``I write this piece to warn against the simplistic notions about China that permeate our media, and to challenge the powerful special interests that want to paint China as a nation to be attacked, not vigorously debated. We face a long and very challenging dialogue with China, and I believe knowledge is an infinitely better negotiating tool than crude propaganda and simplistic nationalism. Am I really saying China should be handled differently? No, just intelligently.” Mark W. Headley In China’s Shoes, Matthews Asia
Well the other main source of concern is no less than China.
Bears have been growling out louder about an imminent bubble bust in China.
As we wrote in China’s Attempt To Quash Its Homegrown Bubble and in China's Bubble And The Austrian Business Cycle, while we agree with the notion that China have been undergoing a bubble process, since most of the symptoms have manifested the typical Austrian Business cycle model, it is quite unclear that that they’ve reached a manic or terminal phase.
Besides, bubbles do not imply an immediate bust. Bubbles operate as a cycle, where it undergoes several phases. A busting bubble is the end game of the terminal or manic phase.
And betting against an imploding bubble requires some timing. Betting too early before the full stretch of the manic phase would leave shorts without underwears.
Mixed Bubble Signals
Figure 5: WSJ/US Global: Mixed Picture
Yes it is true that property prices and loans have meaningfully surged (see figure 5 left window from Wall Street Journal) enough to prompt for many to yell “fire!”, but it also would seem possible that the surge in property prices could have been reflecting on the pace of the increase in the per capita income of the population (see right window: US Global Fund), albeit the speed may have been quite too drastic.
And in the light of the dramatic expansion of loan and property prices, China reportedly is scheduled to raise its reserve requirements by 50 basis points on her banking system for the second time this year by next week (February 25th).
As to the success of a soft landing from China’s attempt to quash her homegrown bubble is yet unclear. A more significant but adverse impact would be a continuing trend of falling asset markets and imploding malinvestments within the economy. This has not yet emerged.
Figure 6: Bloomberg: Shanghai (top) and Shenzhen (below) Stock Markets Seem Stabilizing
So far, China’s stock markets appear to be stabilizing following the repeated assaults by China’s government to control her bubbles.
Both the Shanghai and Shenzhen benchmarks seem to be bottoming in spite of the recent news to tighten lending. This is in sharp contrast to the violent responses seen in both benchmarks last January.
Have China’s stock markets been turning blasé or discounting the government actions? Or has this been a proverbial calm before the storm? Does this also imply that China’s bubbles are now confined to the property sector?
From my observation of the bubble cycles, bubbles have wide spillover effects. They tend to raise asset prices in general but with most of the impact seen on the areas where the malinvestments have been concentrated. This implies that a full pledge bubble should also be manifested in the stock markets.
This does not seem to be happening in China.
Why Stereotyping Misleads
It isn’t easy to read China. She hasn’t been as transparent and the accuracy of her statistics is likewise in doubt.
However, in my view, opaqueness doesn’t justify macro based heuristics to pass negative judgments. That’s because inaccuracy can work both ways: underestimation and overestimation. The bearish camp believes the latter.
Yet, the fact that China has entered into a free trade agreement with ASEAN and the other East Asian neighbors should be seen significantly in the positive light [see Asia Goes For Free Trade].
It would even be a flagrant mistake to compare China to a particular stock or a company.
Corporations are not like economies, the former operates on a profit and loss incentive while the latter functions on a highly complex but interrelated self-operating multiple parts composed of acting people. [see The Myths Of Government’s Managing The Economy]
As Jeffery Tucker of Mises.org explains, ``Society works not because a single mastermind has preset all the moving parts. It works because people find ways to cooperate through private actions that follow signs and rules that cannot be anticipated but can nonetheless be coordinated. Society and its workings cannot be mapped out and the attempt to do so can create frameable images but not civilizations.” (bold highlight mine)
Besides, China’s property markets isn’t anywhere like the US. For instance, the Chinese buy properties with sizeable upfront equity.
Shaun Rein in Forbes writes, ``when buying residential properties, consumers in China have to put down 30% before taking out a mortgage. For a second home, they have to put down 50%, no matter what their net worth.”
In addition, income in China has reportedly been underestimated, again Mr. Shaun rebuts China skeptics, ``If anything, incomes are grossly underreported in China. A simple look at how accounting works will show why. Whereas in the U.S. individuals must report their income to the Internal Revenue Service every year, in China all individual tax is reported and paid for by companies, except for that of high earners. Many Chinese companies limit the tax they pay by reporting low salaries and then paying their employees higher amounts while accounting for the difference as business expenses like phone bills. The employees are happy because they make every bit as much as they were promised, and the companies are pleased to lower their tax exposure.”
``Also, many companies pay for housing and cars for their employees, a holdover from the old system of state-run businesses. Most Western economists don't count those expenses as income, but they should. Deceptive accounting of income is so widespread that the government has announced plans to tax some business expenses in state-run enterprises--the kinds of expenses that let executives pay taxes on earnings of $300 a month while living in multimillion-dollar homes and driving Mercedes.” (all bold highlights mine)
As one can observe, comparing a society to another by simply stereotyping can lead to serious misappraisals.
So perhaps we’d stick to the actions in the stock markets, property and bond markets, interest rates and inflation, aside from sentiment indicators as the Art market and the Skyscraper Curse to identify signs of the whereabouts of the bubble cycle.
Nevertheless, China would have a lot of flexibility to deal with an imploding bubble given her inherent financial advantages.
Doug Noland of Prudent Bear’s Credit Bubble Bulletin rightly observes, ``First of all, authorities are sitting on an incredible war chest of $2.4 TN of reserves. This hoard today provides virtually unlimited capacity to recapitalize its vulnerable banking system. This hoard also provides unusual protection against a run on the Chinese currency. Never, it seems, has a Credit system enjoyed such flexibility to run so hot for so long. At this point, I have to believe that the policy objective is not to rein in excess as much as it is to slow bank lending to what is believed to be a more sustainable $1.1 TN annual pace.”
In short, the economies of scale from massive surpluses matters, I’d like to add her savings too.
Considering all these variables, I wouldn’t bet on the imminence of a bubble bust. Perhaps not this year.
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