Wednesday, April 27, 2011

The Chinese Infrastructure Bubble

China has been the economic growth story of the last decade. Its economic reforms allowed for a massive increase in investment and a modernization of the country. GDP has skyrocketed and been the envy of every developing economy.

GDP growth brings the most important thing that politicians need to stay in power: Jobs. Although China is a communist country and the government does not have to stand for re-election, there is immense pressure from all sides for China to continue its extraordinary GDP growth. The recent turmoil in the Middle East would only further China's desire for continued economic progress.

In such intense situations, it is natural to expect leaders to go to extreme measures to accomplish their stated goals. And China, with its large government influence is in a far better position than most countries to ensure they reach their GDP target, whatever the cost may be.

Capital formation is the investment in a country's infrastructure, such as residences, highways, factories and machinery. The Chinese have increased their capital formation from 35% of GDP in the 1970s to 2000, to nearly 50% today. This massive investment is likely well beyond what is required, is far higher than other developing countries and may be an attempt to hide poor domestic consumption.

Famed Economist Nouriel Roubini recently outlined similar concerns:
" country can be productive enough to reinvest 50 percent of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in sleek yet empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns and brand-new aluminum smelters kept closed to prevent global prices from plunging."

Indeed a bubble does seem to be forming, Asset Manager Niels C. Jensen recently commented:

"Housing affordability has reached ridiculous levels with residential properties now trading hands at values that exceed 20 times disposable income in both Beijing and Shanghai. Tokyo peaked at 8 times disposable income at the height of its property boom, and the US peaked at a mere 6.5 times. Meanwhile, according to the credit rating agency Fitch, private credit has now reached 148% of GDP, which compares with 41% for the average emerging market economy."

Any bursting of this bubble would have large scale effects, particularly on commodity prices which are the key input for infrastructure spending. Resource based economies like Australia and Canada would be especially impacted in this scenario.

SBS has a must see story on the Chinese Infrastructure Bubble.

Jim Chanos on China & Australia


hardcore value said...

wow I guess my article was timely.

Jeremy Grantham said there is a 25 percent chance that China, the world’s second-largest economy, will “stumble” by next year over imbalances such as too much capital spending, an overheating real estate market or accelerating inflation.

Ken Faulkenberry, said...

Thank you for the informative article. I have long ago pulled my investments from China, but honestly did not realize how much of an overspending problem they have. I'm going to take a close look at my investment in BHP Billiton (BHP) because of your article. Thank you.
Ken Faulkenberry

Matthew Meriwether said...

I know to myself that I am financially ready in applying for no credit auto loans. But I’m not sure if the car insurance is included in their auto loan. I hope they offer it to their clients.

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