Harry S. Dent | Friday, December 7, 2012 >>
I recently saw an interesting article in The Financial Times… James McIntyre was observing that foreign investors through Hong Kong were valuing Chinese stocks higher than domestic investors were. We’re talking about “A” shares for domestic investors like the Shanghai Composite.
And we know why!
This is a classic case of what happens when the practice of high savings clashes with overinvestment… or, in other words, when the average people on the ground see what’s really going on while the government works frantically to show the world an entirely different picture and the super-rich desperately hunt for a place to invest.
This is a topic we’ve touched on ourselves several times before, in great depth in our Ahead of the Curve webinars and Boom & Bust newsletter, and a little more lightly here (our latest article being “Proof That China’s Economy is B.S.”).
Our point is always this: the Chinese government has driven up to 50% of GDP through overbuilding everything, from housing to factories, malls and offices. So, foreign investors look at China’s continued dramatic growth – 12% in good times and 6% – 8% in slowdowns (2008 and 2012) – and overestimate the profitability and sustainability of such growth.
How long can the government build houses at twice the rate of new household formation? They’ve been doing it for over a decade now, which is why foreign investors have overvalued Chinese stocks. But these investors are clueless about how vulnerable China’s economy is to a hard landing.
And there’s another big problem in China…
That is, consumers only drive around 40% of the economy. Here in the U.S., consumers drive 70% of the economy, which is what makes economic growth sustainable. It’s what drives business investment to ramp up production to meet demand. It increases government tax revenue and spending capacity.
That’s just not happening in China. Consumers there spend much less of their income than Americans and Europeans do, mostly because they have virtually no safety net for unemployment, retirement and health care. So they save a high proportion of their income for a rainy day.
If they don’t spend, the Chinese government ends up doing the spending just to create enough jobs for all of the very poor rural migrants coming to their cities in droves.
But this high-savings practice leads to another problem. The rich Chinese find themselves hunting for places to invest all their spare cash. So what do they do? They invest in real estate, including the government-driven projects (it’s the whole don’t bite the hand that feeds you syndrome). And in so doing, they contribute to the overcapacity problem.
In fact, they’ve inflated the largest real estate bubble in the world. They’ve essentially made real estate into a online casino sites!
The problem is, this obviously cannot continue. And when this bubble bursts, as it will, China’s economy and stock market are in serious trouble. So are the country’s top 10%, who suddenly won’t feel as rich and they do now. When they feel the pinch, they’ll stop spending as much… they’ll stop speculating… and they end up killing the very bubble they created.
Then how does the Chinese government keep the economy going? Exactly. It doesn’t.
There is no question, the China bubble will burst. And when it does, the landing will be hard enough to rock the world. Don’t believe economists that say that China will help hold up the global economy and put a floor under stocks.
Ahead of the Curve with Adam O’Dell
China’s Shanghai Index appears undervalued. But that doesn’t mean it won’t be even more undervalued in a few months.