The Bubble that is China

BarroMetrics Views: The Bubble that is China

Which economic theory has a solution to this crisis?

We have two main schools in play at the moment: Neo-Keynesian  and the Friedmanites (monetarists). They both believe we can spend our way out of this recession/depression. The former says we’ll solve the problem by spending our way out of it; the latter says we’ll solve by printing (creating) more money.

I am not going to offer a critique of either school here. A far better job has been done that I ever could by W Bonner and A Wiggin in Financial Reckoning Day Fallout. What I will do is  draw your attention to a country where the competing theories meet and hopefully resolve the dispute as to which one has the answer – that country is China.

The advantage that the Chinese have over the Western world for this issue is the fact that if the Government says ‘lend’, the banks will lend. Unlike say the USA where the FED can quantitatively ease as much as it likes but this does not mean that the money is hitting Main Street. Right now the deposits at the St. Louis FED Reserve are still near their record highs. What does this mean? It means the trillions of dollars created by the FED is sitting in banks’ deposits and has yet to hit the US economy.

Compare this  with China where the banks have lent a reputed 7.4 Trillion yuan – more than the budgeted 5.6 trillion. Austrian economics says that if you inflate the money supply you will have:

  1. (By definition) inflation
  2. Mal-investment leading to bubbles
  3. The inevitable correction (crash).

It seems to be the Shanghai Index can be labeled a bubble.

On Tuesday I read a report that suggested the Chinese government was concerned about the use to which the loans were being applied; on Wednesday, the Shanghai Index dropped 8.1% and the press suggested that rumour was the cause.

If you compare the rise of the Shanghai Index with the S&P, you’ll see the effects of the lending policies:

  • The Shanghai Index has rallied 69% to the S&P’s 47%.
  • More importantly, while the S&P has stalled in it’s rally (the momentum peaking in May 2009), the Shanghai Index continued unabated until yesterday.

I am watching, with interest, Chinese  developments. The next step in the drama should be a rapid rise in the inflation numbers. I like the sentiment in Financial  Reckoning: ‘governments and investors don’t get what they expect from the markets; they get what they deserve’.

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FIGURE 1 Shanghai Index and S&P

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