China’s Economy is the Greatest Bubble on Earth


Australia didn’t miss out on the first part of the Global Financial Crisis and it’s not going to miss out on the second part. The second part is coming. And it could be worse than the first. That, in a nutshell, is the message of today’s Daily Reckoning.

For proof of the first claim – that excessive leverage and too much debt cost Australian investors billion of dollars – read today’s essay “Pigs at the Trough” by guest essayist Adam Schwab. Adam’s got a new book out by the same name. And he makes a great point: Australia may not have learned much from the first round of the GFC.

But is there really going to be a round two? Well, if the first incorrect assumption was that Australia didn’t have a bad debt problem, the second assumption is probably even more dangerous. It’s more dangerous because it’s the single most unexamined assumption behind much of Australia’s economic prosperity. The assumption is that we’ll always have China.

A growing number of professional investors are betting against China. It’s true that all of these investors – short-seller Jim Chanos, our friend Dr. Marc Faber, Harvard Professor Ken Rogoff – are all talking their book to some extent. We all do that all the time. But that doesn’t invalidate our arguments.

And the argument is simple: China’s economy is the Greatest Bubble on Earth. James Rickards, the former General Counsel for the famously-failed hedge fund Long-Term Capital Management, told Bloomberg that China is in the midst of “the greatest bubble in history.” He said the Chinese central bank’s balance sheet, “resembles that of a hedge fund buying dollars and short-selling the yuan.” “As I see it, it is the greatest bubble in history with the most massive misallocation of wealth,” he told the Asset Allocation Summit Asia 2010.

Students of the Austrian School of Economics would identify with the comment. Credit bubbles – and the world has arguably been in one long once since the U.S. dollar could no longer be redeemed for gold internationally in 1971 – know that credit creates excess demand. It gives producers a false impression of the consumer appetite for goods and services. Real resources are poured into providing people with products they buy with debt-based money.

When the bubble bursts, the demand goes too. This is why Australia’s government, slavishly obeying Keynesian dogma, has tried to “bring demand forward” or “support aggregate demand”
by giving away the nation’s surplus. And once it was finished doing that, it borrowed (stole) from the future in order to support demand.

But this just perpetuates the misallocation of resources (in this case, stealing tomorrow’s savings to support today’s consumption.) In China’s case, however, the misallocation of resources is even more impressive. There is massive over-capacity in commercial real estate with millions of square meters of vacancies. Whole cities lie empty.

These cities and office buildings were made with Australian iron ore and coking coal. If China’s miracle economy (regularly achieving politically mandated 8% GDP growth to support employment) is really the world’s largest collection of misallocated resources ever, then what do you think will happen to Australia’s economy?

On the verge of another big increase in contract iron ore prices, it may seem like a strange time to ask the question. But it’s probably the most important question Australian investors could ask themselves this year. “What can I do to protect myself against a crash in China?”

The possibility may seem remote. But remember, no one in the mainstream media or economics profession warned you of the GFC either, did they? Even if you think it’s unlikely or absurd, it’s probably something you should think about a bit. We’ve thought about it and we think the best answer is to retire now.

But what does that really mean? It means you should own a lot fewer stocks. But yes, that does contradict the rosy projections for Australia’s super annuation system. Australia’s super system is projected to have nearly $5 trillion in assets by 2025 according to an article in today’s Australian.

Chris Bowen, the Minister of Financial Services, spoke by video to a conference in Brisbane. He didn’t say where all the super money would go specifically. But he did say, “This might mean greater investment in infrastructure assets, provided a stable pipeline of opportunities was available.”

Now you may want your money to go into infrastructure assets. And if you do, more power to you. After all, they are tangible assets. But you can’t put a bridge in your refrigerator. Portable tangibility – wealth you can wear, store, or trade – is the name of the game as you reduce your allocation to deflating financial assets ahead of the hyperinflation. More on that Big Crash two-step in Friday’s letter.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. The key question is when and there may be earlier triggers than China.

    The focus of the CCP will be to maintain national cohesion, at any cost, and wages can and will be dropped (at a flick of a switch) in many industries to retain employment levels. Certainly, many resources may be misallocated by Government spending but the extent to which this happens or not cannot be judged easily.

    What will really hurt China is the continued devaluation of the USD in coming years thus their desire to spend as many USD’s as they can ATM. The loan books may well be manipulated and over drawn BUT the Government will prop up their banks to the extent required while also trying to dampen growth in bubble sectors. Indeed talking about China may is akin to talking about Europe (defined as that region west of the Caucus mountains. In China, as in Europe, the good is mixed up with the bad and the ugly. It is impossible for me to discern which forces of economic adjustment will have the greatest economic impact and what that impact will be.

