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Investors in China warned of parallels to Japanese slump
Niko Kloeten | Wednesday August 12 2009 - 08:02am
The economic boom in China has been driven by credit expansion and hype and the bubble could burst within a year, an international economist has warned New Zealand investors.
Writing for Tyndall Investment Management New Zealand, London-based independent economist Andrew Hunt cast doubt over the supposedly healthy state of the Chinese economy and likened it to Japan in the late 1980s.
He recalled the dramatic expansion of credit that took place in Japan during that period, and the hype that accompanied the massive amount of foreign investment that took place.
Unfortunately, the excess liquidity only hid the shortcomings of the Japanese economy “behind a veil of asset inflation”, according to Mr Hunt.
And he noted that when the Bank of Japan did raise its interest rates in 1989 it killed off not only the excess liquidity but also the optimism generated by marketing hyperbole about Japan being the new economic super power.
“In 1988, the world wanted to buy Japanese equities and emulate its business model but within a decade many of its former fans had become its biggest detractors as they switched from irrational exuberance to irrational pessimism, with a catastrophic impact on equity prices.”
Mr Hunt pointed out several parallels between the current situation in China and 1980s Japan, such as the seemingly strong growth bucking world trends.
And like during the late 1980s there was now talk of a shift in the balance of economic power and the chance of the US$ losing its reserve currency status, he said.
“However, a closer look at China’s available economic data casts some doubt on the true strength of China’s economy and it also reveals the presence of an all too familiar domestic credit boom.”
By any standards, China’s year-on-year 32% rate of credit growth and 28% rate of money growth appeared “excessive” but viewed in the context of China’s “still soft” 4% rate of nominal GDP growth they looked “even more extreme”, Mr Hunt said.
The hype regarding China’s economic boom had become so intense that “even the glaring inconsistencies in the China economic story seem to be being ignored”.
He pointed out some anomalies: for example, China was reporting a strong rise in the output of its energy intensive industries but no increase in energy consumption.
Also, inventory data suggested that a rise in production was feeding a bulge in inventories, which Chinese statisticians class as ‘investment’ rather than ‘stocks’.
He predicted the People’s Bank of China would allow the credit boom to continue for another six to 12 months.
But when the Chinese central bank tightened its monetary stance, which he said would likely be in 2010 as its trade accounts weakened and the Yuan came under pressure, Chinese companies would find it “increasingly hard to finance their by then extremely bloated inventory positions”.
This would cause not only a slowdown in Chinese production but also an “overwhelmingly deflationary” stock liquidation cycle, harming Chinese companies and their overseas competitors who had to match China’s falling export prices.
Mr Hunt recommended a cautious strategy with investing in China, warning that those who played the “greater fool theory” (there will be a greater fool to buy our exposure at the top) have often ended up “going over the cliff”.
Niko Kloeten | Wednesday August 12 2009 - 08:02am
The economic boom in China has been driven by credit expansion and hype and the bubble could burst within a year, an international economist has warned New Zealand investors.
Writing for Tyndall Investment Management New Zealand, London-based independent economist Andrew Hunt cast doubt over the supposedly healthy state of the Chinese economy and likened it to Japan in the late 1980s.
He recalled the dramatic expansion of credit that took place in Japan during that period, and the hype that accompanied the massive amount of foreign investment that took place.
Unfortunately, the excess liquidity only hid the shortcomings of the Japanese economy “behind a veil of asset inflation”, according to Mr Hunt.
And he noted that when the Bank of Japan did raise its interest rates in 1989 it killed off not only the excess liquidity but also the optimism generated by marketing hyperbole about Japan being the new economic super power.
“In 1988, the world wanted to buy Japanese equities and emulate its business model but within a decade many of its former fans had become its biggest detractors as they switched from irrational exuberance to irrational pessimism, with a catastrophic impact on equity prices.”
Mr Hunt pointed out several parallels between the current situation in China and 1980s Japan, such as the seemingly strong growth bucking world trends.
And like during the late 1980s there was now talk of a shift in the balance of economic power and the chance of the US$ losing its reserve currency status, he said.
“However, a closer look at China’s available economic data casts some doubt on the true strength of China’s economy and it also reveals the presence of an all too familiar domestic credit boom.”
By any standards, China’s year-on-year 32% rate of credit growth and 28% rate of money growth appeared “excessive” but viewed in the context of China’s “still soft” 4% rate of nominal GDP growth they looked “even more extreme”, Mr Hunt said.
The hype regarding China’s economic boom had become so intense that “even the glaring inconsistencies in the China economic story seem to be being ignored”.
He pointed out some anomalies: for example, China was reporting a strong rise in the output of its energy intensive industries but no increase in energy consumption.
Also, inventory data suggested that a rise in production was feeding a bulge in inventories, which Chinese statisticians class as ‘investment’ rather than ‘stocks’.
He predicted the People’s Bank of China would allow the credit boom to continue for another six to 12 months.
But when the Chinese central bank tightened its monetary stance, which he said would likely be in 2010 as its trade accounts weakened and the Yuan came under pressure, Chinese companies would find it “increasingly hard to finance their by then extremely bloated inventory positions”.
This would cause not only a slowdown in Chinese production but also an “overwhelmingly deflationary” stock liquidation cycle, harming Chinese companies and their overseas competitors who had to match China’s falling export prices.
Mr Hunt recommended a cautious strategy with investing in China, warning that those who played the “greater fool theory” (there will be a greater fool to buy our exposure at the top) have often ended up “going over the cliff”.
