Back in October, I laughed off the latest China GDP data as utterly fabricated.As it turns out, I was not the only one. China expert Gordon G. Chang (author of The Coming Collapse of China) is more than skeptical — he has the data to question much of China’s growth miracle.

Spoiler alert: Its been wildly exaggerated:

“Beijing, in the 1990s, ordered factories to churn out goods in periods of low demand, and there are indications that officials are resorting to this tactic now. While optimistic analysts point to astounding car sales–up 70.5% in July, 94.7% in August and 83.6% in September–there are reports that central government officials have ordered state enterprises to buy fleets of vehicles and that these businesses are storing them in parking lots across the country. These stories are as yet unconfirmed, but they are consistent with statistics showing that gasoline sales have been flat this year–up only 6.4% in August, for instance, and sliding since then from all indications. So here’s another question: At a time when economic activity is supposedly rising at a quick pace, how can large increases in passenger vehicle sales not be accompanied by corresponding surges in fuel usage? (emhasis added)

The answer is that Beijing’s statisticians have gone back to their old tactic of making up figures to support the Politburo’s predictions. The Chinese economy is probably growing due to state-led investment, but it cannot be doing so at the rates claimed. Wen Jiabao’s stimulus plan is, above all, grossly inefficient. For all the money he is pouring into the economy, the country is getting a small return in economic output. That’s why Premier Wen, despite the high growth numbers he’s been reporting, consistently refuses to end his stimulus program. If his numbers were real, he would be worried about overheating. But he’s apparently not.”

Gee, whoever would have guessed that a Totalitarian government would lie in its official data?

Previously: Who Believes China’s ‘Bernie Madoff’ Data? (October 22nd, 2009) http://www.ritholtz.com/blog/2009/10/who-believes-chinas-bernie-madoff-data/

Source: China’s 8.9% Growth? No Way Gordon G. Chang Forbes, 10.23.09 http://www.forbes.com/2009/10/22/china-growth-gdp-economy-opinions-columnists-gordon-g-chang.html

In recent weeks I have read articles in the economist arguing that there is no bubble in Chinese property. I am not in that camp and believe that there is a bubble that is getting to dangerous proportions.

At last the FT is taking this issue seriously. I will not repeat the reasons - some are covered below. Just think Japan in the late 1980's and Japan's subsequent growth rate ever since.

The problem is a lack of alternative investments for the cash rich in China and loose lending by out of control banks.

This article represents a useful introduction.

Fears of China property bubble [FT]

A large bubble is forming in China’s property market as a result of Beijing’s credit-driven stimulus programme, one of the country’s most prominent real estate developers warned.

Zhang Xin, chief executive of Soho China, one of the country’s most successful privately owned property developers, told the Financial Times the asset bubble was leading to rampant wasteful investment in the sector, undermining the country’s long-term growth prospects.

“Real estate prices should only go up because people want to actually use the space, but at the moment we can see more and more empty buildings across the whole country and in every real estate segment,” Ms Zhang said. “The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried.”

Ms Zhang’s assessment was echoed by Fan Gang, a member of the central bank’s monetary policy committee, who warned on Wednesday that real estate in cities such as Beijing, Shanghai and Shenzhen was expensive and there was a growing risk of asset price bubbles.

Urban property prices in 70 big and medium-sized Chinese cities rose 3.9 per cent in October from a year earlier, accelerating from September’s 2.8 per cent rise, according to government figures.

Price rises in top-tier markets such as Beijing and Shanghai have been much faster. Analysts say the rebound has largely been driven by an unprecedented government-led expansion of bank lending. It is also being driven by government policies, including tax breaks, low interest rates and smaller down-payment requirements.

Investment in real estate development, a key driver of economic growth, rose 18.9 per cent in the first 10 months of the year on a year earlier, a marked acceleration from 17.7 per cent growth in January-September.

Ms Zhang said the current speculation should be a serious warning for the industry and the general economy.

“In Manhattan, they have vacancy rates of 10-15 per cent and they feel like the sky is falling, but in Pudong [the central business district in Shanghai] vacancy rates are as high as 50 per cent and they are still building new skyscrapers,” she said.

“If you look at GDP growth, then China looks like a new engine driving the global economy, but if you look at how growth is being created here by so much wasteful investment you wouldn’t be so optimistic.”

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.   

The blog post title says it all. These are great pictures that should be seen to be believed.

