Tuesday, March 30, 2010

>China Collapse: Are the Bears Out to Lunch?

China has weathered the global financial crisis extremely well. Exports rose 45.7% in February
from a year ago and GDP growth near 10% through 2010 is likely (Charts 1 & 2). In contrast to most developed nations, the Chinese financial system has shown few signs of strain during the downturn. Non‐performing loans (NPLs) are at record low levels and capital ratios at publicly listed banks have been beefed up with rights offerings of around 250 billion yuan over the last few months. Despite these signs of strength, there is a rising chorus of sceptics who argue that the recovery is hollow and that the miraculous growth rates China has achieved over the last 15 years will soon be over.

Of course, these arguments have been made many times during China’s transformation. At its
most basic level, the bear argument is derived from the fact that China has had what is probably the biggest, longest economic boom in history. The logic applied is that the bigger the boom, the bigger the bust. Here are the key arguments supporting the bear case:

Imbalances between China and its debtors have grown relentlessly, which will eventually crack the undervalued rmb and force a limit to U.S. indebtedness.

Excessive dependence on exports combined with a failure to adequately develop domestic consumption leaves China vulnerable to external shocks.

Overinvestment has led to significant overcapacity; corporate profits are threatened and the banking sector is vulnerable to a sharp increase in non‐performing loans, particularly after the credit boom and government stimulus in 2009.

Excess liquidity and volatile capital inflows are leading to frothy asset markets particularly in stocks and real estate.

Inflation is on the rise and the risk of monetary tightening is growing.

Finally, shady accounting and political interference undermines confidence in official statistics and is probably hiding some nasty surprises.

The bear story has a lot of adherents and it is based on assumptions that all the above points
have some validity. A reckoning may well come to pass at some future point but it won’t be soon. Over the time horizon of most investors, it has a low enough probability of occurrence that people should not pay much attention to it. Here’s why.

China’s U.S. $2.2 trillion build‐up of reserves and the flipside—American overindulgence and
excessive debt accumulation—are both clearly unsustainable, yet there are few signs of strain between China and its debtors besides political noise. Despite the financial crisis and the dramatic slowdown in trade between the U.S. and China, the currency peg is intact and the dollar continues to defy its sceptics. China’s stimulus has been successful in bridging the export slowdown with little damage to public.

To read the full report: CHINA COLLAPSE