{"id":3015,"date":"2011-01-22T15:55:21","date_gmt":"2011-01-22T22:55:21","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=3015"},"modified":"2018-09-21T02:08:24","modified_gmt":"2018-09-21T06:08:24","slug":"effect-of-a-chinese-bubble-burst","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2011\/01\/22\/effect-of-a-chinese-bubble-burst\/","title":{"rendered":"Effect of a Chinese bubble burst"},"content":{"rendered":"<p><span style=\"font-size: 16px;\">I can see that my last post about the building Chinese asset bubble has caused some alarm.\u00a0 To allay those fears let me first start by saying that I think the effect of the asset bubble bursting in China will be much less pronounced on the rest of the world&#8217;s economies when compared to the asset bubbles bursting in the United States and Europe during the Great Recession.\u00a0 Here&#8217;s why&#8230;<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">First let&#8217;s recall why the asset bubble bursting was so rough in the First World.\u00a0 It involved whole, huge sectors of the economy.\u00a0 There were construction firms, cement companies, lumber companies, hardware suppliers, local lenders, national lenders, investment banks, realtors, and especially, consumers.\u00a0 So when the bubble burst it took down the values of most investment asset classes (stocks, bonds, commodities and real estate).<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The value of all of these assets was denominated in the U.S. dollar or in the Euro.\u00a0 These two currencies also happen to be the global currencies for trade and commerce.\u00a0 So that meant that the value of trade was effected globally.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The First World&#8217;s economies are largely consumer spending driven (usually around 2\/3 of total GDP).\u00a0 Consumers happened to be the hardest hit by the Great Recession.\u00a0 They were invested in a primary residence, secondary residences (and others), in the stock market, and many folks had jobs directly or indirectly tied to real estate in some fashion.\u00a0 When the net worth of consumers fell they stopped spending which led to a vicious circle that I have talked about many times on the blog, that included declining asset prices, lower corporate profits, and job layoffs.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">So for any decline in China to have the same affect, similar causal structures have to be in place.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Any effect of the Chinese asset bubble bursting would have to come from the interlinking of the Chinese economy with the rest of the world&#8217;s economies.\u00a0 During the Great Recession 5 of the 6 most important world economies were affected simultaneously.\u00a0 This is because of the high degree of interdependency.\u00a0 The Chinese economy is not that integrated with the economies of the rest of the world.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">If you treat an asset bubble bursting as a contagion then you have to look at in what ways that contagion would spread to the rest of the world.\u00a0 Yes, the Chinese have the second largest economy on the planet.\u00a0 But its exports to the rest of the world amount to only $1.58 trillion on a global economy that is ~ $74.3 trillion (source: <a href=\"https:\/\/www.cia.gov\/library\/publications\/the-world-factbook\/geos\/xx.html\" target=\"_blank\" rel=\"noopener\">CIA World Factbook<\/a>) in size.\u00a0 This amounts to a meager 2.1% of total worldwide economic output.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Even if the bubble bursts and it is horrible for the Chinese, their exports would likely not drop that much.\u00a0 In fact, if the asset bubble bursts in China it would lower the price level throughout China, which would make their exports cheaper.\u00a0 That might even spur demand in the First World for additional Chinese goods.\u00a0 But to be conservative, let&#8217;s assume that China&#8217;s exports fell by 25% (a highly unlikely scenario).\u00a0 That would amount to $395 billion in lost economic output.\u00a0 While large that represents only 0.5% of total worldwide GDP.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Of course the Chinese themselves buy foreign goods which also interlinks them to the rest of the planet.\u00a0 Last year, Chinese imports of goods amounted to a meager$1.39 trillion &#8211; or about the same as their exports.\u00a0 So imagine the Chinese are so shut down that they stopped all importing (that would never happen), that would amount to a paltry 1.9% of total worldwide GDP.\u00a0 Not fun, but not scary, either.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">But exports and imports are not the only way that China integrates with the rest of the world, there is also the direct investments made in China by foreigners.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">The Chinese have severely limited the amount of foreign direct investment in China.