15/5/14 10:26 pm Why China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra

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Why China Will Implode: Its A Monumental Building Aberration,
Not An Economy
The thing to understand about China is that it is not just another booming
EM economy that is momentarily struggling to cool-down its excesses
in fixed asset investment and make a transition to some kind of more
normal consumer-based economy. That comforting notion represents an
odd-confluence of propaganda from the comrades in Beijing and hopium
from Wall Street stock peddlers.
In fact, China is a grotesque economic aberration that bears no
relationship to prior economic history or any conventional economic
models-not even to the export-mercantilism model originally developed by
Japan, and which has now proven itself wholly unsustainable. Instead, China is a nation that has gone mad
building,speculating and borrowing on the back of a credit bubble so monumental (and dangerously unstable)
that its implications are resolutely ignored by observers deluded by the notion that China embodies
a unique economic model called red capitalism.
But when a nations debt outstanding explodes from $1 trillion to $25 trillion in 14 years, thats not capitalism,
even if its red. What it represents is monetary madness driven by the state.
Occasionally a picture is worth a thousand words, and heres one buried in a Financial Times story on Chinas
rapidly deteriorating housing market. It seems that during the two-year period 2011-2012, which was the
peak of Chinas much praised aggressive stimulus response to the Great Recession in the DM world,
China consumed more cement than did the United States during the entire 20th century!
That astounding fact needs to sink in, and it is a factblessed by the U.S. Geological Survey. Stated differently,
imagine the whole urbanization and suburbanization of America over 100 years; the building of all the office
towers, skyscrapers and malls which festoon thousands of city landscapes from coast-to-coast; the building of all
the great public works of the 20th century including likes of the Hoover,TVA and Grand Coulee dams and all the
Army Corps locks, dams, navigation and flood control projects; the Interstate Highway system and all the
derivate highways and suburban sprawl which came with it; all the stadiums, auditoriums, airports, bus and train
stations, subways and parking lots that have ever been built in America; and keep imagining because the
underlying proposition is itself scarcely imaginable:
The FT reported overnight that In just two years, from 2011 to 2012, China produced more
cement than the US did in the entire 20th century, according to historical data from the US
Geological Survey and Chinas National Bureau of Statistics. We showed this two years ago -
little did we know that two years later the situation would be completely out of control.
Heres the thing. You cant look at Chinas entirely doctored and goal-seeked GDP accounts and have any
understanding of the thundering collapse which will actually occur when the building boom ends. The idea that
fixed asset investment at 50% of GDP is just some kind of economic ratio that the comrades in Beijing can
15/5/14 10:26 pm Why China Will Implode: Its A Monumental Building Aberration, Not An Economy | David Stockman's Contra Corner
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shimmy down to normalitysay
25% which is still high by every
other economy in the worldfails
to comprehend what Chinas
economy really is. That is, its a
continent-wide construction
project in which everything flows
into obtaining, moving, fabricating
and erecting infrastructureboth
public and private, retail and
industrial.
So when the building stops
because the inflated prices of real
estate are collapsing and credit
expansion can no longer prop up
the bubble, the implosion will be
thunderous. Cement production
could drop from 2 billion tons per
year to 500 million; rebar consumption would crater proportionately; industrial fleets of cement trucks and steel
haulers would lie idle; demand for tires, engine parts and truck fuel would vaporize; vendors of all the services
that support this gigantic flow of cement and steel will be out of business; they empty apartment investments
held by their owners will be worthless.
Thats what will happen when the building stops. This article from the Telegraph suggest such a turn of event
might not be all that far down the road. As one observer ventured:
They can keep on building but no one will buy.

By Ambrose Evans-Pritchard
Chinas authorities are becoming increasingly nervous as the countrys property market flirts with
full-blown bust, threatening to set off a sharp economic slowdown and a worrying erosion of tax
revenues.
New housing starts fell by 15pc in April from a year earlier, with effects rippling through the steel
and cement industries. The growth of industrial production slipped yet again to 8.7pc and has
been almost flat in recent months. Land sales fell by 20pc, eating into government income. The
Chinese state depends on land sales and property taxes to fund 39pc of total revenues.
We really think this year is a tipping point for the industry, Wang Yan, from Hong Kong brokers
CLSA, told Caixin magazine. From 2013 to 2020, we expect the sales volume of the countrys
property market to shrink by 36pc. They can keep on building but no one will buy.
The Chinese central bank has ordered 15 commercial banks to boost loans to first-time buyers
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and expedite the approval and disbursement of mortgage loans, the latest sign that it is backing
away from monetary tightening.
The authorities are now in an analogous position to Western central banks following years of
stimulus: reliant on an asset boom to keep growth going. Each attempt to rein in Chinas $25
trillion credit bubble seems to trigger wider tremors, and soon has to be reversed.


Wei Yao, from Socit
Gnrale, said the
property sector makes up
20pc of Chinas economy
directly, but the broader
nexus is much larger.
Financial links includes
$2.5 trillion of bank
mortgages and direct
lending to developers; a
further $1 trillion of
shadow bank credit to
builders; $2.3 trillion of
corporate and local
government borrowing
collateralised on real
estate or revenues from land use.
The aggregate exposure of Chinas financial system to the property market is as much as 80pc of
GDP. This is not a sector that can go wrong if China wants to avoid a hard landing, she said. The
risk is that several cities will face a controlled crash along the lines of Wenzhou, where prices
have been falling non-stop for two years and have dropped 20pc.
President Xi Jinping has made a strategic decision to pop the bubble before it spins further out of
control, allowing bond defaults to instil market discipline. But the Communist party is in delicate
position and may already be trapped.

Reliance on fair weather land revenues to fund the budget is like the pattern in Ireland before its
housing bubble burst. The IMF says China is running a fiscal deficit of 10pc of GDP once the land
sales and taxes are stripped out.
Zhiwei Zhang, from Nomura, said the latest loosening measures are not enough to stop the
property slide, predicting two cuts in the reserve requirement ratio (RRR) for banks over the next
two quarters. He warned that any such move will merely store up further problems.
Nomura said the inventory of unsold properties in the smaller third and fourth tier cities which
make up 67pc of residential construction has reached 27 months supply. The bank warned in a
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recent report that the property slump could lead to a systemic crisis.
The Chinese state controls the banking system and has $3.9 trillion of foreign reserves that can
be deployed in a crisis. The RRR is extremely high at 20pc and can be slashed if necessary. A cut
to 6pc, the level in 1998, would inject $2 trillion in liquidity.
Nomura said residential construction has jumped fivefold since 2000 from 497m square metres to
2,596m last year. It is unclear whether fresh migrants will continue to pour into the cities and soak
up supply. Nomura said migrant numbers have already halved from 12.5m to 6.3m over the last
four years.
What is certain is that Chinas demographic profile is already changing the economic calculus.
The workforce contracted by 3.45m in 2012 and another 2.27m in 2013. For better or worse,
China is already starting to look very like Japan.
http://www.telegraph.co.uk/finance/china-business/10828912/China-reverts-to-credit-as-property-
slump-threatens-to-drag-down-economy.html
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