China’s Economy is the Greatest Bubble on Earth

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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.
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30 Comments on "China’s Economy is the Greatest Bubble on Earth"

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Coffee Addict
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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… Read more »
Biker Pete
Guest

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! :)

Andy
Guest

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

Curt
Guest

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

baal
Guest
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… Read more »
Biker Pete
Guest

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… .

Bertie
Guest

this crash in China might not come for 10 years or more?

Biker Pete
Guest

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… . ;) )

Stillgotshoeson
Guest

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…

Biker Pete
Guest

Think you’re right, Shoes.

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

GB
Guest
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.… Read more »
Sti9llgotshoeson
Guest
@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… Read more »
SV
Guest
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… Read more »
Tony Scott
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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… Read more »
Biker Pete
Guest
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… Read more »
GB
Guest

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

Biker Pete
Guest

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… .

SV
Guest
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… Read more »
fred
Guest

“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!

Biker Pete
Guest
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… Read more »
Lachlan
Guest

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?

Biker Pete
Guest

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…!~ ;)

SV
Guest
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… Read more »
Biker Pete
Guest

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… .

Lachlan
Guest
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… Read more »
Lachlan
Guest

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.

John
Guest

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

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

http://www.watoday.com.au/business/prosperity-on-rise-as-economy-shows-signs-of-recovery-20100321-qo40.html

SV
Guest

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

John
Guest

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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