China’s emergence as a world power over the last ten years has been nothing short of astounding. While China entered the new millennium with plenty of momentum, its meteoric rise as a world super power has come quicker than many anticipated. Following the decline of the United States, Japan, and Europe, China has emerged as an alternative to the “West.” Now, however, some are wondering if a similar speculative bubble that derailed Japan back in 1990 and the West in 2008 could be building in China.
Two key assets are facing the bulk of the scrutiny from analysts. First, highly speculative and questionable loans given to local governments may turn out to create a market of bad equalities, similar to the multitude of bad mortgages that took down both the U.S. and European economies. Second, skyrocketing real estate values could build into a bubble that could eventually pop and derail the market, just as the housing bubble in the United States set off the 2008 financial crisis.
The following is our rough coverage of the 2021 Sohn Investment Conference, which is being held virtually and features Brad Gerstner, Bill Gurley, Octahedron's Ram Parameswaran, Glenernie's Andrew Nunneley, and Lux's Josh Wolfe. Q1 2021 hedge fund letters, conferences and more Keep checking back as we will be updating this post as the conference goes Read More
China’s shadow banking system
China’s financial system isn’t considered to be as over leveraged as America’s was during the financial crisis. The emergence of an off-the-books shadow banking system, however, makes it difficult to estimate exactly how deeply China is buried under debts. Many of China’s local governments, for example, have set up private companies to handle private sector loans to develop infrastructure. The total amount of loans taken out by these companies is unknown, but if local governments fail the central government may be left on the hook.
China’s financial regulations also remain rather lax and opaque. As such, many private lending and burrowing companies have emerged. Deeply intertwined with various loan and lending programs, investment vehicles, and other financial instruments, the fiscal health of these companies is hard to project. Families and private investors also poured their money into these firms, so the level of exposure remains unknown.
Rising property prices
Property prices have also skyrocketed to unprecedented heights, with costs rivaling New York City, Tokyo, Paris, and other cities in fully developed countries. This comes despite the fact that China is still a developing economy. At the same time, China is littered with abandoned ghost towns after real estate developers failed to attract high numbers of residents. Meanwhile, it’s believed that many apartments are being bought by investors based on projected future demand, but are remaining empty and unrented in the meantime. It’s fair to wonder, then, whether or not the actual demand exists to justify the burgeoning and skyrocketing real estate market.
Both China’s shadow banking industry and its real estate industry is being fueled by speculation. Years of strong economic growth has bred optimism has led many people and companies to bet on the future. Just as American homeowners assumed that housing prices would always rise, some Chinese investors appear to be assuming that China’s economic expansion will continue to expand unabated for the next several years.
China’s cost advantages in danger
While it’s easy to see China’s successes, it’s also easy to over look the country’s weaknesses. Booming real estate costs, for example, could wipe out China’s cost advantages. At the same time, China has found it difficult to move up the value chain, despite the billions of dollars spent on R&D. Meanwhile, despite efforts to develop local consumer consumption, China remains dependent on exports.
China may be able to overcome these challenges, however it’s also possible that the country could suffer setbacks. Under normal circumstances, market forces should be able to cope with and address any economic challenges or downturns. Speculation, however, could make any economic downturn worse or cause a major bubble to build that when popped could derail an otherwise strong economy.
Japan’s stock market bubble
Japan was at the peak of its power when its real estate and stock market bubble popped. The result has been two generations of stagnant growth and increasingly uncompetitive companies. The United States was enjoying several years of economic expansion when the housing bubble collapsed and quickly spread through poorly regulated financial derivative markets, threatening to bring down numerous global financial giants.
With China exhibiting similar characteristics to Japan and the United States during the build up to the implosion of their speculative bubbles, it’s fair to wonder if another bubble could be building. So far, however, China’s government has proven to be more responsive and cautious when dealing with risks and crisis situations. The government has been moving rapidly to build a more transparent financial system, bring loans to local governments under control, and otherwise reforming the economy. While risks are present, China may be able to avoid a catastrophic collapse.