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There is much gnashing of teeth by the realists and
celebrating by the Keynesians over the possibility that the Fed will soon
embark on another round of "quantitative easing". The anticipation
of faster inflation of the US$ supply has put downward pressure on interest
rates and caused the speculative juices to flow more freely in the commodity
and equity markets. The Keynesians, who believe that economic depressions are
caused by a mysterious decline in "animal spirits" and that
everything would be just fine if we would simply return to borrowing,
spending and partying as if it were 2006, are therefore getting their wish.
The realists, however, understand that thanks to the excessive borrowing and
misdirected spending of the boom years there are now huge imbalances in the
economy that must be corrected before a genuine recovery can begin, and that
artificially-stimulated borrowing and spending will only add to the
imbalances by wasting more valuable resources; in other words, they
understand that the problems are real and cannot be made to disappear by
conjuring more money out of nothing or by using some other trick to foster
more of a "devil may care" attitude within the collective mind of
the public.
Strangely, though, many people who are realists when it
comes to the US are anti-realists when it comes to China. Via the application
of sound theory and logic they are able to see that almost all the actions
being taken and proposed by US policy-makers will weaken the US economy, and
yet they ignore the same theory and logic when forming opinions about China's
economic prospects. China, they tell us, is going to go from strength to
strength while the US morphs into a shadow of its former self.
A problem with the idea that China will continue its steep
upward trend while the US economy shrinks or stagnates is that an important
sector of China's economy is almost totally reliant on being able to sell
products to the US. The irrepressible China bulls counter that if the US
economy goes into an extended funk then domestic Chinese demand will take up
the slack, but this makes no sense on a number of levels. For starters, if
the Chinese manufacturers that currently export to the US could make a profit
by selling their products locally then that's what they would already be
doing (why go to the trouble and expense of shipping products across the
Pacific Ocean if you can generate a reasonable return by selling them in your
backyard?). For seconds, the US market for the sorts of consumer goods that
are exported by China is many times larger than the market inside China. The
relative sizes of the markets will change over the long term, but in the mean
time a lot of manufacturing companies in China will find that they are geared
up to make products that cannot be sold. This is an example of the classic
"Austrian" mismatch between production and consumption that often
arises in response to rapid monetary inflation and artificially low interest
rates. It's not that there is insufficient aggregate demand (as the
Keynesians like to claim in their misguided efforts to encourage even more
inflation and an expanded role for the government); it's that long-term
investments were based on consumer spending patterns that prove to be
unsustainable because they are artifacts of a credit bubble.
Unfortunately, having a manufacturing sector propped-up by
unsustainable consumption trends is not the only major problem facing China's
economy. As discussed in previous commentaries and as documented by many
other analysts, China is immersed in a fully-fledged real estate investment
bubble. There are some interesting facts about China's real estate bubble and
the associated mal-investment, including pictures of a completely empty
Chinese city (Ordos) that was originally built to cater for 1.5M inhabitants,
in the slide presentation delivered by Vitaliy Katsenelson
at Casey's Gold and Resource Summit.
One of the indicators that China is an economic accident
waiting to happen is the rapid rate at which the country's money supply has
been rising. The monetary inflation rate was already at nosebleed levels
prior to 2008, but was accelerated by China's monetary authorities in
response to the global financial crisis. The total supply of Yuan is now more
than 50% higher than it was just two years ago. With the effects of inflation
spreading from the asset markets to the markets for basic consumer goods and
labour, China's economic commandants became sufficiently concerned earlier
this week to push interest rates upward for the first time in three years.
That China's economy continues to maintain the outward
appearance of strength, despite a burgeoning inflation problem and
mal-investment on an unprecedented scale, is testament to the extraordinary
degree of control that China's government exerts over the banking system and
the amount of borrowing/lending. Due to this control, insolvent banks
continue to lend aggressively to insolvent State-owned companies, which use
the borrowed funds to build impressive factories, office buildings and
shopping centres, many of which are under-utilised and loss-making.
Eventually, the proverbial chickens will come home to
roost (China's bubble will burst). Best to be positioned so as not to get
hurt when that happens.
Steve Saville
www.speculative-investor.com
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