Bubble ready to burst? (Monday, April 12, 2010)

China is widely considered to have weathered the global financial crisis better than most nations, thanks to a $586 billion government stimulus program that quickly pumped money into infrastructure projects and the rest of the economy.

The largesse was accompanied by $1 trillion in new lending that has some economists and investors wondering if China's growth is a bubble set to burst.

The Asian manufacturing power is now the world's second-largest economy, so what happens there has implications for trade, investment and finance around the world.

China's economy grew 8.7 percent last year, but 88 percent of the growth in the first six months was due to government spending.

"That's really unprecedented. Even in post-war Japan you didn't see those kinds of numbers," Rana Foroohar, international business editor for Newsweek International, said Dec. 14 during a roundtable discussion at the Washington-based Center for National Policy.

By propping up the economy, the Chinese government didn't address its structural imbalances and continued to let real estate prices spiral up, which could lead to a banking crisis if non-performing loans increase, said Francis Fukuyama, professor of international political economy at Johns Hopkins School of Advanced International Studies.

Chinese regulators are urging banks to limit lending and cap overall credit growth as a hedge against inflation.

In a recent Bloomberg News survey of investors, stock traders and analysts, 62 percent of respondents viewed China's economy as a bubble.

“We think that China is producing and is building up inventories at a rate that no other country or region can follow at the moment,” said poll respondent Alcibiades Angelakis, head of marketing and research at Epic Investments in Athens. "This cannot continue for a long time, and we fear that in the second half of this year things will slow down."

Hedge fund investor James Chanos, president and founder of New York-based Kynikos Associates, one of the first investors to predict the 2001 collapse of Houston-based energy company Enron, has said China looks like "Dubai times 1,000 — or worse, "according to Bloomberg.

Last November, the indebted city-state of Dubai caused a mini-financial crisis by postponing payments on $26 billion in debt and restructuring its investment conglomerate Dubai World.

But Jim O'Neill, chief economist for Goldman Sachs, recently wrote in a special issue of Newsweek International that Chinese policymakers learned from the global recession and realize that an overemphasis on exports is an unsustainable economic model.

"The decline in U.S. and European spending convinced Chinese policymakers that they must quickly stimulate domestic demand if they are to have any chance of maintaining their goal of annual GDP growth at 8 percent or higher," O'Neill said.

In fact, retail sales rose 16.9 percent in 2009 as China encouraged more domestic spending to replace lost export business.

The transition away from dependence on the U.S. consumer may be a long-term strategy, but the question is whether China will have enough time to stimulate its own domestic economy if there is a double-dip recession in the United States that slows China's export engine, Foroohar said.

China needs to let its currency, the renminbi, float to market levels rather than keeping it pegged to artificially low levels against the dollar if it is going to spur the consumer market, Walter Kemmsies, chief economist at marine infrastructure firm Moffat & Nichol, argued in his "Strategic View" column (February American Shipper, page 16).

Currency revaluation would make foreign goods more affordable to Chinese consumers, he said, and combined with turning more manufacturing to domestic consumption would reduce the trade surplus with the United States and the need for a rapid revaluation of the renminbi.

However, Chinese policymakers may have second thoughts about loosening capital controls after seeing how they helped cushion the country from the global recession, O'Neill said.

He also endorsed a proposal by People's Bank of China Governor Zhou Xiaochuan last year that the world use International Monetary Fund-backed "special drawing rights" rather than the dollar as a reserve currency. Managing the dollar, euro, renminbi and other currencies against each other is similar to how the gold standard was used decades ago.

"A new multipolar global currency system would allow more diverse patterns of global trade and investment to emerge and help mitigate the global imbalances in saving and spending that have grown out of our dependency on the dollar," O'Neill wrote. "The result could be a wealthier, and economically healthier, planet."