China Struggles to Control Its Collapsing Bubbles

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China Struggles to Control Its Collapsing Bubbles

Like a cheap toy bathed in lead paint, China's economy is more dangerous than it looks on the surface.

In recent months, despite the best efforts of Chinese technocrats, the world's biggest stimulus program has backfired, and the true state of the Chinese economy is beginning to emerge.  This evidence is revealing symptoms of a crumbling system that was built on an unsustainable growth model that relies on ever-increasing exports, even as demand for those imports is shrinking.

For a time, this growth in exports, and the enormous cash flow it provided, enabled the Chinese to provide employment for a large subset of the population.  Under this system, typical market factors such as profits could be ignored as long as the government was able to keep money flowing down to its population.

The plan was to slowly build a self-sustaining consumer economy like the United States, South Korea, or Japan.  Unfortunately, the financial panic of 2008 disrupted global trade and forced China to shift from exports to capital spending.  The resulting $586 billion stimulus program led China to build railroads, highways, and even entire cities simply to keep people employed.  The main result has been the creation of real estate and commodity bubbles, which now threaten to explode.1 

Undoubtedly, China's leaders knew this capital spending boom was unsustainable, but they hoped to prop up the economy, at least through the major party leadership transition in 2012.  But now, things seem to be unraveling faster than expected.  Recent symptoms of this are evident in three key areas: 

  1. Industrial activity
  2. Housing
  3. The banking system

A cooling Chinese economy was indicated by the sharp slowdown in China's industrial activity in November 2011.2  The month saw HSBC's purchasing managers' index, or PMI, drop three points to 48, which is the lowest it's been since the U.S. stock market bottomed in March of 2009.  More significantly, the PMI's industrial production sub-index fell, moving from 51.4 to 46.7.

Exports have also been off, bringing China's annualized export growth in October 2011 down to 16 percent.  While this would be a highly desirable number in a developed economy, it signals trouble for China, where growth was 18 percent in September and 24.5 percent in August. 

Since China's economy is so export-driven, things looked good during the four or five years of tremendous growth in exports leading up to 2009.  But then, China experienced its first significant drop as it emerged onto the global stage.  Exports did improve slightly in 2010...

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