Key Points:
"The trouble is that China today exhibits many of the characteristics of great speculative manias. The aim of this paper is to describe the common features of some of the great historical bubbles and outline China’s current vulnerability."
"Real wages will likely rise if the fl ow of rural labor dwindles, which would allow workers to consume more. But for an export-oriented economy like China, this may be double-edged, since the country’s international competitiveness might be harmed. In recent years, urbanization has been a major source of China’s productivity growth. If this slows, then future economic growth will have to come from a more efficient use of the factors of production."
"Economic theory and history, however, argue against the notion that central planning is the optimal mode of economic development. China has certainly developed rapidly over the past three decades. But under the direction of Beijing’s visible hand, its economy has become lopsided. In the years up to the credit crunch, China’s economic growth was largely dependent on rising exports. China’s exports to the West are already at twice the level achieved by Japan in its heyday. The country cannot continue growing its trade surplus with the West without inviting protectionism. This threat has become particularly acute since the onset of the Great Recession"
"Beijing imposes a GDP growth target on local governments. The problem with targets imposed by a central authority is that they are liable to being gamed. Goodhart’s Law states that whenever an economic indicator is made a target for conducting policy, then it loses the information content that would qualify it to play such a role.16 In China, GDP growth is no longer the outcome of an economic process; it has become the object."
"Roughly a quarter of all investment was government-directed. Many projects, however, were clearly intended to meet the government’s GDP growth target. A news clip on YouTube (originally from Al-Jazeera) shows the newly constructed “ghost town” of Ordos, in Inner Mongolia. An interviewee suggested that building this empty city, with housing for a million, had enabled local officials to meet their growth targets."
"It beggars belief that lending could have expanded so rapidly without some decline in underwriting standards. In fact, many accept that China’s banking system is threatened by another surge in nonperforming loans, as occurred in the late 1990s. However, conventional wisdom holds that if China maintains its phenomenal economic growth, then last year’s loans need not turn bad."
"China’s current situation is reminiscent of the late stages of the dotcom bubble, when investors extrapolated past rates of growth into the future and were bedazzled by the size of the prospective market. As with the Internet frenzy, a surge of investment creates a demand that appears to justify the most optimistic predictions."
"When the China juggernaught eventually stalls... [proponents] will face a rude awakening"
Click here to read this excellent White Paper, written by GMO's Edward Chancellor (registration required)
