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All booms bust. The only question is when.

February 8, 2011
Santiago, Chile

Somewhere in China, an economist lost his job today… it was the poor guy who had been predicting manageable levels of inflation despite rapid headline GDP growth and even more rapid monetary expansion.

Yet, staring at reports which show inflation at a 28-month high, officials at the People’s Bank of China realized that they need to do something about inflation. Now. Especially in light of what’s going on in the world… hence today’s 25 basis point rate hike.

Inflation in China is coming from all sides. Certainly there is the country’s speedy economic growth, commonly reported in the press as ‘overheating’. Then there is the constant battle against America’s #1 export (inflation) as many of Bernanke’s trillions of new dollars have found their way into China’s economy.

Moreover, what a lot of people forget is that China has heavily engaged in its own stimulus programs, which, as a percentage of GDP, dwarf the stimulus packages in most developed countries (including the United States).

Given these genuine inflation fears and the brakes that Chinese policymakers are applying in terms of interest rates and property taxes, it is now almost a “consensus view” in the financial markets that China will face an economic crisis sometime in the next few years.

A recent survey of market participants published by Bloomberg indicated that 45% of those surveyed believe it’s inevitable that China’s boom will turn to bust sometime in the next 5 years.  Another 40% said they expect it to happen sometime after 2016.

The arguments for why China’s economy is a train-wreck waiting to happen are not new.  Prominent short-sellers such as Jim Chanos cite forests of empty apartment towers, deserted shopping malls with no stores or customers, and the empty city of Ordos as proof that China has massively overbuilt.

They argue that the economy is built on a foundation of quicksand, as construction accounts for the biggest single slice of GDP, and at some stage there simply won’t be a need to build anymore.

I can’t disagree.  At some point, perhaps in the not-too-distant future, building in China will slow, and subsequent rate hikes will curtail new expansion.

The way I view it, China has compressed 100 years of economic growth into 30 or 40 years, so naturally the annual growth rate has been fast. One thing that history has taught us, though, is that the free market cannot be continually outperformed by a central planning authority that inflates its money supply.

Rapid credit expansions can definitely give the appearance of strong economic growth, but no credit expansion has ever lasted permanently. In the long run, an economy can only continue to move forward at strong growth rates via increases in savings, productivity, technology, and innovation.

China’s technology sector is advancing rapidly– the country has developed the world’s fastest supercomputer and churns out three times as many engineers as the United States. China’s manufacturing sector has also shifted away from unskilled production to high tech manufacturing based on homegrown designs.

Knowledge is cumulative, however, so it will still take some time for China to be the genesis of the next generation of technological breakthroughs… and hence justify its huge growth rates based on innovation and technological advances.

For now, we can continue to marvel at the rapid pace of economic development in China.  But, let’s not make the same mistake people made with Japan in the 1980s and assume that the Chinese have stumbled across some superior economic perpetual motion machine.

The truth is, nobody knows what China’s real growth rate is. I remember spending time in the country’s gray markets– huge roadside, makeshift shopping malls with tens of thousands of people engaging in off-the-books transactions– thinking to myself ‘no way GDP numbers account for this…’

The fundamentals for growth are definitely there… but we would be foolish to not consider the disastrous effects of a cleverly disguised credit bubble masquerading as ‘the Chinese miracle’, or the consequences of an unsustainable exchange rate policy.

Nothing goes up or down in a straight line, and in the words of one of my most influential mentors, “All booms bust. The only question is ‘When?'”

The reality is, nobody knows when… and more importantly, what happens next.

Our goal is simple: To help you achieve personal liberty and financial prosperity no matter what happens.

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Empires Rise, they peak, they decline, they collapse, this is the cycle of history.

This historical pattern has formed and is already underway in many parts of the world, including the United States.

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About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

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  • Veritabletruth

    um, they have a billion people. vs. what? 400 million in the US?
    OF COURSE they churn out 3 times as many engineers.

    but it’s like when ppl compare the US to northern europe-scandanavia specifically-how they dont have the crime rates, and their schools are better, racial tensions lower. wow-this is apples and oranges. same with china.

    it just bugs when ppl use stats about two completely different sets of variables, to prove a point. fail. uugh. and ppl do this so much with china and scandanavia specifically, in comparison to the US. less sensationalism, more solid critical thinking-there are plenty of suitable comparisons between the US and china-just stupid to compare numbers of engineers. same w/india.

    • http://www.RPTblog.com/ Simon Rose

      Veritable – you are right that the comparison was in gross numbers and not per capita. Nevertheless, “3 times as many engineers” also means more engineers per capita, so it’s an interesting observation.

      I disagree with you about the Scandinavian comparisons as they are usually done on a per capital basis (such as average GDP per capita, crime per capita, etc). These are quite valid as a way of comparing different social systems. The danger is not in the statistics but in the conclusions – I don’t think the US should go the way of Scandinavia just because they have better health and education for instance.

      Statistics are dangerous… but not quite as much as you are blaming them for!

      (former statistics teacher)

  • Veritabletruth

    And, btw, WILL china become the next genesis of technological breakthroughs? That requires a decidedly non conforming mindset. and china, japan, korea,culturally are historically and presently very much about societal norms. lets’ face it-alot of the free thinking rogues around the world, in ‘newly developing countries’-are modelling themselves and their thoughts, after western-US/Europe versions of what is ‘intellectually new’-and this includes science, technology and entertainment. Sure, they may tweak it to make it their own-but most youth are modelling the west….

