The Elephant and the Bicycle

"China is like an elephant riding a bicycle.  If it slows down, it could fall off, and then the earth might quake." - James Kynge's book China Shakes the World

After 30 years of economic growth of more than 8% a year it appears that China has finally reached the end of the road.  During the 30 years of expansion there were a few bumps in the road but nothing like the Great Recession.  Like most investors that get used to an extended bull market the Chinese government did what it always had done and that was to support their economy.  They had the resources and so they sprang into action running a massive deficit, pushing interest rates down to extremely low levels and injecting large quantities of debt.  The idea, as with all stimulus packages, was to weather the storm from the West and ramp up in preparation for the coming global expansion.  When that global expansion took hold they could mop up the excess liquidity and stimulus and profit from the continued economic growth of 8%.

Unfortunately 8 years later the world still has not recovered and the stimulus has created bubbles and excesses all over China making it look like economic growth in China may finally stall bringing the elephant off the bicycle.  Should this happen the repercussions will be felt across the globe as China is now the world's second largest economy, it has massive foreign reserves invested in all the developed nations and has grown itself into a hugely important consumer and industrial market.

As with all attempts to stimulate an economy with debt, the economy becomes addicted and unless more is produced exiting is painful.  Debt produces excesses as why not risk the farm if it is owned by the bank anyway?  It is not your money so keep producing until your line of credit is taken away and then, taking the remaining cash, head onto the next project and leave the mess to the bond holders.  This should sound pretty familiar to most of you who follow this blog and certainly China is not alone in this quandary but let's look at some of the metrics pointing to excesses:

1. China has only consumed 65% of the cement it has produced in the past 5 years.
2. Steel production is larger than the next seven largest producers combined.
3. More than 27 billion square feet of new construction is vacant but more than 1.8 billion more is currently under construction.
4. Property prices in large metropolitan areas is almost 40 times the rental cost.

These are just some of the metrics that show the large excesses that their stimulus has created and the problem is that unless there is significant economic growth these problems will be transferred to the banks and we have all witnessed the problems associated with a financial crisis.  Furthermore a large part of the globe's economic recovery was based on China and the continued growth of the BRIC nations.  These nations continued to expand while the United States continued to print money but, with the reduction in stimulus from the Federal Reserve, the quick money is leaving these markets and showing them to be very vulnerable. 

So for the past 30 years China has been seen as an economic miracle and has managed to avoid the kind of hard landings felt in the rest of the world for the simple reason that their economy was based on solid economic growth.  This has now changed as they have finally succumbed to the West's economic stimulus models and with it we could witness for the first time the elephant fall off the bicycle and this shock will be felt across the globe.