China Debt Bubble Looming

By: Hans_Wagner

According to the latest reports from China, the country’s GDP is growing at 8% a year. This is an amazing achievement and helps to bolster the argument that China will help lead the global economy out of its recession. Since it looks like exports will be the major driver of growth for the U.S., selling goods and services to many emerging economies like China it pays to dig a little deeper to understand this growth phenomenon.

Vitaliy Katsenelson, wrote an interesting research piece on China’s growth in a recent issue of Foreign Policy magazine. Some of you might remember Vitaliy as the one gracious enough to offer a free autographed copy of his latest book to the winner of a contest we held. I mention this as I recommend the article to any of you wishing to learn more about Chin’s economy.

The Chinese economy has grown by making many of the products U.S. consumers bought at very reasonable prices. In many cases the price paid today for the same or similar product is less than was paid ten years ago. Along the way, China amassed over $2.2 trillion in reserves, most of it in U.S. debt of one form or another.

Some people and politicians have suggested China would sell their dollar holdings. If they did, it would hurt the dollar further and cause the Renminbi to rise hurting their own exports. Moreover, they remain highly dependent on exports to the U.S. to support their economy. With the curtailment of consumer spending in the U.S. their exports have fallen more than 20%. As a result, China now has an over capacity problem that will remain as they cannot count on the U.S. consumer to return to their free spending ways.

With the growth of the Chinese economy has come the emergence of a middle class that is as large as the U.S. population. Many of these people are young and want to buy what they see others in the world own. While some of them have been affected by the slow down in exports, many still have good paying jobs or the companies they own remain profitable. These people are buying goods and services from the U.S. and the rest of the world. Their success inspires others in the China to achieve the same life. This is one of the problems China is trying to tackle.

Many people have commented on the positive affect the Chinese stimulus has had on their economy. One of the ways China is trying to correct their overcapacity problem is encouraging more domestic buying of goods and services. Part of their stimulus money has gone to specific purchases of refrigerators and other household appliances trying to encourage greater consumption in specific areas of the country that have not seen the success of the major export centers. As you may know the Chinese save up to 40% of what they make. They need to, as they must pay for their own retirement and health care. They also want to be prepared for the eventually rainy day that seems to come along all too frequently. As a result, encouraging them to buy products is a major undertaking. This effort is achieving some success. For many of these people, a refrigerator is nice, but it is useless without reliable supply of electricity.

This leads us to the next part the Chinese stimulus program. Much of the Chinese stimulus is money given to banks that must be lent out quickly. The volume of credit that China is making available is estimated to be more than 30% of the GDP of the country. That is a lot of money floating around the economy. Before this money was made available, many Chinese banks had serious loan problems. Add in the large overcapacity that has occurred in the last two years and you can see that this problem is significant. The push to get the credit based stimulus money into the economy will cause further loan problems. It will encourage higher levels of speculation, shoddy work, more corruption, and a huge debt load. At some point, the bad debts will become a problem for the country. When and to what extent is the unknown. As these debts default, it will hurt the foundations of the Chinese economy, even if the government tries to patch things over.

Until that happens the Chinese growth story will continue, offering good opportunities for investors. The continued expansion of the entrepreneurial and middle classes will drive demand for many goods and services. In addition, the money being spent to build out the country’s infrastructure and upgraded manufacturing capabilities offer many industrial companies new growth opportunities. These opportunities will remain for several years. However, at some point the growing debt problem will come back to hurt the Chinese economy and along with it, investors who were not conscience of the potential problem. In the mean time, enjoy the growth that is in place. Just do not forget that there is a significant problem brewing, not unlike what happened in the U.S.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2009 Hans Wagner

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