Wednesday, March 24, 2010

China's Red Flags

This morning, via Yves Smith, I read a report from Edward Chancellor, China's Red Flags (free registration required) making the case that China is basically a giant speculative bubble that will blow up soon enough to care about.  We've discussed this a couple of times in the past (eg here, here, and here).  I've been open-minded, but leaning a little away from the bubble hypothesis. However, I have to say that Chancellor's report has me leaning more the other way.

In particular, the graph above is pretty alarming (assuming it's basically accurate - I haven't done anything to verify it myself yet).  It basically shows the fraction of production that is going in fixed asset investment - real property, equipment and software, etc.  This makes it appear that the ongoing 8-10% growth in GDP is requiring ever more investment to produce it, and the growth in this ratio is clearly unsustainable - an economy in which 100% of GDP is going to investment cannot happen. So this looks like a clear case of Stein's law - "If something cannot go on forever, it will stop". The graph would suggest the existing trend cannot continue more than another 2-3 years at the outside.

I suggest reading the whole thing.


Datamunger said...

Wow! Apparently they are going to build a society this decade and then maybe move in and live in it next decade?

(assuming it's basically accurate - I haven't done anything to verify it myself yet)

If the spirit should lead you to poke around a bit, I'm sure you'll have a lot of grateful readers!

KLR said...

Thanks Stuart. Registration, yecchh. Read it for free at scribd.

KLR said...

Told you so. ;) Have read a panoply of these horror stories separately, haven't bothered to bookmark it all for future ref, and Chancellor didn't even bother to include environmental or energy issues - China faces staggeringly huge challenges in securing fresh water, for instance.

"The total amount of floor space under construction in China is equivalent in size to Rhode Island." Then there's the spending predicated on future growth, which shortly begat more spending and growth, which begat yet another round of 8% gains. This is more Orwell or Huxley than Keynes, from the people who brought you the Great Leap Forward and backyard iron smelting.

Thought I'd see what the overachievers at Zerohedge have to say, since Tyler D uploaded the paper to scribd:
GMO's Edward Chancellor Discusses China's Red Flags - A Must Read For A Fresh Perspective On China's Bubble

Stuart Staniford said...

KLR - the reason I haven't been convinced before this was it wasn't clear whether the anecdotes added up to a full-blown systemic problem, or were more in the nature of isolated incidents. The graph above certainly gives me serious pause.

I like DM's formulation of building a society this decade and then moving in next decade...

KLR said...

This is the strongest case I've seen for things heading south soon; do you think this is more ominous than those heady days of NINJA loans and out of control CDOs back in 2006? No end of commentators insisted that arrangement was incapable of falling apart, too.

Infrastructure readymades, yes. Like Kunstler's suburbia, perhaps? Love it or hate it, it's there. Reading Chancellor's paper I began to think of the science fiction of Bruce Sterling; his future scenarios are chock full of down to Earth details, including the odd empty city as I recall. Lots of gritty economic activity, too, arms deals going down in places like Azerbaijan. Early on he moved away from the usual dogfights around Neptune. I remember him saying how Chattanooga in reality was weirder in its own way than most SF writers' future visions.

Stuart Staniford said...

Hmmm. I started checking into that graph. The relevant official stats are here, and they show a completely different pattern than Andrew Hunt's graph (I will post a graph of these stats in the morning, but you can get the general idea from glancing at the table at the link.

Now the question is what is the basis for Mr Hunt thinking what he does?

KLR said...

You want the Monthly Data, the link given in the paper (ref 20) is to it, or results obtained therefrom rather, it's a pretty lengthy URL. Your link is to simple annual data with a few headings, the monthly stuff has Investment in Fixed Assets which is what the graph says in its title, as well as a few other fields, "Sales Price Indices of Buildings in 70 Medium-Large Sized Cities (90 sq.meters and below)" for instance.

That annual data has Final Consumption Expenditures divided by GDP, I see, giving a somewhat less staggering value of 48.8% for 2007, but that's close to the Andrew Hunt figures. I see what you mean now - trend is headed down instead of up now. As I said, the Hunt graph is Fixed Assets, that's where the story is - presumably they've shouldered aside almost all other forms of expenditure...somehow. Like they've abandoned any pretense of supporting pensions? Or these books are more cooked than a side of Kung Pao chicken in a blast furnace.

porsena said...

I'm having a non-economist's problem understanding the concept of investment in fixed assets. If a Chinese entrepreneur buys an existing building in Shanghai this month, is the total purchase price an entry into Hunt's column of fixed asset investments for March? Does the transaction contribute the same amount to the version of GDP tabulated in the chart of GDP by Expenditure Approach?