Some make for very depressing viewing and are very far from the hotel in central Beijing that I recently stayed at. Amazing Pictures, Pollution in China [China Hush]

My meetings in NY and DC were fairly different from the meetings I had in February.  This time around I got the impression that far more people in the US (although still a minority) understand how risky the Chinese recovery has been and how trade tensions are likely to result as a consequence of the stimulus.  In fact I have the sinking feeling that over the next two or three years I am going to find myself spending an awful amount of time thinking or writing about trade disputes between China and the rest of the world.Regular readers know that for me the key source of China’s high savings and trade surplus is the large excess of the growth rate in national income over household income, caused in large part, I believe, by policies that systematically transfer income from the household sector to investment, SOEs and large producers.  Until these policies are reversed I do not think it is meaningful to talk about China’s rebalancing.  Just before President Obama came to China President Hu gave a speech which my friend Dan Rosen in his November 13 Rhodium Group report described as a “stirring speech about a policy big bang to promote consumption-led growth.”  Dan is skeptical, and I am adamant – a surge in consumption will not happen except perhaps briefly as a consequence of government subsidies and anticipated consumption.

In Washington I had the chance to meet someone I admire a great deal, Nick Lardy at the Peterson Institute, and although I shouldn’t put words in his mouth so as not to misrepresent him, I am glad to say that he seems to agree with the analysis of Chinese high savings as a consequence of policy-related constraints on household income growth, although he thinks currency undervaluation may have a greater impact on high savings than low interest rates, whereas I think it is the other way around.  In fact more generally I think this argument has become increasingly influential, and more and more analysts seem to be taking it up, both inside and outside China.

In that light I read earlier this week a fascinating and perhaps important article by Hung Ho-Fung in the current issue of the New Left Review, in which he argues that China’s development model has left it dangerously vulnerable to changes in US demand, and that these polices include repression especially of rural income.  According to Hung:

The PRC’s urban-biased development model, then, is the source of China’s prolonged ‘limitless’ supply of labour, and thus of the wage stagnation that has characterized its economic miracle. This pattern also accounts for China’s rising trade surplus, the source of its growing global financial power. However, the low wages and rural living standards that have resulted from this development strategy have constrained China’s domestic consumer market and deepened its dependence on the global North’s consumption demand, which increasingly relies on massive borrowing from China and other Asian exporters. As those other exporters have been integrated with China’s export engine through the regionalization of industrial production networks, the vulnerabilities of the Chinese economy have turned into weaknesses of the East Asian region as a whole.

Hung goes on to make a point that I wish many more would make.  When people like me warn about continuing domestic imbalances within China and the difficulty that China will face in its transition, we are often attacked for “blaming” and criticizing China.  Monday I was at a conference consisting of many prominent European and Chinese (and a few American) analysts who were discussing global imbalances.  At the end of one panel a member of the audience, who turned out to be from the Ministry of Commerce, demanded the right to make a rebuttal and set off on a fairly strange harangue in which she lambasted, to everyone’s bemusement, any attempt to assign China responsibility for any aspect of the crisis as well as any suggestion that its fiscal stimulus was worsening the underlying imbalances.  China has not, apparently, made even minor policy mistakes at all in the past decade and especially in the past year.

The nationalist argument

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What a difference seven years makes. No one had a problem with Japan having super low interest rates and stoking a global carry trade, nor with the US running overly loose monetary policy that led to a real estate bubble that spread its impact beyond our borders via the creation of toxic mortgage product sold far and wide.

But one difference this time is now the dollar, rather than the yen, looks like the best funding currency, and the dollar is a deeper market, so the scale of potential damage is much greater. Second is that a lot of countries are running loose money policies, but they are at least making some credible noises re tightening (whether they follow through is another matter, of course). The US, by contrast, has made clear that it is keeping things easy-peasey for the foreseeable future. And the US (starting with the Greenspan era) has signaled any hawkish moves well in advance, so the odds that the Fed will have a sudden change of heart are just about zero.

Now, to play devil’s advocate, one could argue that the loose money policy is warranted. There is tons of slack in the economy, unemployment is high and rising, capacity utilization stinks. Surely raising rates now would be the worst move possible, right?

The authorities are completely responsible for the messes on two different fronts that intersect to create monetary policy dilemma. Going below 2% for Fed funds was a huge error (well maybe you could justify 1% as a very short term expedient), but the Fed is now painted in a corner. But second, and the much bigger issue, is that (as everyone can see) all this cheap money is not going into the real economy. A few very high quality borrowers are getting good rates; everyone else finds credit scarce and costly. So spreads are higher than before, and even absolute rates are often higher expect in markets like mortgages where the Fed has intervened.

