STAFF NEWS & ANALYSIS
China's Meltdown Continues
By Staff News & Analysis - December 15, 2011

China's epic hangover begins. China's credit bubble has finally popped. The property market is swinging wildly from boom to bust, the cautionary exhibit of a BRIC's dream that is at last coming down to earth with a thud. Chinese stocks are flashing warning signs. The Shanghai index has fallen 30pc since May. It is off 60pc from its peak in 2008, as much in real terms as Wall Street from 1929 to 1933. – Telegraph/Ambrose Evans-Pritchard

Dominant Social Theme: Don't look now but China is fading.

Free-market Analysis: Ambrose Evans-Pritchard, one of the very best mainstream financial journos, is back with another update on the Chinese economic collapse, and we appreciate his updates. We've been harping on this theme for at least two years. Just Google "Daily Bell" and "China's Potemkin Village."

For a long time we were a lonely voice. Throughout the 2000s, China was the hot story in the mainstream press, and for many it still is. One of Fidelity's managers who has lost some 30 percent of his clients' money in the past year in China just announced he believed the Red Dragon had turned the corner and that his fund would benefit considerably. Good luck with that.

For us, the Chinese miracle, as we eventually came to understand it, was nothing but a concoction of central bank monetary stimulation and the relaxation of state controls on market-driven family businesses.

The larger industrial and banking entities remained firmly under the control of top-level ChiComs – though in a more hidden manner. Westerners were often fooled into thinking there was competition between these vast industrial entities when there really was not.

This is quite akin to what goes on in South America where a handful of top people usually run the important infrastructure businesses while everyone else trades cell phones on the street. The trouble with this sort of economic structure is that it is highly dependent on central banking.

It is central banking – the printing of money from nothing – that drives this sort of economy because the centralization is artificial and could only be maintained either by brute force or by control of the money supply. Those who control the money are the ones inevitably who end up in charge of society.

Why has this system remained popular? Well, it can be very lucrative for the controllers. This sort of economic structure, in fact, has spread around the world because it has been propagated by a power elite that controls the larger central banking structure itself, including the Bank for International Settlements (see other article, this issue).

Because of the opportunities for control and the possibilities of enrichment, the central banking mechanism has proven popular in authoritarian countries like China. In fact, China has stimulated the money supply with remarkable force over the past two decades.

But all good things come to an end. The various bubbles that the ChiComs have initiated are not viable long-term because of the price inflation that such bubbles generate. China has suffered from terrific price inflation in the past several years. Food and housing prices have gone up an annual 40 percent in some regions. This is intolerable.

So the ChiComs have set about "puncturing" the bubble by raising interest rates and generally printing less money. But while this tightening drives down prices, or slows their rise anyway, it also constricts the economy, creating fewer jobs and eventually bankrupting whole businesses.

The mainstream media doesn't report on this very much, of course. Much of the news in the mainstream about China still focuses on the so-called soft landing. The idea is that those managing China's 1.3 billion people and trillion-dollar economy can reduce China's various bubbles without ruining the underlying businesses.

This might be possible in an environment where the bubbles were a few years old. But China's bubble economy has been decades in the making. The result ,in our humble view (as we have pointed out before), simply cannot be a "soft landing." And over at the Telegraph, Evans-Pritchard agrees. Here's more from the article:

It is hard to obtain good data in China, but something is wrong when the country's Homelink property website can report that new home prices in Beijing fell 35pc in November from the month before. If this is remotely true, the calibrated soft-landing intended by Chinese authorities has gone badly wrong and risks spinning out of control.

The growth of the M2 money supply slumped to 12.7pc in November, the lowest in 10 years. New lending fell 5pc on a month-to-month basis. The central bank has begun to reverse its tightening policy as inflation subsides, cutting the reserve requirement for lenders for the first time since 2008 to ease liquidity strains.

The question is whether the People's Bank can do any better than the US Federal Reserve or Bank of Japan at deflating a credit bubble. Chinese stocks are flashing warning signs. The Shanghai index has fallen 30pc since May. It is off 60pc from its peak in 2008, almost as much in real terms as Wall Street from 1929 to 1933.

"Investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICS (Brazil, Russia, India, China)," said Albert Edwards at Societe Generale. "There is so much spare capacity that they will start dumping goods, risking a deflation shock for the rest of the world.

The article continues in this vein – unfortunately, for Chinese optimists. China's $3.2 trillion foreign reserves are shrinking as "hot" money leaves the country. "Our foreign reserves are basically falling every day," Li Yang, a former central bank rate-setter is quoted as saying.

According to the article, China's property downturn began to become serious in August when construction firms reported that unsold inventories had reached $50bn. But now, Evans-Pritchard writes, "A fire-sale is under way in coastal cities, with Shanghai developers slashing prices 25pc in November – much to the fury of earlier buyers, who expect refunds. This is spreading. Property sales have fallen 70pc in the inland city of Changsa."

Even China's ghost cities are losing value (the ones everyone confidently predicted the ChiComs had built to house floods of impoverished peasants). Apartments in the famous empty city of Ordos in Inner Mongolia have dropped by 70 percent.

China jammed about a trillion dollars of phony money into its economy in 2008. This was supposed to buy time for the ChiComs to goose citizens into taking over from consumer weary Westerners. The idea was that the Chinese – only generations removed from the mad starvation of the Great Leap Forward – would buy the stuff they were increasingly good at exporting.

But perhaps familiarity breeds contempt. Or realistic Chinese simply understood that spending their hard-earned yuan on Donald Duck flashlights and disposable kitchenware was not a great idea. In any event, grooming the shaky Chinese middle class for rampant consumerism simply hasn't worked. The article points this out:

Mark Williams from Capital Economics said the great hope was that China would use is credit spree after 2008 to buy time, switching from chronic over-investment to consumer-led growth. "It hasn't work out as planned. The next few weeks are likely to reveal how little progress has been made. China may ride out the storm over the next few months, but the dangers of over-capacity and bad debt will only intensify".

In truth, China faces an epic deleveraging hangover, like the rest of us.

We disagree only with this last statement. China does not "face a hangover." That makes it sound as if what's going on today is in a sense unexpected. In our humble view, this increasingly obvious Great Depression was entirely predictable (see other article this issue).

The powers-that-be still don't want to advertise what's going on in China because that will give the proverbial game away. The idea is to pretend (via the mainstream media) that what is about to happen to the world is a "surprise." That it was not something that could be predicted.

This insulates the "controllers" from the accusation that they have deliberately put into place mechanisms that will create the kind of chaos that is gradually creeping up on the world. First the US … then Europe … now China.

Without legs, no economic stool can stand. Ask why one would organize a global economic mechanism that would eventually result in a legless stool. Well … out of chaos comes order.

After Thoughts

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