Noted US short-seller Jim Chanos grabbed headlines in early 2010 when he stated China is “Dubai times 1000 – or worse.” Managing partner of Kynikos Associates, a hedge fund with $6 billion under management, Chanos made his name betting on the failure of companies.
Barron’s described his prescience on Enron as “the market call of the decade, if not the past 50 years.” China, Chanos argued in an appearance on CNBC and then in following presentations, is a bubble waiting to burst. Chanos believed that its hyper-stimulated economy is not as healthy as many people believe and that strong components were overheating. Easy credit had let real estate and stock market prices shoot upward.
He also said the Chinese government was cooking the books to show growth in gross domestic products. Combined with manufacturing overcapacity and the underperformance of the government’s now expended $900 billion economic stimulus, it meant the “entire system is teetering toward collapse.”
While no Asian financial experts questioned Chanos’s abilities – after all a dead fish smells bad regardless of which side of the Pacific it is beached – many thought at the time that his critique of China Inc. was, as one bluntly expressed it, “a load of cobblers.” Little has since occurred for opinions to be reassessed.
Peng Wensheng on China’s economy
Inflation: while CPI inflation (currently 5.1%) may rise with cyclical conditions, it could fall below 4% in the second half of 2011. Growth: projections for 2010 saw economic growth at 10.2%, for 2011 around 9.5% as a result of policy tightening. Currency war: a colorful term, but not an accurate description. The danger is that hyperbole could lead to protectionism. Compromise and cooperation should prevail. Yuan as an international currency: China clearly wants it to play a major role in international trade and financial transactions, but for this to occur there must be further relaxation on capital account controls and convertibility within the next few years.
Peng Wensheng, the chief economist and managing director of the
China International Capital Corporation (CICC), China’s first joint venture investment bank, said he believes that perceptions of a financial meltdown in China, caused by the housing market or other reasons, were misguided. Japan, but not China
“There are indeed concerns about the Chinese housing market, but they are of a different nature to those expressed by Mr. Chanos,” explained Peng, a quiet-spoken man. A critical feature of recent financial crises, from the scare in European debt back to the 1990s Asian meltdown, was external finance. Involved heavily in the boom, when conditions hit a tough period external finance quickly withdrew, causing a sudden stop to the economy. In some cases, a liquidity problem became a solvency issue. “China does not have that problem,” says Peng, noting the one comparable situation to China may be Japan.
“Japan had a property bubble that burst, but it did not have a sudden-stop financial crisis, because Japan did not rely on external finance, as domestic saving was extremely high. In that respect, China is in a similar situation (see graph). We have a lot of domestic savers and don’t rely on external finance. So, the probability of a sudden stop of external finance triggering a crisis in China is unlikely.”
Peng, who formerly worked for Barclays Capital as head of China research and with the IMF, says China also has domestic strength. In many situations, a crisis inspired by external finance causes a sudden stop in domestic finance. When domestic banks suffer huge losses, as they did in the global financial crisis, they cut back lending and risk-taking, which damages the whole economy.
“China is a different case,” Peng explains. “The government owns the majority stake of most banks, so I don’t believe that if the banks suffer huge loss from, say, a sharp decline in property prices, there will be a sudden stop in domestic lending. The government will not allow that.”
The probability of a financial crisis in China resulting from a property price collapse is low, Peng believes. “However, while I think people tend to overemphasize the negative impact of a downside in the property market, they underestimate the longer-term damage to the Chinese economy if the current property prices continue to rise.”
A dangerous gap
He sees this damage as twofold. First, rising property prices create an ever-widening wealth gap between higher- and lower-income groups, as well as between the city and the country. This is creating near-term social problems: housing is becoming unaffordable for increasing numbers of the population, so the government must determinedly control pricing.
Second, there are longer-term structural concerns that rising house prices benefit the working generation in the prime of their income earning at the expense of the younger generation. If the wealth of this older generation becomes concentrated in housing, 10 years from now their investment strategy is likely to be one dominated by security and low risk.
“It is not good for the innovative capacity of the economy if too much wealth is concentrated in the older generation. When combined with population aging, this means the young generation will have a significant burden compared with the previous generation in supporting the elderly,” Peng says.
Although, he argues, Japan did not have a financial crisis comparable to the US or Europe, it does not mean it performed better. Indeed, the Japanese economy has been moribund for two decades. “China has to safeguard itself against the Japanese style of long-term damage to growth stemming from a housing bubble, rather than be concerned with a short-term collapse.”