Edward Chancellor, author of an excellent book on past financial manias called Devil Take the Hindmost: A History of Financial Speculation (my review is available here), believes that investors will be grappling in the future with the bursting of a bubble, this time in China. In a recent article on the GMO website, Mr. Chancellor outlines ten reasons why China is in the midst of a great speculative mania (registration required). Among them:

  1. A compelling growth story: China recently overtook Germany as the world’s number one exporter and Japan as the number two economy. Its economy has been growing at a torrid pace for decades and investors have no trouble extrapolating that growth far into the future given China’s large population and lower level of development.
  2. An Investment Boom: China is investing massive amounts of money in infrastructure but not always efficiently as you can see on the news clip on Ordos, a town built to house a million residents but sitting practically empty.
  3. Easy credit: Interest rates in China are kept far below the natural rate leading to speculation in stocks and real estate.
  4. Rampant credit growth: Unlike developed economies, Beijing is able force banks to lend and the banks responded by lending massive amounts of money, which likely resulted in a decline in underwriting standards.
  5. Rapidly rising property prices: Chinese stock markets are experiencing high stock turnover, rising number of IPOs and strong early trading gains. Meanwhile, property markets are overheating despite a massive inventory overhang.

Mr. Chancellor is not alone. In a recent talk, Jim Chanos, who famously shorted Enron when it still was a Wall Street darling, explained why he thinks China is a massive asset bubble. Vitaliy Katsenelson, author of the excellent book Active Value Investing (read my review here), is another skeptic. He calls China the “mother of all Black Swans” and has written numerous articles (such as this one) on the subject.

In a span of just ten years, investors have dealt with the aftermath of an internet bubble and a real estate bubble. Will the China be next?

This article has 22 comments

  1. Worth noting that Canadians are pretty strongly exposed to this likely bubble, regardless of if they are directly investing in China or not.

    China has been the key driver of demand increase in commodities / natural resources. Their demand has fostered global supply growth, even if not quite enough to meet demand. If China crashes, so do worldwide commodity prices – and this has negative impact on the Canadian dollar and the Canadian resource-based economy more broadly.

  2. Excellent point Houska. The TSX gets whacked every time China pulls back on bank lending and it zooms higher when they announce a stimulus program or easier lending rules. The big question now is WHEN? These problems have been brewing for a very long time and it’s so hard to predict when or if it will all come home to roost.

  3. Suggestion:

    Make the font on the main page a little bit darker.
    It looks much better when you click through to the post.

    • Canadian Capitalist

      @Houska, @2 Cents: I can think of a few effects of a collapse in China:

      1. As you point out, commodity prices will be hit. Which will affect the dollar and the overall Canadian economy. Which will likely affect the stock market because the banks are very sensitive to the Canadian economy and the TSX is concentrated in financials, energy and commodities.

      2. China will experience deflation. But, all that factories likely won’t remain idle. They’ll be churning out cheap goods for export and unlike Japan, China will be exporting the deflationary effects worldwide. That’s likely not good for stock markets anywhere.

      3. Inflation and interest rates will likely remain low. It is possible that the market is being smart about the low yields in Government securities after all.

      Cash and good-quality bonds might be the only asset classes that hold up in this scenario. I’m not about to dump everything and move to cash but I’ve learnt my lesson from the last bear market and I’m keeping lots of cash around just in case, stocks become ultra-cheap again.

    • Canadian Capitalist

      @Scott: Fixing the colors on the main page is a high priority on my to-do list. I want to assure you that it will get fixed.

  4. I don’t like the new, constrained to the middle of the page, layout. I have a proper sized monitor and I get these white bars down the sides.

  5. The thing is… Both China and India have, for all practical purposes, an infinite supply of incredibly dirt poor people willing to work for a dollar a day. This should keep their own domestic inflation rates in check, but it can definitely affect those of us who sell anything into those economies. Obviously at some point in the distant future when their middle class hits several hundred million people, things can really start to get out of control, but at this juncture in time, we can consider their poverty stricken population to be effectively infinite.

  6. Phil is right… China is a new entity with new systems. I suspect the old filters won’t work without adaptations.

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  14. International LL

    Terrible article. I’ve been reading about the “Chinese bubble” for nearly 20 years now. So few non-Chinese understand Chinese culture and Chinese investment culture. Housing is viewed very differently.

    I’m glad I’ve ignored the advice of the China Experts who can’t use chopsticks.

  15. Phil, who wrote above, China already has a huge middle class. You need to go spend a year or two in China to open your eyes.

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