Thursday, February 12, 2009

China: What to be Concerned About

There has been a big debate over the economic health of China. Some believe it is quite healthy and will not see the level of trouble many other countries are facing, while others believe it is the same or worse. I did some digging, and found some interesting information on the subject. Here's a synopsis of what is happening relative to the United States:

The crisis in Western markets began at the top and worked its way down. When the US property bubble burst, it hurt some homeowners, but the real damage it inflicted was to undermine confidence in complex financial instruments and the banks that owned them. It was essentially a financial panic, and the first people to be laid off were Wall Street MBAs working at investment banks and hedge funds.

The effect on the real economy only came later. As big-name banks failed, consumer confidence took a nosedive, and as surviving banks retrenched, credit to consumers and business dried up. Only in the fourth quarter of last year - six to nine months after the first big bank, Bear Stearns, collapsed - did these factors result in significant working-class job losses.

The process unfolding in China is precisely the opposite. The threat comes not from the commanding heights of the economy, but from the grassroots. All along the coast, thousands of small factories that rely entirely on US and European export markets are cutting back production or shutting down. Their margins were thin to begin with, and now their orders are being slashed. The first to be affected aren't the global professionals that populate China's big cities, but the migrant workers that made those factories hum.

This is big. The U.S. relies on China's manufacturing sector for cheap goods. A huge number of Chinese workers rely on those jobs, and when U.S. demand drops, they feel it. This is an important balance that must be considered when thinking about the health of China.

The fact that China's slowdown is originating from the bottom up, rather than the top down, carries important implications. The first is the visibility of the problem. Today, China's high-income urban areas are experiencing a false dawn as banks churn out easy cash to prop up the economy. But quietly, behind the scenes, Chinese companies are revising their profit estimates downward, by as much as 50% for 2008. The bad news just hasn't hit home yet.

The second difference is the solution. Unlike the West, China does not face a liquidity problem, where financial markets have frozen and the government can thaw them out with easy money. China faces a breakdown in real demand due to an over-reliance on external markets, a core element of its growth model that will require a wrenching structural shift in the economy to correct.

This is an excellent analysis of the Chinese situation. Although China is rising as one of the world's future superpowers, there are many dangers for investors looking for a safe haven.

Full article is China on the Brink, by Patrick Chovanec at Asia Times.

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