Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 26-Apr-07
China's economy grows at 11.1%, continues to explode

Web Log - April, 2007

China's economy grows at 11.1%, continues to explode

And champagne corks pop once more, as the Dow tops 13,000.

If you even heard this story last week, you probably thought it was "good news": China's economy grew at an annual rate of 11.1% last quarter.

The reason that even Chinese officials are expressing dismay at this figure is because it represents a total failure to slow down the overheated economy. The extremely high growth figure doesn't represent real growth of Chinese industries. Instead, it represents pumped up liquidity and an increasingly credit-based economy, just like in the United States.

China's economy has been growing at near 10% annual for an extraordinarily long time -- since the early 1980s -- but for almost five years now, China's leaders have become alarmed that the growth has been too fast, and has created severe imbalances.

And yet, China's attempts to slow down its economy have been a total failure. China's growth not only has not been slowing down -- it's been accelerating -- from 9.5% in 2004 to 9.9% in 2005, 10.7% in 2006, and now to 11.1% in the first quarter of 2007.

Recall that in March, Chinese premier Wen Jiabao said that China is "unsteady, unbalanced, uncoordinated and unsustainable." The overheated economy is one of the principal reasons.

Stephen Roach, the chief economist at Morgan Stanley, who is well-liked by the Chinese, and who was just promoted to be Morgan Stanley's Asia chairman, was evidently really shocked by the new growth figures.

Here's what Roach wrote in January:

"At the same time, I also believe that China is serious in its current cooling-off campaign. I expect it to be surprisingly successful in slowing down an overheated -- and commodity-intensive -- investment sector. If I’m right, that could prove to have far more challenging implications for the demand side of the commodity super-cycle than most expect."

And now, here's what he wrote last week:

"For those of us who have been steadfast in our optimism on China, the blistering first-quarter GDP report throws down the gauntlet. The government has no choice but to move quickly and aggressively to rein in the excesses of this white-hot economy. To stay bullish on China – and that remains my view – policy makers must do a much better job in establishing traction with both the bank lending cycle and the real economy. China has no other choice. ...

In the aftermath of this blistering 1Q07 GDP report, there is considerable focus in the markets on a new round of monetary tightening that will be needed to bring the Chinese economy back under greater control. While I have no doubt that additional actions will be taken by China’s central bank, I continue to believe that such moves are largely window dressing for a still blended economy. Fueled mainly by the combination of excessive bank lending and internal cash flow, China’s runaway investment boom has not responded to repeated tightening actions by the monetary authorities. That’s certainly not for any lack of trying. During the past year, bank reserve ratios have been increased seven times while domestic lending rates have been hiked four times. But these actions haven’t put a dent in bank lending growth, which was still surging at a 16% y-o-y rate in March 2007. ...

As is typically the case in this still-blended economy, the real tightening is likely to come in the form of administrative edicts issued by the modern-day counterpart of China’s central planning agency – the National Development and Reform Commission (NDRC). By setting stringent criteria for project approval on a case-by-case basis, the NDRC has both the clout and the tools needed to exercise much tighter control over the investment process. I had expected a new round of administrative actions to be unveiled around midyear – tied to increasingly stringent requirements on energy consumption and greenhouse emissions. But in the aftermath of the blistering first-quarter GDP report, I now believe that the next series of administrative edicts will be announced sooner than that, followed by additional actions on energy conservation and pollution. The longer China waits, the harder it will be to strop its rapidly moving investment train.

From where I sit, the Chinese government has no choice other than to up the ante on tightening and macro control."

In essence, Roach is saying this: China has totally failed to slow down the economy using standard macroeconomic controls. Now what China has to do is assume full dictatorial controls as in the days of Mao Zedong, and force businesses to do as their told, or be locked up for 20 years. No wonder the Chinese love Roach.

The problem is that it won't work.

From the point of view of Generational Dynamics, China's economy has increasingly been in an unraveling bubble. The cause is generational -- large masses of people are abusing credit because their generation has no memory of the last financial crisis, in the early 1930s.

And Communist nations are just as subject to generational cycles as capitalist nations are.

It's certainly ironic that China today suffers from exactly the same list of complaints that Karl Marx claimed only happened to capitalist nations: sharp class distinctions with the wealthy élite class exploiting the poverty-stricken lower class; vulnerability to business cycles; and a restive peasant class on the verge of total rebellion. Whenever I talk about China, I always have the temptation to scream, "Workers of China, unite!! You have nothing to lose but your chains!"

There's more to the unraveling of the Chinese economy than just GDP growth.

Recall that on February 26, I posted an article describing that the Shanghai stock market bubble appeared close to bursting. Manic Chinese day-traders would sell their homes and borrow money to invest in the stock market. Then the Shanghai stock market fell 8.8% in one day, causing a brief worldwide panic.

