I travel around the world to uncover stories that impact Capitol Hill. Often, the most important stories need an outsider’s perspective to understand them. This week, I spoke at conference called FreedomFest 2013. This conference included some of the greatest strategic thinkers in the world, and several had chilling comments about China.
Jim Rogers, Steve Forbes, Alex Green, Mark Skousen, Joseph Farah, and Bert Dohmen are just a few of the thinkers who shared their insights about investments and governance in a world of increasing risk. I deeply value the opinions of the unique minds attending FreedomFest. And this year, an important trend has emerged. This trend is influencing events that will impact your life and your investments…
The collected voices share a great fear about what lies directly ahead for China. China’s central bank responded aggressively to the financial crisis of 2008. It responded with liquidity and easy money. And this flood of easy money has helped produce an incredible array of malinvestment. (Austrian School economists developed the concept of malinvestment to explain the consequences of a central bank providing too much monetary stimulus.)
Governments and firms were required to keep the economy growing at all costs, which led them to poorly allocate the excess funds. This flood of artificially cheap money paid for projects that require huge debt service payments, but provide little economic value.
For example, highways and bridges to nowhere were built. High rise apartment buildings remain vacant, and entire cities are ghost towns waiting for businesses and inhabitants to show up. One of the most colorful descriptions I heard was of the Guangzhou South Train Station. This colossus of a station is eerily vacant. Imagine going into Grand Central Station, and not a soul is in sight…
What’s more, China’s Vice Finance Minister, Zhu Guangyao, admitted this month that local government debt levels are unknown. Official figures haven’t been released since 2010 and are likely much greater than the forecast 10.7 trillion yuan ($1.7 trillion).
Estimates of China’s local government debts range from Standard Chartered Bank’s 15% of GDP at the end of 2012, to Credit Suisse Bank’s 36%. The debt rating agency Fitch forecasts that the figure is 25% of GDP, so it downgraded China’s sovereign debt rating in April.
Collapse on the Horizon
Now that the stimulus of 2008 has worn off, the economy is in worse shape than before. China is currently dealing with an overhang of excess debt, along with too much factory inventory and housing capacity. These excess supplies have become dead weight. Therefore, China is again scrambling to stir up growth, and officials will be forced to order more stimulus. The big concern now is that the excess debt will cause a full-scale economic collapse.
The clearest sign of distress in China can be seen via the inverted yield curve. An inverted yield curve happens when short-term interest rates become higher than long-term interest rates. This means that there’s a structural problem within the economy’s interest-rate-setting mechanisms. It shows that banks in China are apprehensive about defaults and insolvency at other banks and firms. So they’re demanding a premium to lend to others on a short-term basis.
Simply put, China is facing a crisis of liquidity. Whether or not Chinese liquidity problems will become as desperate as they were in America (after the collapse of Lehman Brothers) remains to be seen.
What we do know, however, is that America’s yield curve inverted before the recessions of 2001 and 2008. Mark Skousen summed up the attitude toward China when he said, “The inverted yield curve in China is forecasting a recession, and I would be very cautious about owning Chinese stocks at this time.”
The reality is that this is already affecting the United States. As an aggressive seller of U.S. Treasury debt, China may be the cause of the spike in long-term interest rates in the United States. And let’s not forget that China has us eating out of their palm in more ways than one.
Bottom line: We all need to pay attention as the China situation unfolds. It could be the event that tips the entire world into another recession.
This article originally appeared at CapitolHillDaily.com and is reprinted here with permission.
Photo Credit: johntrathome (Creative Commons)
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