Tuesday, July 18, 2006

China Bubble Watch: If China Builds It, Will They Come?

I have been a partisan of the China-bubble hypothesis for some time. But a fair question is when? I have been predicting it for well over a year, with nothing but double-digit economic growth to show for it. But here are some items I have found around the web:

-"The competitiveness of China’s manufacturing industries has suffered serious erosion over the past year, according to one of the world’s largest trade sourcing companies.

Hong Kong-based Li & Fung group, which manages a $7.1bn a year trading business, said price rises crept back into the Sino-US and EU supply chains last year, after at least six years of often “severe deflation”.

William Fung, Li & Fung managing director, reported an average 2-3 per cent increase in the once unbeatable China price its US and European clients were willing to pay. He pointed to a “double-digit” rise in Chinese labour costs, the revaluation of the renminbi and higher oil and energy costs for the shift."

Source: "China's competitiveness 'on the decline'," Financial Times, March 2006.

- Over 60% of China's vacant office and residential stock has been on the market for at least a year, and the amount of such stock increased by 13.8% last year. (Source, July 2006).

On the other hand, it may be that the vacancy rate arises more from large developments almost completely unfilled rather than widespread vacancies in Beijing and Shanghai. Anecdotal evidence is always the worst kind, but a student reports based on personal experience that there are entire massive developments going begging far from these two mega-cities, even as this report from Collier's (pdf) suggests that Shanghai office vacancy rates at the high end of the market have been trending downward for several years.

On the other other hand, the report also suggests that this is largely because of demand by foreign firms to be in Shanghai. If the Thai experience is any guide, foreigners are always the last to know, so this could actually be a warning flag.

- The number of civil protests over land redistribution continues to rise year after year. While this is probably not a long-term deal-breaker, it could easily accelerate an otherwise manageable short-term decline.

- The nonperforming-loan problem is tough to get a handle on, but there is no reason to be optimistic. Earlier this year there was the notorious incident in which Ernst & Young dramatically raised its estimate of Chinese NPLs in the four largest state-owned banks from $225 billion to $911 billion, the latter figure about 40% of Chinese GDP. It withdrew the report the very next day, citing an early release that bypassed normal vetting procedures, but the whole episode reeked of political pressure.

- The decline of the yuan, thanks to China's massive dollar reserves, has been orderly thus far. But if it is not, then the problem would be as bad as, if different from, the 1997 Thai problem, in which many Thais had taken out dollar-denominated loans only to see the value of the baht crash. Now it would be Chinese firms priced out of foreign markets. That the dollar has declined so much against the euro and other currencies that largely float unmolested, but not nearly so much against the yuan and other East Asian currencies, is a sign of trouble.

I must admit that my pessimism has been entirely unjustified thus far. And yet, and yet...every juggler reaches the point of one ball too many, at which point they all come crashing down.


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