China is the Next Goldilocks Economy to Fall

The first time I heard an economy called “Goldilocks” was in 1999, right before the dot-com bubble burst in 2000. I heard it again in 2005 and all the ways to 2007, right before the meltdown started. And it is happening again! JP Morgan just put out a report saying China is a Goldilocks Economy. Can the end be far away?

I have earlier cautioned on Chinese statistics. They count GDP differently than we do – when budgeted or shipped, not spent or sold. Much of their apparent demand for commodities is stockpiling not production. It was not that hard to call the end of their secondary top last August.

I hear wistful Liberals decrying how hard our Democracy is and wishing we could just make things happen like China does! They wonder why China can stimulate and we can’t. Well, Obama could have gotten the stimulus he wanted through, so there is no one to blame for than bad one passed than him. And he could have focused on fixing the financial sector rather than chasing progressive fancies like healthcare reform for free. Even SNL is laughing at that, now. No one is talking of bending the cost curve anymore. Instead, they are saying his political fortunes would be better served if the travesty of a bill were to fail.

Maybe the problem lies in our fantasies about China, not our bitches about the US. Barry Ritzholz first laughed off the bogus Chinese stats, but now he is not so sure: “China expert Gordon G. Chang (author of The Coming Collapse of China) is more than skeptical — he has the data to question much of China’s growth miracle.” In sum, real stats like gasoline sales are flat, belying the claimed 8%+ growth.

The amount of stimulus by China is huge as a percent of GDP compared to the US, and they may not be getting that much for it. Those wistful Liberals may think it is ok to slosh around excess money, since it adds to an abstract “aggregate demand” and should help fill the gap of a drop in private consumption and investment. Where the excess ends up matters, however, especially if it lands in a whole passel of malinvestments, such as Ghost Cities being raised in China with nothing productive in them. Or, the US favorite for malinvestment, a horrific housing bubble, which may be emerging in China again. Eventually the piper has to be paid.

Now the cracks have begun to form. The Bank of China is over-extended, giving it no safety net from a hiccup. The hangover from binge lending may apply to all the top Chinese banks. Their plans for bolstering their balance sheet sent Asian markets tumbling at the same time as Dubai defaulted. Ouch.

I suppose wistful Liberals think it will be easy for the command economy to bolster their banks, but one of the best analysts of the China scene argues otherwise:

The low deposit rates mean that Chinese savers are effectively being taxed to replenish bank capital. … Chinese households are bearing a pretty hefty share of the cost of China’s investment-led boom, and it is these same households whose surging consumption will be necessary to absorb the increased production resulting from the investment boom.

Given the increased financial burden being placed on them, I doubt that they will be able to do so. After all, it is because of lesser versions of these same policies in the past that the enormous gap between production and investment exists in the first place. And if they cannot raise their consumption sharply to absorb all this additional excess production, the banks will be stuck financing rising inventory and unprofitable companies. It’s a vicious circle.

There is no easy way to resolve this problem … .

The Big One for China may be an entirely unexpected Black Swan: the Chinese going into a trade deficit. The argument is that the US will go into a double-dip next year, reducing the pull of exports out of China, and China will begin to tip over into a trade deficit as their consumers choose spending over low-rate savings to bolster the banks. Compounding this might be Japan hitting the point of no return, where they no longer can fund their out of control public spending deficit without raising rates and also sliding back down. China may be forced to devalue their currency, an event so contrary to expectations it will confound markets and drive the US Dollar up.

Before then, a continued weak Dollar would also undo the Chinese stimulus. Karl Denninger reports that a 10% drop would reduce the value of reserves by 3x (Y1.5T) that China is spending on the stimulus (Y586B). Ouch again.

Whens something cannot go on, it won’t. The assumptions of the Goldilocks Chinese Economy seem doomed to be shown to be as false as such claims were shown to be in prior bubbles.

What is it about a bubble that the pundits miss, and instead of seeing what is really happening, causes them to gush over the very conditions that are driving the bubble just as it is about to burst?

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About Duncan Davidson 228 Articles

Affiliation: NetService Ventures

Duncan is an advisor to NetService Ventures, where he focuses on digital media and the mobile Internet.

Previously he was at four start-ups: Xumii, a mobile social service based on a Social Addressbook; SkyPilot Networks, the performance leader of wireless mesh systems for last-mile access, where he was the founding CEO; Covad Communications (Amex: DVW, $9B market cap at the peak), the leading independent DSL access provider, where he was the founding Chairman; InterTrust Technologies ($9B market cap at the peak), the pioneer in digital rights management technologies, now owned by Sony and Philips, where he was SVP Business Development and the pitchman for the IPO.

Before these ventures, Duncan was a partner at Cambridge Venture Partners, an early-stage venture firm, and managing partner of Gemini McKenna, a joint venture between Regis McKenna's marketing firm and Gemini Consulting, the global management consulting arm of Cap Gemini.

He serves on the board or is an adviser to Aggregate Knowledge (content discovery), Livescribe (digital pen), AllVoices (citizen journalism), Xumii (mobile social addressbook), Verismo (Internet settop box), and Widevine (DRM for IPTV).

Visit: Duncan Davidson's Blogs

2 Comments on China is the Next Goldilocks Economy to Fall

  1. China does NOT follow Western economic principles. China does NOT build for today, China build for the future.
    People predicted China’s economic failure are wishfull thinking-they can not stand the fact that China is rising. They want China to fail because of their believe.
    People who predicted China’s political failure do not understand Chinese history. Chinese societies never rebelled in time of plenty.
    China is always changing not only economically but politically as well. The difference between China 30 years ago and China today is greater than the difference between China and Canada. China can have more changes within a single party system than most country with multiparty systems. In our DEMOCRATIC societies, we can change the governing body without changing the system. In China, it can change the system without changing the governing party. In the next 10 to 20 years, we will see wealth spread from the coastal cities to the interior. It is actually happening as of this minute. Today, roads, schools, hospital and industries are being build in the interior at great speed.
    Will China collapse one day? Maybe, but not in my life time and may not be yours.

  2. For those of you waiting for the Chinese economic bubble to burst, I hope you are not holding your breath. It may last for years. China came a long way in the past 30 years, but it still has a long way to go to reach even 50% of the standard of living in the West or Japan. As far as development is concern, only about 12-15% of China is close to fully developed. The rest of China is only starting to develop.
    People talk about a Chinese real state bubble. What real state bubble? The average living area of a Chinese family is less than 50% of families in the West. With another 300 million people in the next 5-10 years moving into cities, the price going up is not because of bubbles, but because supply can not meet demand. There are lots of empty buildings? How many of those are actully completed? Some of them maybe asking too much?
    Too much steel and cement capacities? Is is not too bad? Some of the inefficient mills may have to close. Or is it?

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