Ten Ways To Spot A Bubble In China

26 Mar

From SeekingAlpha:

Edward Chancellor, author of the seminal book on financial speculation and manias “Devil Take The Hindmost,” is now turning his eyes to China. He sees a number of red flags which point to excess in China.

Chancellor writes:

“In the aftermath of the credit crunch, the outlook for most developed economies appears pretty bleak. Households need to deleverage. Western governments will have to tighten their purse strings. Faced with such grim prospects at home, many investors are turning their attention toward China. It’s easy to see why they are excited. China combines size – 1.3 billion inhabitants – with tremendous growth prospects. Current income per capita is roughly one-tenth of U.S. levels. The People’s Republic also has a great track record. Over the past thirty years, China’s Gross Domestic Product has increased sixteen-fold.

So what’s the catch? The trouble is that China today exhibits many of the characteristics of great speculative manias

  1. “Great investment debacles generally start out with a compelling growth story.” 100% yes. Check.
  2. “Blind faith in the competence of the authorities.” See Roach’s comments above or read Goldilocks is not sleeping in America anymore; she’s now in China. Check.
  3. “A general increase in investment is another leading indicator of financial distress. Capital is generally misspent during periods of euphoria. Only during the bust does the extent of the misallocation become clear.” See my posts China’s present growth story is built on malinvestment and Jim Chanos still bearish on China, talks malinvestment for evidence that China is misallocating resources. Check.
  4. “Great booms are invariably accompanied by a surge in corruption.” Remember this post “I want to be a corrupt official when I grow up”? That’s exactly what Chancellor is talking about. Check.
  5. “Strong growth in the money supply is another robust leading indicator of financial fragility. Easy money lies behind all great episodes of speculation from the Tulip Mania of the 1630s – which was funded with IOUs – onward.” Andy Xie: Chinese monetary policy has to be tightened Check.
  6. “Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts.” Think Latvia or Argentina. Are the Baltics the new Argentina? And we know China’s peg is creating problems because that’s a bone of contention right now. Check.
  7. “Crises generally follow a period of rampant credit growth.” “Enron-Esque Characteristics” Hiding An Even More Explosive Credit Growth In China. Check.
  8. “Moral hazard is another common feature of great speculative manias. Credit booms are often taken to extremes due to a prevailing belief that the authorities won’t let bad things happen to the financial system. Irresponsibility is condoned.” See Stephen Roach’s comments again. Check.
  9. “A rising stock of debt is not the only cause for concern. The economist Hyman Minsky observed that during periods of prosperity, financial structures become precarious.” See #7 again. Check.
  10. “Dodgy loans are generally secured against collateral, most commonly real estate.” The Andy Xie story shows you this. Check.

It looks like China is ten for ten. Is China in a bubble blow-off top like Japan post-Plaza accord? I say yes. Anyone who thinks this will not end badly is in for a rude awakening.

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