Monday, July 6, 2009


As this economic crisis took hold, all we keep hearing about is how China will keep the global economy moving.

Such are the glowing reports about China, that mainstream analysts are predicting that China will overtake the US economy as the largest in the world by 2020. Currently it represents about one quarter of the enormous US financial machine.

But I don't buy into that argument. China has some very serious problems.

Part of the recent optimism in world markets rests on the belief that China’s fiscal-stimulus package is boosting its economy and that GDP growth could come close to the government’s target of 8% this year. Some economists, however, suspect that the figures overstate the economy’s true growth rate and that Beijing would report 8% regardless of the truth.

While it is true that China's stock markets are surging, and it's true that China is buying commodities... there are structural reasons for this and they raise some serious red flags (pardon the pun).

First of all China has been pumping it's own stimulus money into the econony. To the point were some fear China's banks are veering out of control. The half-reformed economy of the People's Republic cannot absorb the $1,000bn blitz of new lending issued since December.

Money is leaking from stimulus projects directly into Shanghai's stock market (many are already calling it a huge, developing bubble). The money is also being used to keep bankrupt builders on life support.

That money is doing very little to help lift the world economy out of slump.

Fitch Ratings - an international ratings agency who provides issuer and bond ratings, research and surveillance on banks - has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than suspected.

The China Government is so hellbent on meeting its growth target of 8% that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree" . The agency says China's monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye.

And all the money is funding an illusion of a booming economy.

Take China's current penchant for buying commodities. Our markets are hearlding this a sign the Chinese economy is in full production mode.

It isn't.

China has been on a buying spree to stockpile and build its inventories of metals, including 235,000 tonnes of copper, over recent months. China also bought "590,000 tonnes of aluminium, 159,000 tonnes of zinc, 30 tonnes of indium and 5,000 tonnes of titanium", said Yu Dongming, who works in the National Development and Reform Commission's industry department.

Many analysts believe this is one way China can diversify it's huge holdings of American dollars without bringing large atention to it's activities.

So much for commodities fueling China's economic engine.

Besides buying commodities, China's stimulus money is fueling other bubble conditions.

China's banks have issued a staggering 5.2 trillion yuan ($761 billion US) in new loans in January to April - equivalent to 17% of the country's gross domestic product in 2008.

But the pace of lending is faster than infrastructure projects could possibly be started up, Fitch Ratings banking analyst Charlene Chu said in a conference call. One warning sign, she said, was an admission in the central bank's quarterly report that regulators were looking into where all the bank loans are going.

"We know this is not being totally dictated by the government, because if it were they would know exactly where it is going," Chu said.

Recently China's bank regulators issued new draft rules that would impose much stricter controls on most loans - requiring lenders to hold onto the money and pay it directly to companies contracted to provide materials and services for projects.

The aim is to prevent funds from being diverted to other investments or misuse - a problem noted in a recent report by China's National Audit Office.

The surge in lending early this year was partly driven by the determination of banks to meet profit targets by ramping up the volume of loans to help make up for shrinking interest-rate margins, Chu said.

Meanwhile, the glut of money available has piled more pressure on loan profit margins, obliging banks to lend even more to keep up.

"This just becomes a vicious cycle," Chu said.

Beyond these bubble concerns are serious internal problems.

China's countryside people do not enjoy any of the economical advances in China. This means two things.

One, a mass immigration from the countryside to the big cities. China doesn’t encourage mobility and restricts the movement of the population through preventing essential services from "illegal immigrants". The result - those immigrants have to live in sub-human conditions in ghettos around the big cities. The number of those immigrants is estimated at 150-200 million.

Second, there’s a growing disapproval among the low rank factory workers that causes strikes and demonstrations, which are banned by the Chinese law. According to the security ministry, the number of demonstrations in China have risen from 30,000 in 1999 to 75,000 in 2004. The number of demonstrators has multiplied by 8.

Today's newscasts have coverage of one such violent clash with authorities.

Then there is China's own financial deficit

The "one child" policy has created a social problem, that is apparent in the old-young population ratio. As of today, 11% of China (150 million) are over 60, with estimates of 30% by 2050. While in 1980 there were 13 workers per a pensioner, in 2003 it went down to 3.

Of all the population, only 13% have pension plans. The financial deficit that was 4.5 billion US$ in 2000 has exploded to a 100 billion US$ in 2005.

The world-bank’s simulation has estimated China’s deficit in 2050 to be 1 trillion US$. Hundreds of millions of Chinese approaching pension age might become a real burden on the developing economy.

I could go on and on.

The bottom line is that China is not the looming economic superpower that will crush the United States economy twenty years from now.

Will it get bigger?: certainly.

Will it become the world's dominant power?: I don't think so.


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