Is China Poised for a Crash?

Jacob Harper |

One Aug 8 China will begin releasing detailed data concerning the status of the nation’s economy: inflation levels, industrial output, retail sales. The country has experienced massive economic growth since the early 2000s, and analysts, for the most part, expect the positive trends to continue through 2013.

Not all the numbers out of the East have been rosy. In June, the country reported declining exports and slowing industrial production. The country’s construction boom has also been singled out as being suspect, as the country continues to build high-speed rails that go nowhere and massive cities that largely remain uninhabited.

The country’s boom is eerily reminiscent of what happened to Japan prior to its “Lost Decade.” If what happened there also happens in China, the second largest economy in the world could be at the end of its spectacular run, and in fact could be nearing a total collapse.

China’s Lending Spree

China’s economy is unique in the world in that it is a free market, albeit one that is tightly controlled by the central government. This fact was highlighted when growth slowed in July and the government responded by saying they would lower small business taxes and inflate domestic consumption.

This follows a series of stimulus and “credit binges” the country had gone on in earlier instances where the country felt actual growth was underperforming projections. China has experienced a proliferation of “shadow banking” and usury practices which have devalued the yuan, and has proven difficult to manage.

China has injected massive amounts of capital into the private sector, by some accounts up to $2.5 trillion US between 2008-2011. This capital is lent out to construction companies, who build these projects that go nowhere.

China could clamp down harder on the loose credit. But if that were happen, it could slow growth – or even the appearance of growth – to a complete halt.

The China Bears and Bulls

Gordon Chang, author of the book “The Coming Collapse of China,” says China might only be growing 2 or 3 percent, instead of the 7 to 8 percent the country consistently claims, by looking not at construction, but electricity usage, which he feels more accurately reflects growth. And In June,  Vasu Menon, head of content and research at OCBC Bank Ltd. in Singapore, told Bloomberg TV "China has had a credit binge for way too long" and could not continue to simultaneously clamp down on shadow banking without curbing credit.

Perhaps the most famous China bear is famed short-seller Jim Chanos. Chanos is perhaps best known for predicting the collapse of Enron, citing the company's loopy accounting practices. He has never been shy about applying this thinking to the entire country of China.

Chanos said, “bubbles are best identified by credit excesses, not valuation excesses. And there's no bigger credit excess than in China.” In a presentation in May, Chanos didn’t call for a catastrophic collapse like Enron experienced. But he did say a correction was coming, and coming soon.

Despite the predictions of pessimists like Chanos, prior to hard data becoming available several analysts are keen on the country. JPMorgan & Co. (JPM) Private Bank Chief Investment Strategist Kate Moore calls the country “screamingly cheap” and a 40 percent discount for developing markets. She specifically cites the country’s favorable forward earnings ratio of 8.5 percent.

The Bubble: Deflate, Pop, Or Neither

Bulls further cite the fact that the bears have been calling for a Chinese crash for some time, and as that has failed to materialize, the fears are overstated. That, while a bubble might be occurring, China’s tight control over the economy allows them to, as the Washington Post put it, "pop the bubble deliberately” and thus prevent an outright collapse.

Professor Michael Pettis of Peking University, who specializes in Chinese financial markets, liken this philosophy to the economic meltdown of the US in 2007, and thus believes a major correction is on hand. Pettis wrote, “Those who worried about rising consumer credit in the US were not wrong every single year until 2007-8, when they accidentally became right. They were right every single year, and were proven right in 2007. Those who have been arguing that China is experiencing an unsustainable increase in debt have not been wrong every quarter that China has not collapsed.” 

China's growth is not up for debate. What is is whether the government is shrewd enough to sustain it. The proof is in the hard data. The country will release trade figures on Aug. 8, and inflation, industrial output, fixed-asset investment and retails sales data on Aug 9.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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