Now some readers will correctly say that overly loose lending is what created the problem, and we need to undo that, but they are conflating two issues. Tightening up on WHO gets credit and HOW MUCH they get is separate from pricing. If this was mere improved standards, you’d expect to see more discrimination within various types of borrowers. But instead, across entire swathes of borrowers, particularly consumers and small businesses, banks have simply turned off the spigot. This has little to do with a return to prudent practices. In fact, it illustrates a real cancer: that across consumers and many small business owners, old-fashioned multi-variable decision-making (which included some verification of income) has been replaced by heavily or entirely FICO based systems. Those systems failed utterly. But they were cheap to operate, banks have no intention of reverting to earlier, more costly approaches. So we have a credit assessment process that is broken, but no one wants to admit it.

So if all this loose money isn’t getting to the real economy, there should be no reason not to raise rates, right? Wrong. This little procedure is again, entirely about the banks, screw the real economy and everyone in it. First, low rates (and now a steep yield curve) are an ideal setting for banks to make money. Greenspan pulled the same trick in the wake of the S&L crisis, and it enabled banks to rebuild their very wobbly balance sheets comparatively quickly (I’m amazed at the revisionist history about the early 1990s banking woes, which also involved pretty serious damage from dud LBO loans, and left the US banking system seriously undercapitalized). This plus high spreads makes ofr a very attractive environment for any new business.

But the second reason for keeping rates low is explicitly to keep asset prices aloft. The bubble is an explicit goal of policy. Remember, early in the crisis, they was talk of the markets being irrationally depressed. Funny how it is only prices that are seen as inconveniently low, and not ones that are insanely high, that are criticized.

But to cite Richard Nixon parodists: Let us make one thing perfectly clear. These monetary shenanigans are in no small measure the result of the utter failure of nerve late last year and early this year, to take sick institutions and resolve them. In many cases might not have entailed the bogeyman of nationalization (as in protracted government ownership), but throwing out the old top management and board, and forced debt to equity conversions. Cleaning up the banks was never treated seriously as an option, when the track record clearly shows that that is the fastest, least-cost way to deal with a financial crisis.

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On the eve of U.S. President Barack Obama’s visit to China, a major Chinese official has criticized U.S. monetary policy in unusually harsh language. Liu Mingkang, China Banking Regulatory Commission chairman said the zero interest rate policy of the U.S. Federal Reserve posed a “new systemic risk.”

Liu, using language reminiscent of warnings by NYU economist Nouriel Roubini and speaking at a financial forum in China’s capital Beijing, said:

This situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices… It is boosting speculative investment in stock and property markets and will pose new, insurmountable risks to the global recovery and, particularly, to the recovery in emerging markets.

In my view, this is pure political posturing by the Chinese in order to defuse any U.S. criticisms of Beijing’s currency peg. Call it a pre-emptive strike. The U.S. has seen the unemployment rate rise to 10.2% and the trade deficit rise quite dramatically as well. Many are blaming the Chinese and their currency peg to the U.S. dollar.

The Chinese expect Barack Obama to deliver a message that his administration will find it increasingly difficult to hold protectionist pressures at bay given the Yuan’s firm peg to the U.S. dollar even while the dollar has plummeted.  To prevent the U.S. from successfully painting the Chinese peg as the sole major risk to the global economic recovery, the Chinese must therefore point to the destabilizing measures taken by the U.S. to reflate its domestic economy.

All indications suggest that we are now returning to the same unbalanced pre-crisis growth model – but with the global economy in a considerably more fragile state. In this climate, the issues of the Yuan currency peg and low interest rates in the U.S. will continue to be front and center going forward.

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE. 

As Robert Lucas, Nobel Prize in Economics, said recently: If we knew the timing of the next asset bubble, we would sell our assets one week before. Perhaps he was trying to show the futility of regulations and policies against bubbles. But his remarks - typical of a free-market brilliant economist - might represent the beginning of an authentic short-term "research program" devoted to the U.S. recovery and to the U.S. inflation.

Yes, Bernanke more than tripled the monetary base and adopted a policy of benign neglect with respect to the dollar, hoping the currency would devalue, just like in 1933 when Roosevelt did the same thing and avoided deflation.

The economic analyst’s task from now on is to guess the timing of the U.S. recovery and the U.S. inflation, because this will provoke a major change in U.S. economic policy: raise in interest rates and dollar revaluation.

