It must be lonely being a China bear….particularly for those dubious about its longer term prospects, as opposed to those who might simply think its stock market is a bit ahead of itself even after its recent correction.
Vitaliy Katsenelson, in an article at MorningStar, beings almost sounding a tad persecuted before he warms up to his theme. that there is more in common between Japan in the late 1980s, when it seemed poised to continue its inexorable rise and China today. And the differences for the most part favor Japan. Katsenelson first quotes Jim Grant at length, then offers his own comments.
From Morningstar (hat tip reader Michael):
China today is where Japan was in the late ’80s, except with the greater political instability that comes with a semi-controlled economy and the lack of a social safety net (read: jobless, hungry people don’t write angry letters, they riot)…Today China projects to the world a similar image as Japan did in the 1980s…Lately, the Chinese economy has been impressing us with its growth…But Chinese economic structure is not is not superior to the West’s; the Chinese can just cook GDP numbers better and control their economy more effectively through forced lending and spending.
However, these short-term advantages come with long-term consequences – there will be a steep price to pay for them; there always is. I’ve written a lot about this (here and here). Instead I’ll quote James Grant, the publisher of Grant’s Interest Rate Observer. Jim is providing the latest issue of his newsletter free…Here are a few quotes …:
“A superb primer on the risks of China’s go-for-broke lending drive was published by Fitch Ratings on May 20. Is it not passing strange, the agency asks, that Chinese lending is accelerating even as Chinese corporate profits are shrinking? ‘Ordinarily, falling corporate earnings are met with tightened lending, but in China, precisely the reverse is evident. . . .’ You would expect—and Fitch does anticipate—that the borrowers of these trillions of renminbi are not so profitable as they were in the boom, and some will therefore struggle to service their debts.”
I think this chart, also excerpted from Grant’s Interest Rate Observer, tells the full story of the quality of China’s latest growth…
“Examining, first, the track of Chinese bank lending and, second, the trend in Chinese nonperforming loans, the seasoned reader will remember … Drexel Burnham Lambert. In the mid-to-late 1980s, the American junk bond market combined breakneck growth with muted default rates. The secret, fully revealed during the subsequent bear market, was that the default rates were a direct product of the issuance rates. Borrowers didn’t default because of—to adapt the Fitch formulation to that earlier time—the ‘pervasive rolling over and maturity extension of bonds as they fell due.’ Drexel failed when the junk market did.
Yves here. Hyman Minsky fans will recognize this as his Ponzi unit paradigm. Back to Grant via Morningstar:
“Since 2005, China has generated 73% of the global growth in oil consumption and 77% of the global growth in coal consumption.” [emphasis is mine]
Yves here, I know extended quotes in blog posts can be a bit confusing. We are now done with Jim Grant and are back to Katsenelson in a second of two linked articles:
Today, Chinese economic growth is the force pushing the global economy. The quality of this growth, however, is low as it is predicated on massive (forced) lending and thus unsustainable. As Chinese growth slows, China will turn from a wind into sails of global economy to its anchor. The impact will be felt in many, often unsuspected places.It will tank the commodity markets, commodity producers and commodity exporting nations. Let’s take oil, for instance. As incremental demand from China collapses, oil prices will follow, taking the Russian economy with it, as Russia is for the most part a one-trick-petrochemical-pony. According to GavKal Research China accounts for 15% of Brazil’s exports (up from 1.5% a decade ago), significantly impacting the economy of that South American nation..
Demand for industrial goods will fall off the cliff. China consumed a lot of those goods – $550 billion worth annually (also according to GaveKal Research). So if Caterpillar expects to sell more of its yellow earthmovers to China, it will have put that thought on hold for awhile…..
Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5% mortgages and 6% car loans.
Identifying bubbles is a lot easier than timing them. An astute observer could have seen the Japanese bubble developing in 1986, 1987 and 1988, but he would have been “wrong” until 1989….
Yves again. The other reason to take this gloomy appraisal seriously is that in the Great Depression, it was the big exporter (the US) that faced the most difficult adjustment. Overconsuming indebted countries in Europe simply defaulted.
Richard Kline 
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Myself, I doubt that the historical comparison—China 2009 : Japan 1989—is a particularly good one; it may well even be an invalid one. A few points.
Japan in 1989 was a mature industrial country. China in 2009 is nothing like a mature industrial country; there is much room for expansion, and a good measure of the 'industry' is comparatively low-value assembly with significant overcapacity (now being sharply contracted).
Japan in 1989 had an extensive financial sector, with a large and liquid stock market. China in 2009 has a financial sector small not only in relation to the country but even moreso in relation to the global economy. The stock market is narrow, small, and immature. Both depend _heavily_ upon the state for funds and 'guidance.'
Japan in 1989 was an urban-dominated society with a very large middle class, though one not very liquid or wealthy. That middle class saved relentlessly, creating a sizeable pool of assets nationally. China 2009 is still (still) primarily a rural country. The middle class is tiny compared tot he population as a whole, if increasingly potent because connected to the global economy. Still, the asset base of that tiny middle class is small in relation to the economy. In many respects, the pool of rural capital is much more important to China's domestic economy than the pool of middle class urban capital; that is my surmise (though I'll say that the issue is debatable, and in fact would benefit from closer study by someone).
One could go on, but the main point I'd make is that this just isn't a good historical comparison. One more accurate would be comparing Japan _1959_ with China 2009. That is much closer. And independent of broad comparative issues, I'll say also that from the cyclical standpoint this is much, much closer to a true comparison. For one thing, this represents both national economies at comparable places in the innovation cycle: we should be anticipating a _significant_ innovation boom in China. [Note: The most accurate cyclical comparison would be Japan 1949 to China 2009, but the post-war devastation in Japan suppressed output and skewed society in a way that distorts more than it reveals. Try, then, Japan 1955 or so for an optimal placement.]