China bubble about to pop

Filed in archive risk on April 6, 2010

More warnings about the bubble that is China. The last thing anyone wants to hear is that China is starting to look like the early stages of the US subprime crisis, but that's the line from the experts.

The Telegraph reports that SVM Asset Management is warning that the parellels with the US housing bubble are very clear and that the growth is unsustainable. The biggest cities in China have taken on enormous debt with enormous confidence being in steadily rising property prices with little thought given to capital repayment. Sound familiar?

GMO's Edward Chancellor has warned of China's 10 red flags:

1. Great investment debacles generally start out with a compelling growth story.

2. A blind faith in the competence of the authorities is another typical feature of a classic mania. In other words, you can't always trust the numbers that a government is putting out.

3. A general increase in investment is another leading indicator of financial distress. Capital is generally misspent during periods of euphoria.

4. Great booms are invariably accompanied by a surge in corruption.

5. Strong growth in the money supply is another robust leading indicator of financial fragility. Easy money lies behind all great episodes of speculation from the Tulip Mania of the 1630s - which was funded with IOUs - onward.

6. Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts.

7. Crises generally follow a period of rampant credit growth. In the boom, liabilities are contracted that cannot subsequently be repaid.

8. Moral hazard is another common feature of great speculative manias. Greed isn't necessarily good and we tend to act irresponsible during intense periods of speculation.

9. A rising stock of debt is not the only cause for concern. Investments financed with borrowed money don't generate enough income to either service or repay the loan.

10. Dodgy loans are generally secured against collateral, most commonly real estate. Thus, there is a combination of strong credit growth and rapidly rising property prices which will inevitably burst.

Chancellor says China meets all 10 criteria. His report, as published by the Vancouver Sun, says the bubble is about to pop. He says the problem is that much of the bubble is about cheap labour. But that is about to end. "China's population is set to decline in 2015," he writes. "The worker participation rate will peak this year. It's anticipated that the number of people joining the workforce will fall off quite rapidly. Yet it's this section of the population that tends to move to cities and has provided China with an apparently limitless supply of cheap labor."