Reflections On The Pao Mo Bubble
"...China's boom could still continue for a while. But at the same time, it's also important to keep in mind that China's current boom is not sustainable as it’s been based, to a larger extent, on a huge credit expansion. All [Westerners] can think of is that China is a 'virgin' territory with 1.2 billion people ready to buy whatever they’ll sell them. They think that doing business in China is a walk in a park. Nothing could be further from the truth..."
By Michael Boyd
SourceMontréal, Canada - A lot has been recently written on China. China is perceived as offering incredible, lifetime opportunities to make a quick buck. However, in spite of its rapid growth, China faces a number of almost insurmountable challenges which, if not resolved soon, may significantly curtail its future growth and lead to social unrest or even upheaval.
EconomyThere is no question that China is growing at a very fast pace. The recent official statistics tell us that the GNP has been growing at somewhere around 8%. Given that the "official" statistics have always been fudged to suit the current purpose of the government, it is entirely possible that they are still being fudged (in this case downwards), to avoid the backlash in relation to a huge trade surplus with the rest of the world. As such, they may have shown a slower growth than actually has been taking place. I suspect that the actual growth rate is closer to 12% to 14% than to the reported 8%.
What most people probably don't know is that China's current boom is unsustainable because it is based on a massive expansion of credit (i.e. it's financed by debt). This should sound familiar because the same situation has existed in the U.S., only on a much larger scale. The latest figures show that China's M2 money supply grew by 21.6% over the past 12 months. At some point over the next year or so China's government will be forced to take serious steps to curtail the credit expansion. When this happens there will probably be a very sharp downturn in growth.
In fact, excessive credit creation has already attracted the attention of policymakers in China, who have announced their intention to sharply restrain credit growth. Thus, China's growth will probably slow down considerably beginning next year, as a result of the government reigning in excessive credit growth. In addition to the slowing domestic demand, China's growth will further weaken because Chinese exporters are currently shipping next year's exports ahead of the removal of export tax breaks which will take effect early next year.
Now, having said all that, it is important to realize that China's boom could still continue for a while. But at the same time, it's also important to keep in mind that China's current boom is not sustainable as it's been based, to a larger extent, on a huge credit expansion.
Construction
There is no question that China has been growing very rapidly. The signs of this growth are everywhere. The most visible is the incredible amount of construction that's going on in and around the major cities. New apartment buildings, condominiums and other skyscrapers are being built everywhere. In addition, old housing is being demolished to make room for new. Every piece of land in and around towns and cities is being optimized and used, be it for construction or for agriculture.
The most striking example of the boom is Shanghai, a city in a class of its own. Shanghai is one of the most modern cities in the world. It is like Hong Kong, but newer and more impressive. I've visited 22 different cities in China, yet nothing compares to Shanghai - it is outstanding in terms of its architectural design, which I suspect is one of the most modern in the world. Other cities, including Beijing, do not show such a splendour, richness and grandeur. In fact, most of them look poor and run down, with maybe some pockets of new apartment/condo housing and hotels.
Environment
In spite of all this growth, most if not all cities, towns and villages, including Shanghai, are incredibly polluted. The air is so polluted that one can't see (or take a picture!) for more than 50-60 meters ahead - all you see is haze and smog.
I traveled the Yangtze river along the 3 Gorges all the way to the currently being built dam and hydro electric power station. As you may know, the Chinese government has decided to build a power dam on the Yangtze river to produce cheap electricity. This project has been extremely controversial and condemned by the western world because it will cause the water level on the river to rise by some 140m in some parts, flooding everything in its path: villages, towns, fields, etc. The scenery along the Yangtze river is magnificent, especially the 2nd and 3rd Gorge. However, the pollution is so bad that even there you can't see for more than 50 m in most parts. In addition, the river is also polluted and, frankly, stinks incredibly. I suspect there is no wildlife in it. And all this is in the "wilderness," away from major towns and cities. Since coal and wood are still a major sources of heating and energy throughout China, one can only imagine the level of pollution in and around mining towns and towns and cities that use coal as a main source of energy.
The boom in China and the relaxation of vehicle ownership laws has also resulted in an exponential increase in the amount of cars in China. Not only is traffic unbearable (and driving difficult and dangerous), but it also further adds to the existing pollution.
Investments
To the proponents of making a quick buck in China , all of the above matters not. All investors can see and think of is 1.2 billion people in great need of things and ready to buy whatever those people can and will deliver. What these proponents are unaware of is that most people in China are poor and have no money to buy much beyond bare necessities - they scrape by just enough just to maintain their (sub)existence. In addition, there is very high unemployment, especially in the rural areas. This, in turn, results in a huge migration of the population to the bigger cities. Currently, there is an army of unemployed, hungry and frustrated young people heading for the major cities in search of employment and a better life.
