Bears Say China’s Economy Set to Collapse

Depending on who you listen to, China will either emerge as the savior the world needs to pull out of this ongoing economic funk, or it will be revealed that China is nothing more than a “paper dragon” destined to collapse under its own weight. For a growing group of analysts – euphemistically known as the “China Bears” – it is the second scenario that they feel will be the most likely outcome.

One such bear is Gordon Chang – a Chinese-American lawyer and author who has long advocated that China’s current economic growth is not sustainable. In his 2001 book “The Coming Collapse of China”, Chang argues that despite reports to the contrary from Chinese authorities, the economy is actually in disarray, and he points specifically to the conflict between China’s communist past, and its growing dependence on capitalism, as the internal conflict that will ultimately lead to the end of China’s economic revival.

In an article appearing in Forbes in October, Chang challenged the Chinese government’s claims that the economy is back on track and growing by an annual rate of 9 percent. Change suggests that this growth is not evidence of a recovery, but is derived almost entirely from direct government intervention:

Since last November, Beijing has spent perhaps as much as $900 billion from its own funds as well as those of the larger state bank – to jump start its $4.3 trillion economy. No government can disburse that amount of cash without creating some economic activity.

Chang points to “inconsistencies” with the economic statistics published by Chinese officials, highlighting the claim that even though new car sales are rising exponentially, gasoline consumption remains static. This apparent contradiction is just one example of how Chang believes China misrepresents reality; he even goes so far as to suggest that Chinese state-run companies are buying large numbers of cars and then simply storing them in a misguided attempt to maintain automobile production levels.

Famed hedge-fund manager James Chanos also questions China’s reporting accuracy. Chanos rose to fame on Wall Street in the 1980s by betting against the viability of some big-name companies, and is credited with being the first analyst to question the veracity of Enron’s public disclosures. Specializing in shorting stocks he deems to be over-performing, Chanos amassed a personal fortune; he has now turned his attention to China.

Chanos believes there is far more at play than China simply “cooking its books” to enhance its production levels. He suggests that overproduction is actually widespread across many sectors in the economy, and if China continues to produce goods at its present rate without an appreciable increase in demand, prices will plunge to the point where China is eventually forced to make drastic cuts to production. This would throw thousands of people out of work and is exactly the scenario put forward in a gloomy report produced by Pivot Capital Management and released earlier this year:

We believe the coming slowdown in China has the potential to be a similar watershed event for world markets as the reversal of the U.S. subprime and housing boom.

This is not simply empty rhetoric as the inter-dependencies between the US and China cannot be overstated. China is currently the third largest economy in the world with many expecting it to take the top spot away from the US before the close of the next decade. China is also America’s primary source of lending and now holds more than $800 billion in US-denominated debt and the US relies on China to help cover its yearly operating deficit. In return, the US is by far the largest market for China’s exports, purchasing nearly $400 billion in 2008.

This shared reliance between the two countries is more than a little messy, and represents a serious liability for not just the US and China, but the entire global market. If we ever expect to return to economic activity approaching the levels we experienced prior to the crash of 2007, we first need the economies of these two powerhouses to not only stabilize, but to return to positive growth.

In light of this dependence then, it is more than a little distressing to hear comments from an official as highly placed as Treasury Secretary Timothy Geithner who, during a state visit to China this past Spring, said:

Purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past. In China, growth that is sustainable will require a very substantial shift from external to domestic demand, from an investment and export-intensive growth to growth led by consumption.

Given this outlook from the US Treasury Secretary himself no less, it is understandable why the China Bears are gaining greater momentum.