds of a delayed collapse are dropping rapidly. Actually, the Chinese central authorities are desperately trying to gently deflate.
As would be expected in a command economy, most of the loans made are to support government policy, primarily in infrastructure.
But, State planning is inefficient: just witness China's biggest airport recently built in Guangzhou; it competes with four other newly built facilities of similar size in Zhuhai, Shenzhen and--within 60 miles--Macau and Hong Kong. These airport projects, as well as The Great Mall of China and Ordos City--are all the result of government officials trying to meet GDP growth targets and financed courtesy of the municipal, provincial and national banks.
Which is to say that the Non-performing Loan Portfolio of China, Inc. is in far worse shape than you can imagine. It is this drain on the financial sector's cash flow that is a first spot brewing trouble. Then there is a truly huge real estate bubble, with housing built to a very low standard; it will not stand the test of time....and last, but not least, there is the extreme high environmental cost, see:

Time will tell, but this situation needs to stay high on the radar, and if only because of the symbiotic relationship called Chimerica. Whether you like it or not, America and China are tied to the hip...

Now, if China goes "all out" on car manufacturing for example, we will most probably run very soon into the next predicament: energy.

Especially, if this guy Mike has it right on his new blog:
(Granted, a very long shot, needs a lot of validation, but gets my monthly price of "most original approach")

Datamunger said...

Civilization has been turning farmers into factory workers for a couple of centuries now and has gotten much better at it as the decades have passed. The process is very well understood.

The question is whether it can be reliably turbo-charged by a powerful government with a large supply of farmers?

The chance of a serious blowup has gotta be above single digits. But odds of success don't seem horrible. How does China's growth rate compare with the other Asian tigers in their respective hay-days?