China’s Stimulus and its Consequences

Is China leading the global economy out of the severe economic recession or is it setting the table for another leg down by creating another bubble? Is the United States economy beholden to developments in the People’s Republic of China? Let’s look eastward and navigate the Chinese economic landscape.

Recall that China has recently become our largest creditor. Additionally, China’s economic stimulus enacted and largely disbursed is already three to four times the size of the United States stimulus as a percentage of GDP. (U.S. stimulus of $700 billion is approximately 5% of GDP. China’s stimulus of approximately $600 billion is the equivalent of 20% of their overall GDP of $3 trillion) From China’s perspective, it is nice to have an enormous surplus and a government controlled economy.

Let’s review some of the inner workings within the Chinese stimulus and the current view of the Chinese economy and markets. From Stratfor Global Intelligence, we learn:

1. fully one fourth of the Chinese stimulus is targeted at helping the province of Sichuan recover from a massive earthquake in May 2008.

2. the bulk of the Chinese stimulus is focused on infrastructure with little assistance for faltering export based industries.

3. loan growth has exploded in the first half of the year. This has to be a positive, correct? Stratfor is very concerned and writes:

China is more concerned about maintaining employment than about ensuring that money is used efficiently. And the result of such a sudden surge in loan-granting will inevitably be a mounting of nonperforming loans that will eat at the very heart of the Chinese financial system (a similar problem is what brought down Japan in 1991).

And that is the good news. Much of this loan surge — by some reports, perhaps as much as half — is being lost to scams, corruption and simply using the money to play the various Chinese stock markets. The Shanghai Composite Index, for example, is up 50 percent since its lows in November 2008 — an otherwise inexplicable development considering the steady stream of bad economic news that has trickled out of Beijing in recent months.

As I think of this analysis, I immediately wonder if China is creating a semblance of a bubble in their economy and in their stock market. Arjun Divecha, portfolio manager of Berkeley, CA based GMO, holds similar concerns. In an interview published in Barron’s this weekend, Divecha was aksed about his concerns in China and specifically Chinese lending. He asserts:

“I believe a lot of the money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.

We know they are buying real estate, and they are doing all kinds of things we don’t think in the long run is particularly productive investment.

Barron’s asks Divecha what will be the consequences in China of this stimulus plan? He responds:

“Two things are likely to happen. First, longer term, if the banks don’t have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on the money. I don’t know when that will be. But I worry that it is coming.

A fair amount of the stimulus money has found its way into the real estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.

Is the United States likely to suffer a similar consequence? I am very concerned.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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1 Comment on China’s Stimulus and its Consequences

  1. Oh really? I thought for years the Chinese were criticized for not “liberating” the credit market and having its citizens “save too much”

    Is that sour grape you were tasting when you wrote this about a “bubble”? How about write an article that the last 30 years of Chinese economic growth was a “bubble”, maybe you’ll win a Nobel Prize for that.

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