China’s economic ‘miracle’ is no such thing.

It has had a few key advantages over the West since 1990 or so.  Firstly, China did not have to go through the pain of developing products and services for sale, as a late market entrant it was able to pick winners, like CDs, and not have to develop and pay for losers, such as vinyl records and cassette tapes. Secondly, it has a massive population who will pretty much do as they are told (interestingly for a communist country, trades unions are banned).  Thirdly, it does not suffer from costly and burdensome environmental and safety regulations, not to mention pesky accounting standards.  Lastly, it had Western governments who wanted low interest rates to pay for a massive increase in spending.

The trade goes like this: here in the UK we want rubber ducks, but because we have high labour and transaction costs, in part thanks to EU regulation, it is cheaper for us to buy our ducks from a factory in China. The rubber duck factory owner and his friends in the local party get rich and buy a house each.  The problem is that there are not enough houses yet built, so even though developers are springing up all over the place the supply of the properties to sell cannot keep up with the demand from all of our rubber duck manufacturers and their friends, and so house prices rise, and this brings in more speculative cash and we have compound inflation of house prices.

69/70 of the major cities reported house price increases at an average annual rate of 8.5% with some cities like Shanghai and Beijing reporting annual rises of 15% in September, and property alone accounts for 25% of overall Chinese investment goes on property.  The local banks, who are very new to this game, are very keen to lend to buyers as prices always rise.

This has led to the private domestic credit ratio becoming the largest in the world, hitting 221% in July according to China Securities Journal – an arm of the regulators (the UK’s ratio is 120% and we all know how that is crushing our economy).  According to Ambrose Evans-Pritchard of the Daily Telegraph, since 2008 China has increased credit from $9 trillion to $23 trillion – the increase alone being the size of the entire American commercial banking system.

China’s problems also involves its population.  Earlier this year the International Monetary Fund reported that, owing to the disastrous one child policy, the working population will soon go into precipitous decline and the surplus labour supply coming from the countryside will disappear, leaving care for the elderly a major problem.  China will also then lose its competitive advantage, and countries with cheaper labour costs will start taking the rubber duck economy elsewhere.  House prices will collapse, taking with it the most over extended credit system in the history of the world.

So why should we care if China collapses?  As long as get our little duckies from somewhere it doesn’t really matter does it?  Oh yes, it does.  For twenty years as a massive exporter and having virtually no internal market China grew its earnings in Dollars, Euros and Pounds.  Where did it put those $ € and £.  Into Government bonds.  It owns almost $4 trillion of the stuff, US T Bills, German Bunds and UK Gilts.  As China bought these bonds along the way the prices rose which allowed world governments to sell more and more to finance their crazy spending, the higher the price meant that the interest rates offered by the governments in their subsequent sales were lowered so lowered global interest rates.

This was deliberate American and European rate policy, as the Governments were using China’s trade surplus to borrow at lower and lower rates.  As the demand for the Chinese rubber ducks erodes the Government will be forced to spend a higher and higher proportion of its money on its hospitals, schools, courts, and to pay for this it will have to liquidate its bond holdings.  The crash of worldwide bonds will smash the values pension funds, insurance companies, banks and so on, and Governments will have to borrow at higher and higher rates as the market retreats from wanting to hold the stuff, and the lower the price goes more and more stop-losses will be triggered, driving the prices even lower and so on.  This will automatically mean that interest rates will go up alarmingly quickly, and this will shrink the Western economies at a rate never seen.

 

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