China’s Economic Boom Turns to Bust

There are plenty of investors out there hoping that China’s leaders will be able to halt the disturbing deterioration of its economy. In just the past few weeks, there has been a whole lot of data showing China is not quite the miracle economy everyone thought it was.

Allow us to make some introductions. China – meet the dark side of the boom. Dark side of the boom – meet China.

At some point in November, China’s economy looks to have crossed the threshold from boom to bust. It seems to have happened so quickly. In our October edition of Sound Money. Sound Investments, we laid out all the reasons why we thought China’s economy would crash in 2012. The way things are going we might be late on that call…

If you think China’s central planners can tweak some levers in a control room to correct the situation, you’re not really thinking. Once a boom turns into a bust, it takes on a life of its own. In the same way as the boom gets away from the authorities, so does the bust.

The latest bust anecdote out of China involves a story from The Times of London:

In the Inner Mongolian sprawl of Ordos, the Chinese coal city ravaged by the wildest excesses of boom and bust, a swerving, screeching economic phenomenon has careered on to the streets: the drink-driving debtor.

At the wheel of these cars, weaving madly in deliberate view of the police, are men on a mission – they want to be arrested, breath-tested, charged and locked safely behind bars before their creditors come calling.

Welcome to debtors prison, Chinese style.

The creditors are not banks. They are individuals or families involved in the underground lending market. And unlike banks, it is their money that has disappeared.

How did this unorganised lending racket unfold? Let’s just say it’s a product of the law of unintended consequences.

At the start of 2011 the government realised the boom they had unleashed in 2008, like a young dog at a beach, had run away from it. Property speculation was getting out of control.

So they ordered banks not to lend. Such is the arrogance and ignorance of central planners, they think they can control the market by making a few announcements and pressing some financial buttons.

The banks reined in their lending – somewhat – but the demand for credit, set off by the speculative boom in the property market, remained. So individuals stepped in to supply the demand.

Because China’s interest rate structure is all screwed up (where deposit rates are below the rate of inflation) people realised they could earn a better return by pooling their resources and lending to property developers.

That’s a good strategy while property prices are rising. But now, they are beginning to fall. The lenders have lost money and they’re after debtors’ fingers, hands, or whatever it is that Chinese street justice demands in these situations.

The city of Ordos is – or perhaps we should use the past tense, was – a wealthy coal mining region. However, according to The Times article much of that wealth has been ploughed back into the property market.

You can have a look at the ‘fruits’ of that investment here. It’s truly mind-boggling.

The funny thing is, investors in the West are relying on the bureaucrats who caused all this to fix the problems.

They won’t be able to. Chinese policymakers have about as much chance at halting the property and fixed asset bust as the Fed had in stopping the subprime crisis.

They’ll try of course. This will give investors hope and lead to another round of unintended consequences.

We’ll have more on China’s policy impotency tomorrow…

In the meantime hear what Slipstream Trader’s Murray Dawes has to say about the current downturn in the stock market. Better still view Murray’s latest stock market update on YouTube now.

Greg Canavan,
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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