Well, the Chinese learned nothing from that experience. The Shanghai market has recovered that loss, and Chinese investors have returned to full-scale mania. Get these figures, as reported by China Daily:

My view is that China's investors are much more manic than America's investors.

The news about China's first quarter growth is stunning, though few people seem to realize it. This represents a total failure of China's macroeconomic policy, since they've been trying for years to bring down the growth rate to 7% in a so-called "soft landing." They've failed year after year, and the situation is getting worse, with more and more dislocations and worse imbalances. The Beijing government knows that things are going wrong, and they're getting increasingly desperate to change things, but they can't.

Even so, I don't believe that the Chinese have even the vaguest idea what's coming. In America, we had the 1930s Depression, and even though most people believe it can't happen again, at least there are small minority that know it's coming.

But in China, as far as I can tell, they don't have any idea at all what's going to hit them. They did have a financial crisis in the early 1930s, but it wasn't at the scale of the Great Depression, and anyway they blame the Great Depression on the evils of capitalism, while their managed Communist economy is presumably immune to it. And as I said, they learned nothing from the Shanghai collapse on February 27. It's going to be a huge and disastrous shock to them when it happens. My personal belief is that the most likely trigger of the coming world financial crisis will be triggered not by Wall Street but by China.

One of the questions that web site readers ask me most often is this: "You're predicting a worldwide financial crisis, but you never give a precise date, and so you can always say that it's still coming. That way, you're never wrong."

This is a fair question. I've answered it before, but the China situation gives me a perfect opportunity to answer it again.

The prediction of a worldwide panic and financial crisis is not the only prediction I've made. Implicitly or explicitly, I've made many other predictions that can be verified on an almost daily basis.

These other predictions have to do with the values of trend variables. I've shown that the stock market is far overpriced by historical standards, using both exponential growth forecasting methods and mean reversion techniques with price/earnings ratios.

Wednesday's rise to above Dow 13,000 is not good news, because it makes the stock market more overpriced than ever, with the result that the stock market is now overpriced by a factor of 252%. (Dow 13089.89 = 252% long-term trend value, 5193.) At the peak of the stock market prior to the crash of 1929, the stock market was overpriced by a factor of 255%.

I've shown that other trend variables -- exponential growth of credit usage, exponential growth of trade deficit, exponential growth of hedge funds and derivatives -- show no signs of leveling off.

The point is that mainstream macroeconomic theory has predicted that all of these trend values should have corrected themselves years ago. Instead, they keep getting worse. If any of them started improving as mainstream macroeconomics says they should, then it would be possible to claim that I and Generational Dynamics are wrong. But it never happens.

This is the proof that we're headed for a financial crisis: That as long as these trend variables are growing exponentially, with no sign of leveling off and getting better, then a financial disaster is inevitable. And then by comparing today's abuse of credit with similar situations just before the crash of 1929, just before the 1637 crash of the Tulipomania bubble and just before the Panic of 1857. Based on these historical comparisons, I can credibly make the claim that we're headed for a crash, and it's going to happen sooner rather than later.

This new situation with China provides me with one more example.

The best macroeconomic experts in the world are available to help China. But they've failed repeatedly to achieve anything. Even though they've applied macroeconomic controls to slow the economy down, it keeps speeding up. This isn't an accident. The generational forces are too strong; standard macroeconomic controls cannot succeed.

This is a point that I keep making: That mainstream economics has repeated failed, over and over, to predict or explain anything that's happened since the 1990s bubble, including the bubble itself. Mainstream macroeconomics has been a failure.

Last year's article on "System Dynamics and Macroeconomics" shows how macroeconomic theory can be made able to predict and explain more of the real world than mainstream theory. However, since I'm a "nobody," I can't get anybody to pay attention to it. But I can assure you, dear reader, that this theoretical development is completely valid.

In March, I posted some additional theoretical work, in my article based on research by Harvard economist Robert J. Barro. The point of this work is that shows how macroeconomic theory, enhanced with Systems Dynamics, predicts and explains periodic international financial crises.

So I've used several methodologies to prove that we're headed for a major international financial crisis. The only thing I can't provide is an exact date. (And, let's face it, if I had a date then I wouldn't tell you guys; I'd keep it to myself and use it to make some money.)

China is indeed "unsteady, unbalanced, uncoordinated and unsustainable." There are well over 100 million itinerant works, income disparities are growing, and rebellions are occurring more often. A nationwide rebellion could begin at any time, but it probably won't happen as long as China is in its bubble economy. Once the bubble bursts, and hundreds of millions of Chinese become unemployed, a war will not be far off. (26-Apr-07) Permanent Link
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