    My gut feel is that things will continue muddle along in China until the USD (and Euro) tank beyond a tipping point would lead to economic contraction in China and other creditor countries. And of course spending by China and other creditors of that pile of dollars and not replacing them a sufficient number treasuries will speed up the process.

    I could guess wildly that it could (or should) be a number of years before Chinese bubbles start to pop on their own accord BUT market sentiment could accellerate or delay such and event event significantly. In addition, I don’t underestimate the economic ruthlessness which could be applied by the Government of China from its’coercive power and its’ pile of foreign exchange and gold.

    On another Chinese note, Mr Albanese will soon need to apologise, make corporate undertakings to do better and demonstrate significant financial good will to some good causes whether or not he thinks RIO was in the wrong.

    Sorry but I’m fence sitting on the China bubble issue (for the moment).


    Coffee Addict
    March 18, 2010
  2. Dan: “We’ve thought about it and we think the best answer is to retire now.”

    Probably very few here are well-placed to do so, Dan. As I type I’m listening to Joyce attempting to force Conroy to spill the beans on the KRH. We’re destined to get just dribs-and-drabs of KRH before 11th May… and you _may or may not_ be right in your recommendation. (Where’s Ned to bring us up-to-date??!)

    The Confucian curse is more appropriate now than at any time in our lives! :)

    Biker Pete
    March 18, 2010
  3. Hey did you guys notice the Stockland CEO say that his company’s product, house and land packages, were unaffordable for the average person? His solution was to build and sell garages in place of houses. Apparently their houses are too large, but could have fooled me last time I walked through a Stockland display home. Welcome to China, Australian – style

  4. Yes, China’s market is going to crash and it’s going to take world markets with it. Time to move to cash.

  5. china has never been a capitalist country. it may be free market leaning.. but…. don’t bebt on bernake of kudlow to cover your ass.

    as to Von Mises and the gold standard: any stable society can issue stable currency, but few prolific societies ran on anything but the silver standard. frankly as i see it, gold has too much value in elecronics and the energy medicince of the near future to waste it as a mere commodity of exchange.

    china has always been the mother of all bubbles, phoniness, morphine, rare earths, gold, fossils, quartz, germanium, and all sorts of factory produce. why piss on a proven winner, just because your not a communist…

    btw, i still love america, and the american way, just because the flushers in washington d.c. don’t work anymore, just proves that grandpa and the real conservative party were, in fact, correct…..

    stick it up your arse you rich republican pukes.

  6. Andy, I had a look at Stockland’s offerings in WA, after reading your comment. Their WA business appears to be doing fairly well, with some whole ‘house and land subdivisions’ entirely _sold out_ here.

    Property affordability certainly varies across Australia… .

    Biker Pete
    March 19, 2010
  7. this crash in China might not come for 10 years or more?

  8. Surprised there’s so little press about Google bailing from China…
    Initially the Chinese government may feel relieved, but Google’s evolution in the next decade may see enormous pressure on China to persuade them back.
    (Not that I think Google would need much persuasion… . ;) )

    Biker Pete
    March 19, 2010
  9. China’s evolution in the next decade may see enormous pressure on China..

    Civil unrest down the track is not out of the question for China.. They are slowly heading towards western culture and ideals of capitalism, especially the younger generation and the middle classes so the worl could well see a push away from communism in China.. a push that will be restricted (violently I am guessing).. time frame is open though.. we may see a couple of attempts at it…

    March 19, 2010
  10. Think you’re right, Shoes.

    Potential political instability is the real threat to China’s growth.

    Biker Pete
    March 19, 2010
  11. There are four forces working against China’s export orientated economy at the moment

    1. The factories in coastal cities are having problems with labour shortages – it seems no one in china wants to work for peanuts anymore
    2. The US government is raging over the peg to the dollar and will likely slap tariffs on chinese goods
    3. Inflation is starting to increase as it should after last years spending spree
    4. Increasing costs of inputs – raw materials

    All four forces at once is putting tremendous pressure on the the price of chinese goods making them more expensive. China being the manufacturing hub of the world will likely suffer a serious correction if their manufacturing industry sees a significant decrease.

    The day of reckoning is fast approaching IMO…

  12. @GB The company I work for went built a factory in Shanghai a couple of years ago.. Wages have doubled in roughly 2 years there.
    Another problem with labour is alot of villagers come in to the big city on promises of big money (well big compared to what they get back on the farms) however a many companies that start up in China fail first year so the villagers go back to their farms.. tell the others it is not worth it and they don’t go back

    your other 3 comments are bang on the money as well…. many companies move to offshore locations to get cheaper labour or promises of tax benefits, the problem with China for many companies is they have not had time to recoup investment costs before the other costs have started to rise, and further to that.. China is Nationalised.. most companies can now not get their equipment out.. it stays in China. Your business may fail but all your plant and equipment stays in China.. Companies may already be looking to India and South Africa as their next “cheap source”
    with China being a written off in a couple of years.. not all comapnaies for sure but certainly some of the bigger ones.
    Australia and America had large manufactoring industries.. thay moved off to cheaper countries.. post war Japan boomed with investments from American companies after cheap labour, labour and costs got to high in Japan and manufactoring moved from Japan to China, Thailand, Malaysia, thses countries are/will get expensive more quickly than Japan did.. rate of global growth and consumption dictates this.. then the next cheapest country becomes the flavour of the balance sheet…

    March 21, 2010
  13. Dan D: “What can I do to protect myself against a crash in China?”

