Analyst: China's Days of System Stability are Numbered

I have been warning here at EPJ, and especially at the EPJ Daily Alert that much of the boom in China has been a fraud. It is centrally planned madness, where entire uninhabited cities have been built just so a positive ding in the GDP number is recorded. There are pockets of a true free market boom in China, but there are huge pockets of total central planned sectors, with the results you would expect, incredible misallocations. As I have reported, even vice-president Joe Biden has warned about the Chinese economy and the 30 million plus vacant apartments.

Now a new report by Tim Staermose, Chief Investment Strategist at the SovereignMan.com suggests that China may be very near the crash phase. He writes:

For a few decades now, the Communist Party in China has had an implicit social and political contract with the Chinese populous for decades, which goes something like:

“We will deliver economic growth and improvements in your material living standards. You will meekly do as you are told, refrain from dissent, work hard, save a huge percentage of your money, and ignore obvious corruption.”

While nearly everyone in China has benefited to some degree under this current “system,” the wheels are definitely starting to come off. Official GDP numbers are now slowing, real estate prices are falling, and inflation is quickening.

Now, I’ve made no secret that I’m decidedly bearish on China’s medium-term prospects. After my trip there back in June to conduct some good old-fashioned “boots on the ground” research, I wrote extensively about the massive overbuilding of apartments, office blocks, and all manner of infrastructure on an almost unimaginable scale.

Put simply, every year since 2005, more than 50% of China’s GDP has consisted of construction-related spending. The law of diminishing marginal returns says this simply cannot continue.

It represents a misallocation of the household sector’s hard-earned savings on a colossal scale, and I believe it will end badly. Not a day goes by that there aren’t riots and protests somewhere in China (including cyberspace) as the downtrodden man in the street reaches his froggy boiling point.

Increasingly in China, though, those who see the writing on the wall can see that the days of system stability are numbered. And they’re not hanging around.

For a number of years, mainland Chinese buyers have accounted for nearly all new apartment sales in Melbourne and Sydney. On numbers I’ve seen, they have been investing between A$2 billion and $3 billion a year.

An increasing number of mainland Chinese are establishing permanent residency and sending their child(ren) to school and university in Australia. And Simon recently reported that from an offshore strategies conference in Shanghai that the room was packed full of Chinese people learning how to diversify abroad.

They all want to have their options open when China’s economy and political system hits turbulence.

Judging by the poor economic numbers coming out of China, this day of reckoning is drawing ever closer. One alarming indicator is that the Chinese renminbi has traded down to the lower limit of its strictly controlled trading band for SEVEN TRADING SESSIONS IN A ROW.

This suggests that there is more money leaving China than being earned from overseas trade or invested there. The exchange rate may be only one simple indicator, but it’s a great barometer for what is going on: China is not going to be the savior of the global economy, but rather another casualty.

Indeed, the Chinese crash is going to be huge. The wealth of those owning the vacant apartments is going to crash to zero. What's more, unlike the real estate crash in the US, the reports I am getting are that much of the construction that has gone on in China has been of very poor quality. Tens of millions of the "vacant apartments" may not be inhabitable at any price. Given that this was all done under the current Chinese regime, it is difficult to believe that they have any where near the sophistication to get out of the mess. Violent crackdowns on desperate people rioting can not be ruled out.

Here's billionaire short-seller Jim Chanos on the real estate part of the developing crisis. Note: Chanos is very negative on the real estate situation in China, and correctly so, but he is an optimist compared to my view:

Chanos: China is “on a treadmill to hell,”

China’s property market is a bubble that may burst by as early as this year, according to hedge fund manager James Chanos.

The world’s third-biggest economy may need to keep up the pace of property investment because up to 60 percent of its gross domestic product relies on construction, said Chanos. The bubble may begin to “run its course” in late-2010 or 2011, he said in an interview on “The Charlie Rose Show” that will air on PBS and Bloomberg TV.

China is “on a treadmill to hell,” said Chanos, who said in January the nation is Dubai times a thousand. “They can’t afford to get off this heroin of property development. It is the only thing keeping the economic growth numbers growing.”

Chanos is correct about the Chinese housing market being a bubble, however, it is always tough to call the top on these things. As I have stated before, they can go on for years.

The one indication that the bust may come sooner rather than later are continued indications that China may be slowing money supply growth. If this is indeed the case, and it is very near impossible for an outsider to get a sense for how accurate the money supply numbers from China are, then the bubble could break very soon.