Is China the Next Bubble?

That’s the headline of a long and probing New York Times article that looks at China’s economy from various angles, weighing the arguments of whether it’s a bubble ready to pop or an essentially unstoppable engine that will experience slowdowns and bumps, but not collapse.

I won’t pretend to know the answer, but this article offers some good background to help view the situation more objectively.

One of the key points it makes is the importance of investment spending in China’s economy. This is my main argument when I spar with those who claim foreign businesses in China, excluding those related to manufacturing of items for export, are thriving. People point to the new stores and products and the vast construction effort in cities like Shanghai as proof of prosperity. Actually, they are proof of investment in the hope that one day they will prosper.

Nearly half of China’s economic growth is investment-related spending, an extraordinary figure that reflects public spending on highways and dams, as well as private-sector projects. Calculations by Smith Barney show that Japan in the 1980’s, Southeast Asia in the mid-1990’s and the United States in the late 1990’s each had a few years of investment spending well above historical averages. In each case, overcapacity accumulated in many industries and, eventually, a bubble popped.

China has developed a special disadvantage, in that its economy has become so ravenous for commodities that it is pushing up global prices for products like oil, for which China has become the second-largest market, after the United States. With very low wages and real estate costs, factory managers find that materials are their biggest cost by far, and a sudden jump in their cost can leave businesses with no competitive edge.

The People’s Bank of China, the central bank, has reported an acceleration in wholesale price inflation this winter. The big question is how quickly this will feed into consumer price inflation, which could antagonize politically important urban residents. If consumer prices start rising significantly, the central bank will come under growing pressure to let interest rates climb, which could make more factories less competitive as loans become more costly.

China still has some advantages that, at least in the short term, may forestall a plunge in investment. One is a banking sector willing to lend heavily to even the most indebted companies, provided that they have political connections. But in postponing the final reckoning in the current business cycle, China may be making an eventual bust even worse.

There are so many ways to interpret China’s economy and its direction that I’ve personally given up. My common sense tells me there has to be a slowdown, but even so, there’s enough momentum to keep the economic engine going for years to come. Unless….

And this is where the article leaves us, with a possibility. Political turmoil or other unpredictable factors could threaten China’s fragile economic stability. A sharp slowdown could cause it all to come crashing down.

In the years immediately after the Tiananmen Square killings in 1989, China became relatively placid, perhaps in part from fear. But that calm seems to be fading now.

President Hu Jintao has gingerly tried to restrict some police powers – like the ability to detain people without proper identity documents – and is seeking slightly greater openness in Chinese society. Human-rights groups report a growing number of protests in China, mainly workers and retirees seeking unpaid salaries and benefits. At the same time, many on the mainland are acutely aware of the huge marches organized over the last seven months by democracy activists in Hong Kong, now an autonomous region of China.

Whether any of these forces become significant enough to rattle China’s stability is anybody’s guess. Peaceful change toward a more democratic system may still be possible, especially if it is fairly gradual.

But if the economy slows sharply, political instability could follow. That would be a serious problem, and not just for China, but also for the rest of the world.

There’s a lot more to this article than I can quote here. It offers a good overview of China’s entire financial landscape, without preaching one way or the other.

The Discussion: No Comments

No comments yet.

RSS feed for comments on this post. TrackBack URL

Sorry, the comment form is closed at this time.