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June 13, 2011

When the Chinese bubble breaks, the world will...

Pundits in the world have been warning about the real estates bubble in China, which was formed after the Lehman Brothers financial crisis. The Chinese government boosted budget spending and bank loans (the total sum is about 400 billion dollars) in order to make up for the lost export, staging a false boom sustained by bubble.

On June 1 the People's Bank of China issued a warning about 1.8 trillion dollars (equivalent to one third of GDP) of loans which local half-official investment banks have given to the locals. This is ominous, because the real estate prices are falling in large cities on the coast area (at the rate of more than 20% annually in Beijing, for example). Perhaps, the Chinese bubble has already started bursting.

If so, a large portion of the loans above may become non-performing, and if this happens, the banks will stop giving new loans.

Then the Chinese economy will dip a lot, because its GDP is greatly sustained by the massive construction. Investment--mostly construction of infrastructure-- counts for 40% of the GDP, and more than 70% of its growth comes from the growth in construction.

1. If this ever happens, what will be the outcomes?
(1) Consumption, investment (including FDI) will fall. In 2009 China had 109 billion dollars of net surplus in the capital account (with 36.5 billions dollars of net FDI). If this be out, China may well lose more than 5% of their GDP.

(2) The Chinese may send their savings abroad by all possible means. In 2008 China's "FDI" abroad was 56 billion dollars, and if it reaches 100 billion dollars, China will lose another 5% in its GDP.

(3) The capital exodus will push down the yuan's rate, exacerbating the inflation, which has already become visible in food prices. The inflation will push up the production cost, stripping their products of competition edge.

(4) In this way all ingredients of the economy will shrink--consumption, investment and exports. The GDP figure may well fall quite substantially.

(5) Inflation (in the order of 20~30%) and unemployment will augment the social unrest, and the people will start demanding more equality. Their voices will be directed against foreign firms as well. If this occurs, the Communist Party Congress scheduled for next March will have to be postponed.

2. If the Chinese economy substantially sinks, how will it affect the world?
Some people say that it would be end of the world. But are we dependent on China to that degree?
(1) First of all we should keep in mind the fact that China has not yet become an indispensable export market for us. For example even Germany has a huge trade deficit in their trade with China (the proportion is about export 35:import 55).

China is the largest importer of Japanese goods, but their "imports" largely consist of machineries, equipments and components to be used mostly by Japanese factories in China. They thereafter mostly export finished products abroad. For the Japanese and many other foreign firms operating in China final destination of their final products is not so much China as the third countries.

(2) Some may argue; if the Chinese economy sinks, and if they stop purchasing the treasury bonds of the U.S., the interest rates will go up, negatively affecting the American economy. But China has already reduced its purchase of the American treasury bonds.

(3) Will IMF, for example, have to help China out, if the bubble bursts? Probably not, because their huge foreign currency reserve (2.8 trillion dollars) will be able to cope with all kinds of currency speculation.
But if their GDP shrinks greatly and if this brings about serious social unrests, we would not have sufficient means to save China.

China's domestic policy will then become more conservative with priority attached to equal distribution. Foreign companies will be stripped of favorable treatments and will be urged to increase benefits to their Chinese employees.

If this be overly done, it will hamper China's growth for many years to come.
The recovery of the American economy was not in time for the Chinese, while their inflated spending back-fired on them. Now authodox communists would be able to contend that Deng Xiaoping's famous policy for opening has failed and that they should go back to the good old days of communism.


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