    My question: why should I?

    Apart from short-term pain crash in China might be a good thing for Australia. We will get off the resource and finance drugs, have a cold turkey for a year or so, A$ will drop to about 0.50US$ and then we will realise that we can do so much more.

    Apart from minerals, we used to export agricultural produce, including rice to China, computer software, and high-tech machinery. There are other countries in Asia, besides China, in case you did not notice and they want our technologies, software etc, even if their labour cost is much lower.

    Cheap labour does not equal low cost quality product. Ask Qantas – they outsourced their maintenance to Malaysian airlines and got a big hole in one of there jumbos. Ask CBA – they outsourced processing to India and one day all debits/credits were performed twice on all accounts.

    I found several listed software companies with existing products and high-profile clients in Asia. They do their R&D work here. High $ rate decimated their profits, but they are still profitable. There are other examples in agriculture etc.

    Why would not such companies benefit from bursting of China bubble?

    I would also expect to see some return of manufacturing, especially in complex products.

    Yes, the mad scramble to dig up more holes will slow down somewhat, but it will only take it to “normal” levels.

  14. This is one of the best short articles on elements our present economic state I have read in quite a while. I follow about a dozen or so newsletters and blogs and have noticed increasing mentions of ideas that are in line with the thinking of Austrian School Economics. I have been a reader of material from the Mises Institute for some years so an inclination towards that area of thought has probably drawn me to the books of Bill Bonner, Addison Wiggin and your sites such as yours.

    When I use this material as an additional overlay to that of Steve Keen and Robert Prechter I find that an interesting view of the world comes into focus. It is a view almost diametrically opposed to that of politicians, economists and most mainstream media commentators, so much so that I sometimes feel like I’m living on another planet.

    Tony Scott
    March 21, 2010
  15. Some great points made here. Any crash will present opportunities, as the last correction amply demonstrated.

    My own query relates to the final point you’ve made, SV: “…the mad scramble to dig up more holes will slow down somewhat, but it will only take it to “normal” levels… ”

    My own perception about ‘normal’ levels is that inflation is _always_ with us. Here I’m choosing not to relate income to purchasing power, although to elect not to is illusory. However reduction of personal debt with what are effectively 50c dollars is an effective wealth-building strategy, over time; particularly if the asset is income-producing.

    Technological developments will be interesting. Three decades ago I’d have laughed at the idea of paying a company for a monthly mobile phone service I didn’t need. Now I see that Better Place visualises that same kind of plan for electric car batteries by 2020. In the US, WalMart is considering free recharge facilities in their immense car parks. Really cheap transport may change the demographics… where we live, amount of disposable income, leisure activities… .

    Again, my optimism may be misplaced here… . :)

    Biker Pete
    March 21, 2010
  16. SV – so when one door closes another one opens?

    so its just a matter of working out what will grow if there is a slowdown

  17. If it truly is Armageddon, Maslow’s hierarchy gives us a few clues. ;)

    If it’s a mere correction, the two old, opposing adages about ‘buying low’ and ‘catching the falling knife’ come into play… .

    Biker Pete
    March 21, 2010
  18. Biker Pete – “dig up more holes will slow down”: I was referring to a likely reduction of exploration and mining activities, but I did not quite understand your question or point; please re-phrase it.

    Of course, where we are now, it is sensible to reduce one’s debt. Most people’s incomes are not safe, especially in boom industries.

    If countries start defaulting, international debt markets will seize up again and prices of debt-funded assets will drop, no matter whether they are income producing or not. ASX200 will drop, but that’s mainly big banks (debt-funded), big miners and Telstra.

    A$ will drop, and this will cushion miners’ wages and their employers’ profits. And it will also make a lot of other exporting industries viable.

    GB – when the going gets tough, the tough get going. “Tough” are the companies that already make a profit in a competitive environment, have positive cash flow and healthy bank balances and provide something essential, either for consumers or businesses or (even better) governments. I like software exporters with lots of costs in A$ – they are super-leveraged to drop in A$ – and at least I understand something about software.

    I am with Biker – need to watch technology.
    More to that – the last decade was about financial innovations. Time to move on – start real innovations.

