The Coming Crisis in China

10/15/2009 12:00 pm EST


Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carl Delfeld, editor of, says China’s economy may face big problems as overcapacity and overheated bank lending result in a sharp slowdown.

As China’s leadership celebrates the 60th anniversary of Communist party rule, I wonder how many party dignitaries realize the potential economic train wreck coming at them.

The country has substantial overcapacity in manufacturing, real estate, and infrastructure, as well as deteriorating credit quality and weakening export markets. All of these factors will lead to a growth rate far below that expected by the markets and will, in turn, lead to a China crisis, circa 2010.

In 1990, China’s [gross domestic product] was roughly equal to that of Taiwan; now, it is ten times bigger. But China’s investment-led industrial growth, already into its twelfth year, is very long in the tooth. Pivot Capital Management [says] the longest previous period of investment-led economic growth was nine years, experienced by both Thailand and Singapore.

China’s approach to producing double-digit economic growth is drawn from the Asian model playbook. Heavy investment in industry leads to rapid growth in manufacturing output and this leads to rapid export growth and huge trade surpluses.

For China, though, investment (gross fixed capital formation) is at 70% of GDP, and the return on every marginal dollar invested in China is decreasing. In 2000, it took $1.50 of credit to generate a dollar of GDP, but by 2008, it took $7 of new credit to generate a dollar increase in GDP. The global macro picture will accelerate the China crisis, because it will shine a spotlight on China’s shrinking export markets and industrial overcapacity.

China’s attractiveness as a low-cost base for global manufacturing is also less compelling given supply lines spanning the Pacific. Apix Partners found that China’s pricing advantage for goods arriving in California relative to domestic prices has declined from a 22% advantage to just 5.5%.

This may be reflected in China’s slowing exports. Import growth continues to outpace the nation's export growth, and China is now on a path to start reporting trade deficits soon, perhaps as early as the first quarter of 2010, according to Eric Fishwick, head of CLSA Asia-Pacific Markets' economic research.

China’s bank lending explosion has led to credit to GDP during the first half of 2009 rising to 140%, levels equal to America in 2008 and Japan in 1991 just before their market meltdowns. Chinese financial institutions extended $1.2 trillion worth of local-currency loans in the first eight months of this year, an increase of 164% from the same period in 2008.

All this means trouble not just for China’s economy, politics, and stock market, but [it could] derail what many view as a global recovery. The recent 10% GDP growth rate that everyone seems to assume as a given will be around 5% for 2010. Unemployment is thought by many analysts to already be over 10% and will worsen to uncomfortable levels.

The recent bounce in the Shanghai Composite index has stocks trading at vulnerable levels. When it sinks in that China, rather than a provider of global growth is actually in the same slow-growth, high-debt boat as America and Western Europe, all bets will be off.

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