Yet the life in the bigger cities is not much better. Affordable housing is nonexistent and finding work is equally hard. Thus, you have this huge influx of cheap labor and no employment or housing to provide them with. The migrant population is willing to work for peanuts, taking away jobs from the local population. You also have a growing disparity between a relatively small segment of population who "have" and the majority who "have not," In my opinion, it's a powder keg ready to explode sometime soon.
Yet Westerners think nothing of these problems. All they can think of is that China is a "virgin" territory with 1.2 billion people ready to buy whatever they'll sell them. They think that doing business in China is a walk in a park. Nothing could be further from the truth.
In fact, the current rush of Westerners to capitalize on the potential China boom reminds me of the similar rush some 10 odd years ago to capitalize on the opening up of the iron curtain in Central and Eastern Europe. Many Western companies rushed to the countries of the former Soviet bloc, believing that there was a huge market of over 400 million people in need of everything and ready to buy whatever they could sell them. So, they spent millions and millions of dollars trying to establish themselves in these countries, only to realize that the business environment was so much different from the Western model that they were not able to adapt and function well and/or become profitable.
Among the chief difficulties in the former Soviet bloc were rampant corruption, flawed and unclear legal systems, a lack of property and ownership rights, a lack of legal/police protection, high crime, etc. - all problems which seem to plague China today. On top of that you had hungry and angry, disillusioned people lacking the means to buy even the basic necessities, who often turned their anger against Western interests. Many of these companies lost a lot of money in Central and Eastern Europe, eventually having to abandon their expansion plans or significantly scale back their operations there. I suspect that a similar situation exists now in China and, although there are some opportunities in the long run, many pioneer companies will get "killed" there or at least suffer significant losses.
Gold
There has been a lot of speculation about Chinese citizens buying gold and their influence on its price. The premise is that because the Chinese government has relaxed the laws allowing Chinese citizens to hold gold, the Chinese demand will drive the price of gold significantly higher. ("Ah, if only each of them bought an oz.!" dream the gold bulls.) However, this theory fails to take into account the fact that most Chinese citizens are dreadfully poor. I suspect that their main goals are to put food on the table and to buy the basic necessities, not to speculate on the price of gold.
In addition, over the last few years the Chinese government has significantly changed its policy on housing. In the past, people were pre-assigned housing units by the government. Many of them lived in those apartments for many years. In recent years, the government has implemented a new policy whereby all existing apartments along with the newly built ones are for sale. Thus, anybody who has the money can buy them. Those who can't afford to buy are thrown out. (Those who are employed have the obvious advantage of an income, but they are often also able to obtain preferential, employer-backed loans to buy the dwellings they live in.)
The prices of apartments or condos range anywhere from US$350-$500 per m2 in the medium-size towns or smaller cities to $600-$800 per m2 in the larger cities, all the way to $800-$1000+ per m2 in large cities like Beijing, Shanghai, etc. Thus, for a small apartment of 60m2, one needs to pay $30,000-$60,000. Now, if the average worker is paid $500-$1,000 a month, apartment prices are exorbitant for locals. The point here is that even if the locals had some spare cash, I presume they would put it toward buying their own apartment as opposed to buying gold.
The other argument against Chinese citizens buying large quantities of gold and thus influencing its price has to do with the Chinese currency. Since the yuan is pegged to the dollar and as such is kept artificially low, when it will finally be allowed to float freely, it will appreciate considerably. Thus, I am not convinced that the Chinese would want to buy gold, which can fluctuate wildly or even drop in price and does not pay any interest (there are also storage costs, fear of theft, etc.) while they can keep yuan in the bank, collect some interest and in the end be almost sure of a significant (40%?) appreciation of their investment. Given the above, I doubt that Chinese demand for gold would be significantly large so as to influence its price upwards.
One-child policy/Wealth
In all fairness, it's important to mention that the one-child policy in China of the last several decades has created a situation where grandparents, uncles, aunts, etc. have only one child or few children to dote on and support financially. These are the kids for whom life is a little bit easier. In fact, even Chinese families admit that these children are spoiled rotten. They may, in fact, be the only segment of the population truly able to afford new apartments, condos, etc. - and may even be able to buy some gold to boot. But even they have to cope with the same problems with which China is plagued: high unemployment, low wages and an overall difficulty of day-to-day life. As a result, their main priorities may still end up being putting food on the table and seeking a better education and a better quality of life for their own families.
Conclusion
To summarize, there is no question that there are many business/investment opportunities in China. Its economy has been growing at close to 12%-14% per year. In spite of this growth, however, there are many challenges facing contemporary China - such as rampant corruption, a flawed and unclear legal system, a lack of property and ownership rights, a lack of legal/police protection, high crime and crumbling infrastructure - just to name a few. Thus, while on the one hand China has experienced a tremendous growth, especially in its major cities, on the other it faces numerous challenges which, if not resolved soon, may significantly curtail its future growth and lead to significant social unrest.
Michael Boyd is a polish-born entrepreneur currently residing in Montréal, Canada.