The Only Chinese Hard Landing Will Be On America’s Head

A lot has been made of the so-called Chinese property bubble. And after 2008, when America’s subprime bubble was the straw that broke the camel’s back, who can blame those who see China as low-hanging fruit? In the hedge fund world, both Hugh Hendry and  Jim Chanos (among others) are significantly outperforming the market by shorting Chinese companies.

But the naysayers will be proven sorely wrong.

There are many differences between the Chinese situation and the American one but there is one that outsizes all the others. Over-inflated American (and by-extension, Western) property was being used as a spring-board to fund consumption. Growing home equity allowed real-estate owners to remortgage, and use their surpluses to buy boats, cars and trips around the world; i.e., living beyond their productive means. Once the property bubble burst, not only were many home-owners left underwater, but all of that excessive consumption came to a halt, with a significant negative effect on GDP. China simply doesn’t have that problem. The Chinese nation and its government are not net-borrowers but net-savers.

In addition, there is no evidence that China has the same problem with widespread securitisation that America had in 2008. The subprime bubble created huge systemic risk in the financial sector by bundling up subprime debt in mortgage-backed securities and collateralised debt obligations, and spreading it around American and European balance sheets. This made the system very fragile — as a few defaults, could lead to a global cascade of margin calls and defaults.

In fact, Chinese leverage levels are dropping.

From RBS:

Chinese firms are generally in good financial conditions. The latest data suggests that Chinese companies actually have seen their leverage ratios decline in the past three years, on the back of strong profitability and retained earnings. Most sectors have seen a decline in leverage. Property development was the only main sector that shows the opposite trend of rising leverage but it accounts for only about 6% of total loans. In fact, the average leverage ratio of Chinese companies is one of the lowest among key economies and emerging markets. At the same time, they have maintained one of the strongest profitability.

Chinese GDP (and profitability) is ballooning (and will continue to do so) because of global demand, even on the back of the recessions in Europe and America. That’s because China does everything much more cheaply, and so now controls crucial supply chains in components and products. Now that the world is flat, manufacturing such components in other places is not economically viable, so the supply chains no longer exist, and manufacturing-oriented labour markets are stagnating.

China’s good fortune is its high population levels and high population density.

From Noahpinion:

It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?

Of course, China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

With 10-year yields now well below 2%, that sure looks like a bubble to me.

24 thoughts on “The Only Chinese Hard Landing Will Be On America’s Head

  1. Treasuries aren’t in a bubble – the Dollar is. If China sells off all its Treasury holdings the Fed would be happy to go on a buying spree, sending CPI to the moon and gold out of the solar system.

  2. You have a great site and most of your stuff is pretty much right on. This post, however, is way off base.

    China is a central planning socialist basket case, not significantly better off than the US (and much worse from a demographic perspective). China will be like Japan in less than 10 more years.

  3. Yes — the dollar, not the treasury is the real bubble. But perhaps the treasury will be the pin that bursts the dollar bubble, via the mechanism I described. We shall see.

    Matthew — I know China has a problem with capital misallocation, something true of all planned economies. What I would like to hear is how this makes China different to the United States or any other top-tier power (Japan, Germany, UK, etc). The key difference is that Chinese central planning has been significantly better and more long-termist than any of the other centrally-planned pseudo-market economies.

    • They have a terrible demographic problem too — basically like Japan, only 20 years later. That one child policy is going to cut them off at the knees. And I am not as impressed as you with the results of Chinese central planning. Not that I have much of anything good to say about American governance.

      Also, there is a lot more manufacturing in America that many people realize.


      The United States is the world’s largest manufacturer, with a 2007 industrial output of US$2.69 trillion. In 2008, its manufacturing output was greater than that of the manufacturing output of China, India, and Brazil combined, despite manufacturing being a very small portion of the entire US economy as compared to most other countries”

      Just not many manufacturing jobs.

      • Meh. China overtook America last year in absolute value, but that’s not the point. A lot of American “manufacturing” is reassembling foreign components. The key to watch is not dollars but supply chains. Global supply chains begin in oil-producing nations (predominantly middle east) travel via the east asian productive base to the West for finishing/assembly/consumption.

        The only supply chains America really fully controls are its military ones, for obvious reasons. But what use is a hyper-powerful military when your adversaries (OPEC, China) can easily trigger massive domestic problems (i.e. heavy inflation) by dumping treasuries and slowing the supply of goods, resources and oil?

        A hugely understated cause of 2008 was the ballooning oil price, multiples above-cost for extraction and shipping. That’s the danger of a cartel. And American military adventurism has hardly broken the Eurasian authoritarian backbone (Russia, China, Iran, Pakistan), nor the energy cartel.

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  10. China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

  11. China $123,000,000,000,000* *China’s estimated economy by the year 2040In 2040, the Chinese economy will reach $123 trillion, or nearly three times the economic output of the entire globe in 2000. China’s per capita income will hit $85,000, more than double the forecast for the European Union, and also much higher than that of India and Japan. In other words, the average Chinese mega city dweller will be living twice..

  12. China and India economies are underestimated using the IMF PPP calculation. University of Pennsylvania would adjust upward China’s PPP by 20% and India’s by 15%.

    Credit Suisse has estimated that China has about 30% more GDP in hidden economy

    • The way I look at it, GDP isn’t actually very relevant at all. Total factor productivity is the real measure, but it’s notoriously hard to measure accurately.

      Another interesting measurement would be output in joules. I imagine China is by far the highest in the world.

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