Jul 20 2007 1:54PM | Permalink | Email this | Comments (3) |
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Another bubble is heading for a big pop or at least a period of loud leaking. It is the Chinese economy which has become dominant variable in the world economy with a substantial impact on commodity prices, inflation, credit costs and goods exports in the US and the rest of the world.

China’s 2nd Q GDP growth soared to 11.9%, far above the sustainable pace of about 6-8%. Spending in China has been progressively more dependent on hype and hope than real demand for several years.

The bubble could get bigger yet as China tries to prevent it from an embarrassing shrinking before next summer’s Olympics. But the pop or loud hissing leak should now be in your planning horizon.

Here is what is happening in China’s half capitalist — half socialist economy. The price system is not yet fully developed so prices do not give off all of the market signals that we are used to here that save us from ourselves by shutting off excessive spending before it gets too far out of hand.

Chinese consumers have limited options for theirs savings. They can deposit it in official banks and get a 3.33% interest rate, just raised by 0.27%, or they can put it into private investments in real estate or stocks where returns have been many times higher because of the massive inflow of funds. The Shanghai stock index is up 95% year to date. Putting your savings into an official bank for a 3.33% yield — 3.06% a few days ago — does not make sense when the consumer price index is now rising at a 4.4% annual pace. So, savings from inexperienced investors goes to the private side of the economy making credit readily available and very cheap for real estate and manufacturing companies.

The consequence for the US construction market is that the resulting explosive growth in Chinese construction and factory production is boosting the prices of commodities worldwide. At the same time, it also sucks in US manufactured exports, keeping US manufacturing construction growing rapidly and sends back China’s huge trade surplus to the US, flooding our financial markets with liquidity and keeping US credit rates low relative to recent growth and inflation trends.

Ahead, the consequences reverse but it not yet clear how soon. There will probably be no significant impact in 2007 but the probability of an impact in 2008 is too high to ignore. A sharp drop in Chinese economic growth will be accompanied by a rise in credit costs in the US. The immediate cause will be a collapse in Chinese equity and real estate prices and some loan defaults by Chinese companies. This will result either the Chinese government raises credit costs significantly to rein in excessive spending and world credit rates rise sympathically or because world financial market force Chinese rates up in response to the onset or soon expected onset to a collapse in the Chinese investment bubble.