One might say that this will be the end of the present “dollar party” when carry-trades based on very short-term loans denominated in U.S.$ are financing all around the world purchases of risky assets denominated in dollars and particularly in other currencies- Brazilian stocks, U.S. stocks, Brazilian real, Australian dollar, oil, gold, sugar, etc. A party – but probably many bubbles.

Undoubtedly, new asset bubbles were formed in 2009 leading to economic policy dilemmas in many countries. As a matter of fact, in the U.S., another type of monetary policy of the Greenspan style (without rigid inflation targets) would certainly have already led to higher interest rates. In Brazil, paradoxically,  if you raise interest rates the real will appreciate even more, and if you lower interest rates the stock exchange will continue with the bubble. And so on.

This dollar party was somewhat unexpected, after the seriousness of the 2008 crisis. But bankers and traders do not lose time: they perceived the carry-trade opportunity, with dollars at zero interest rates, even if only for a few days, and additionally with the currency devaluation.

The mismatch between the U.S.$ loans and the long-term nature of the assets being purchased is dramatic, because after all - when things go wrong - liquidity disappears, particularly in countries (Brazil) where the exit doors are small and foreign exchange markets are thin( using the expression of Robert Mundell, another Nobel Prize).

Our recommendation is to keep an eye on what's happening in the United States - as always. It is true that in cases like China (or even Brazil) the bubbles might burst before the U.S. interest rates go up and the dollar recovers for internal reasons and domestic policy mistakes, but in general the "negative" signs will come from the US.

And the curious thing is that such "negative" signs will be derived from very good news: The US will be growing again at a fine pace without inflationary pressures. Our guess estimate is that this will occur in the very beginning of 2010 - not too far from today – after fourth quarter figures in the U.S. But let us keep researching carefully because the bets are huge.

As Asia starts down the path to recovery, it is going to have to tackle two issues which are constraining its long-term growth potential: firms that save but do not invest and wealthy households that are reluctant to consume.

At first glance, such behavior seems inexplicable and counter-intuitive.  Let’s imagine for a moment you are an investor—you may well be— you put quite a bit of money into a company to back its expansion plans. Initially, these plans prove successful, and the company makes quite a bit of money. But then the firm ran out of investment ideas. What would you expect them to do?

Surely, you would expect them to return the money you provided, for example by paying it out as dividends. But in the past, prosperous decade before the current downturn this hasn’t been happening in emerging Asia. Firms have been sitting on their profits, not investing them, but not paying them out in dividends, either. That is a puzzle, and a problem.

It’s a puzzle because it’s not obvious why firms should sit on money when they don’t have any need for it. When firms initially started doing this after the Asian crisis of the late-1990s, they had a ready rationale. They wanted to pay down their excessive levels of debt, which during the crisis had brought some of Asia’s largest companies low. But as the years went on, and debts fell, first to safe and then to low levels, it was clear that something else must be going on.

There’s a further puzzling aspect. Economic theory states that households can “pierce the corporate veil” and extract value from a company even if it doesn’t actually pay out profits as dividends. That’s because the retained earnings would increase the firm’s net worth, which would be reflected in its share price. Households could then sell the shares, or borrow against them.

Either way, they could spend more. This theory has been tested in empirical research and found to hold in advanced countries, and some emerging markets. But it doesn’t hold true in China or the rest of emerging Asia. Households simply do not consume more, despite holding valuable financial assets.

Why does this matter? It matters because Asia’s corporate savings puzzle lies at the heart of its economic imbalances. It is precisely the substantial and growing excess of savings over investment in the corporate sector, coupled with subdued household consumption, that over the past decade has produced the region’s large external current account surpluses.

We tried to analyze this mystery in Chapter III of the Asia-Pacific Regional Economic Outlook.

We discovered two vital clues:

• Corporate governance. The higher the level governance, the more shareholders are able to exercise their rights and prevent firms from hoarding cash.
• Financial sector development. The more liberalized the financial market, the less firms hoard cash, because they have easier access to funding and are less worried about being shut out of financial markets. Financial liberalization also allows households to consume against their corporate wealth, because they can borrow using their financial assets as collateral.

These finding have profound implications for policy. For example, the econometric estimates imply that if Asia were to reach the average level of corporate governance in advanced economies, it would be able to lessen corporate savings by as much as 2½ percent of GDP. Similar advances in financial sector liberalization could reduce savings by 5 percentage points.

Resolving the conundrum of firms that save but do not invest, and households that hold this wealth but cannot consume may enable Asia to finally catalyze domestic demand.  It could help to  restore rapid growth, even in a “new world” of softer advanced country demand. Improved corporate governance and further financial sector development may be two remedies worth exploring.

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.