    I just think what the world is creating is a new wave of walmart consumers, as a whole. And innovation is few and far between-i’m doubtful that another generation will see china being the forefront or renegade of new inventions-despite the history of the nation and culture as a whole. we’ll see. but school systems are arguably even worse than the US, in many countries. Sure, churn out engineers-but i see them, working here in So CAL-from india, korea, japan…and it’s sitting in a cubicle doing waht you are told. this is not the same as creating the new.

    schools systems arguably worse-b/c you see either 50’s style-a la Chile, or the robotic, rote style of repetition, throughout the non western world. How does this result in a more advanced anything? Just curious. Perhaps the social harmony resultant, leads to more prosperity, for a time…..but it is temporary. again, we shall see.

  • Richard

    “Knowledge is cumulative, however, so it will still take some time for China to be the genesis of the next generation of technological breakthroughs.” That is a very astute observation.

    I worked for the world’s largest semiconductor manufacturer for 15 years. I spent most of that time in high volume manufacturing and one small stint in R&D.

    Unless you’ve actually worked in that part of the manufacturing world, it is very difficult to understand and appreciate the extreme complexity of that manufacturing process.

    The designs are extremely complex but doable. Making small run batches of the product is also doable for R&D testing (generally because you have a virtually unlimited budget with NO concern for costs) but the Achilles heel of the whole thing is this: can you ramp up to manufacture it in high volume?

    Ramping tech manufacturing is generally where the wheels fall off.

    The Chinese have a definite leg up because they are standing on the shoulders of the giants that came before them. It will be interesting to see how they perform once they are relying exclusively on their own design and manufacturing processes.

  • http://justen.us Justen Robertson

    “One thing that history has taught us, though, is that the free market cannot be continually outperformed by a central planning authority that inflates its money supply.”

    I think you (and most economists) are actually looking at this from the wrong angle. That’s not what is happening in China. What is happening is that more freedom is outperforming less freedom. The introduction of a (relatively) free market after decades of communism and a long history of feudalism and bureaucracy has caused an *incredible* economic boom. The central planners aren’t creating this, they’ve just stepped out of the way enough for this to happen. Everywhere they continue to intrude deeply, e.g. in housing and development outside of the free cities, is a disaster, and that’s where the system is going to fail (and is already showing cracks). Now if they stepped out of that realm too and let the market sort things out the bubble might deflate gently, but they won’t do that; they’ll meddle like the U.S. is doing and with the same consequences, amplified over a larger landmass, economy, and population, and probably to disastrous effect.

  • http://www.RPTblog.com/ Simon Rose

    Yes SB, all booms will bust. But with China there’s a massive difference that belies your attempts to make comparisons to Japan etc. The difference is in foreign investment. With China owning a huge proportion of the world’s mineral resources, it stands to earn significant foreign income even if it’s domestic economy slumps.

    I can’t think of any other economy that has invested so heavily in real assets (not just gold in a vault). This makes me a lot less worried about empty malls and office buildings.

    Compare China’s economic outlook to Dubai’s (construction bubble burst and they may never escape). I think China’s long term outlook is very stable compared to the historical examples you gave.

    The big questions for me are about human rights and democracy, not about construction and technology.


    • http://twitter.com/ukgoldbug Gold Bug

      Quite a few governments not only have few real assets but no gold in the vaults either. For an individual gold has several advantages over real estate – portability, easy to exchange or sell, easily hidden, likely to soar in value.

  • Johnny Bronx

    How will a Chinese bust affect the US recovery?

    Also, my understanding is that there is a 19% male surplus in the first generation to come of age under China’s one-child policy. I don’t see a lot of children being born to such a generation, especially if China keeps it’s policy. What will happen to their economy when their population numbers start to go down?

    • amerikanka

      Yes, as a woman who has considered adopting an unwanted baby girl from China, I’ve often wondered if they will eventually need to start adopting themselves.

  • http://moneycrisisgameplan.com/the-elevation-group-mike-dillard/ EVG

    To their credit, China has also focused on amassing silver and gold bullion, silver mines, rare earth mineral mines, etc…

    Meanwhile the U.S. is trying to catch up on rare earth minerals mining production before we become too dependent on other countries, much like we are right now for crude oil.

  • http://moneycrisisgameplan.com/buy-silver-bullion/ ISN

    To backup their economy and currency, China is wise in buying lots of gold and silver bullion, and also precious metals mines around the world.

    This may allow them to position their currency as the ‘world currency’ to replace the faltering U.S. Dollar

  • Bill

    Simon says: “Also, the new HIRE Act legislation imposes additional reporting requirements and restrictions for foreign accounts that gradually phase in over the next two years.”

    As this legislation becomes clear, could you please give us clear understanding of what the new legislation wants from us blow by blow and step by step please? Thanks, Bob

  • Peter Leg

    China is going to crash that’s a given but I think China will be one of the last countries standing. The govn is so careful about people power because they know what it can do and they are taking extra measures to keep the masses happy. And the masses are happy. There is plenty of food to eat and it is grown very close to the cities. So it is not a problem getting the food to the people in the cities.
    I think Egypt is a classic example of overpopulation pressures, they have had 100% population growth over the last 50 years and that is coming back to haunt them big time. And population is going to be a problem in many other countries very soon. I don’t know how China will fare as they have a very large population base to start with.
    I do agree there are heaps of empty buildings around. The building boom got a bit ahead of itself and now the govn is bringing measures to try and slow it down. The one thing that worries me is water, they know they are running out of water but they are not educating the masses to conserve water. To my knowledge there is very little personal water conservation. If they jacked up the price then the people might stop wasting water. But at the moment it is so cheap there is no incentive to save water. At the moment there is a serious drought in the north of China and that could get a lot worse.

  • http://www.animalsdinosaursandbugs.com/The-Future.htm Peter Legrove

    I think Egypt is a classic example of overpopulation pressures, they have had 100% population growth over the last 50 years and that is coming back to haunt them big time. And population is going to be a problem in many other countries very soon. I don’t know how China will fare as they have a very large population base to start with.

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