  19. “btw, i still love america, and the american way, just because the flushers in washington d.c. don’t work anymore, just proves that grandpa and the real conservative party were, in fact, correct…..

    stick it up your arse you rich republican pukes. ”

    hi baal,what will happen if China had fight with America about rate exchange but China won’t buy USA longterm bond any more? massive and long time deficit of financial treasure is extremely dangerous!at this point,China do better.i think!

  20. My query was regarding “normal” levels, SV. I’m not sure we’d just close all the mines if prices fell, having watched stockpiling continue when this has happened in the past. Seems to be some economic rationale at play there… perhaps flat(ter) production costs(?)

    I’d actually thought the ‘it’ you were referring to meant the economy in general… that a period of deflation would follow… .

    For a couple of decades, we’ve made lists of projected future ‘costs’ of everyday items five years hence… with friends, on New Year’s Eve. These are sealed, with an opening date, in my safe. Everything from the price of a loaf of bread, a Holden car, interest rate. To make it even more interesting we’ve included future prime minister, winner(s) of sporting events, etc, etc. Winner gets a good bottle of top plonk each year.

    What we’ve found, during more than twenty years is that nothing has fallen in price. The GFC made no difference at all. Admittedly, we’d have been wise(r) to include items such as computers, television, etc. I guess we’d never fully comprehended how cheap such innovations would progressively become, relative to income.

    While it has never yet been the case for cars, electric vehicles will, in time, fall in price… in the same way as solar panels have. The only ‘alternative’ vehicle I’m really interested in is the Tesla… and my leash is a little too short to permit its purchase(!) At half the price (and we may well see that) I’d be driving one.

    Biker Pete
    March 21, 2010
  21. A China bust would be bad for me and all Aussies per income. However I think other things may take precedence before China namely Europe. The DXY started to breakupwards from its low 80s consolidation on Friday. Maybe its the start of a new breakout? Is more drama going to unfold in Europe this week more likely?

  22. Frankly, not much positive seems likely for the whole northern hemisphere.
    I think many here forget that, in addition to presenting opportunities, that long-awaited major crash might, in fact, have some negative personal impact.

    Maybe, as Dan suggested recently, retirement is not a bad option. :)
    Always have been the shy retiring type…!~ ;)

    Biker Pete
    March 21, 2010
  23. BP – no I don’t think WA will close all the mines at all, just that it will dig less new ones. Less skilled labour shortage, somewhat lower wages – but not a bust. I think we are in agreement here, actually.

    Interesting about your predictions… completely understand the logic. But we are told that what we are witnessing is the end of a super-cycle that started right after WWII. History is then not a good basis for predictions. Go figure…

    Lachlan, outside of re-adjustment period of a few years, what negatives do you see for most working Australians? I mean, even if your income in $$$ drops, does this mean that you will be less able to:
    – find employment or business income
    – feed and shelter your family
    – have good time with friends
    – fulfill your dreams and ambitions.

    I can see one positive of every worker having somewhat lower income – we all will pay less tax!

  24. SV: “I can see one positive of every worker having somewhat lower income – we all will pay less tax!”

    I once declined promotion because I believed that, SV. I just didn’t know how tax worked at that time… .

    Biker Pete
    March 21, 2010
  25. SV I like the tone of your posts. I am an optimist but in a sense that precludes a continuation of the status quo. I believe every cloud does have a silver lining though some wont reach for it.
    Some of the future hopes (post crash) I have include
    *a return to focus on industry and agriculture (things we really need)
    *less welfare leading to increased self reliance, family values and respect for others.
    * people rediscovering simple things and types of happiness they lost in the struggle to keep up with Jones’ during the easy credit years.

    Nobody much likes to talk about such things. Suffering will come first but pointless spending a minute to worry about it. Frankly I just dont see that the material race has made happier on average. Its not that money or possessions are bad in my view, quite the opposite. Just that people fear missing out. When living standards accelerate like they did peoples egos drive them to compete for more and more (Im not excluding myself) and they fail to look to the side a little…at what they’re losing, or what they’ve already lost and what they are becoming and the hole they are digging.
    Catchya later SV
    Then again I could be wrong and lovely bubbles of nothing will continue forever.

  26. Oops just to make clear. If the status quo remains Im still optimistic. Despite some setbacks the status quo is currently providing me a set of opportunities I am happy with.

  27. Lachlan: “If the status quo remains I’m still optimistic.”

    It looks like the status is more than quoing, Lachlan:

  28. Troy, 11 century BC. Upon seeing the horse Laocoön exclaimed: “Beware of Greeks bearing gifts”.

  29. Troy, 11.000005 century BC. Upon seeing the horse the Trojans replied: “Don’t look a gift house in the mouth, Laocoön!”


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