\u00a0 In fact, in 2009, the latest year for which statistics are available, foreign direct investment was estimated at ~$90 billion by all foreign investors (source: <a href=\"http:\/\/www.uschina.org\/statistics\/fdi_cumulative.html\" target=\"_blank\" rel=\"noopener\">The U.S.-China Business Council<\/a>).<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">If the bubble burst let&#8217;s imagine a disaster scenario: the value of investment falls by 50% (highly unlikely).\u00a0 If that situation unfolded we would be talking about a $45 billion loss.\u00a0 Again, not fun, but not even close to catastrophic.\u00a0 That loss would represent a loss of global gross domestic product of only 0.06%!<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">You see almost all investment in China is still overwhelmingly done by the Chinese government itself.\u00a0 In fact, investment in China last year was $4.2 trillion and was equivalent to 69.9% of all economic activity in China last year.\u00a0 This is a massive percentage.\u00a0 That is another way of saying that the Chinese government is to the Chinese economy, what the First World&#8217;s consumers are to their economies.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Trade throughout the world is largely denominated in the U.S. dollar.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The U.S. dollar and the Eurozone&#8217;s euro are the dominant world currencies.\u00a0 In fact, almost all trade in the world is conducted in these two currencies.\u00a0 During the Great Recession that meant that the contagion affecting the U.S. and Europe spread throughout the world.\u00a0 The Chinese currency, the yuan, is not a global currency for transacting business.\u00a0 So a decline in the value of assets denominated in the Yuan will not spread much beyond the reaches of the yuan currency&#8217;s power.\u00a0 In other words, the damage will largely stay in China.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Chinese banking is insular and not that connected to the rest of the world.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The Chinese are an insular people even despite their huge and successful record as exporters.\u00a0 That means that what is raised in China, stays in China.\u00a0 That includes capital.\u00a0 China has six very large banks whose sole purposes are the full-employment of the Chinese people and the full-deployment of Chinese capital.\u00a0 They do this with massive inefficiency; hence, the Chinese asset bubble.\u00a0 These banks therefore, are not big investors in projects outside of China.\u00a0 The most important exception is Chinese purchases of foreign government debt.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">It is well known that the Chinese purchase large amounts of foreign government debt.\u00a0 What is not well known is just how much they hold.\u00a0 To me this would be the largest effect on the global economy when the Chinese asset bubble bursts.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The Chinese will have to look inward if there is a bubble burst, ergo their ability to finance government deficits around the world will be reduced.\u00a0 That may drive up lending costs in the First World as the demand for their debts declines, prices (i.e. interest rates) will have to go up.\u00a0 It is difficult to say just how much damage this would do.\u00a0 Some estimates place Chinese holdings of foreign debt at around ~$2.5 trillion.\u00a0 That equates to approximately 3.4% of total worldwide gross domestic product.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The Chinese will in all likelihood not sell their holdings of foreign debts to raise capital.\u00a0 Why?\u00a0 Doing so would drive down the price of these assets which would only hurt the value of these holdings for the Chinese.\u00a0 So the primary effect would be to raise interest rates on new debt issues.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Commodities prices will collapse.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">The Chinese are voracious consumers of the world&#8217;s commodities, ranging from gold to oil to lumber to cement.\u00a0 In fact, the Chinese have single-handedly led to a bull market in commodities prices for the last decade.\u00a0 That demand has also attracted huge amounts of speculative investment.\u00a0 Expect the prices of these goods to rapidly fall.\u00a0 To my way of thinking, the lowering of the price of these goods and services is a good thing for the worldwide economy, in general.<\/span><\/p>\n<p>&nbsp;<\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Psychological impact.<\/span><\/li>\n<\/ul>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Of course there is the psychological impact of a Chinese recession on the world&#8217;s citizenry.\u00a0 Clearly this is a matter of timing.\u00a0 If the asset bubble bursts in China in the next year, my feeling is that the psychological effects would rank a 6 on a scale of 1 to 10, with 10 being very bad effects.\u00a0 However, once news spread that the effects of the collapse were largely contained to China, I think the psychological impact would dissipate fairly rapidly.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">So to sum it all up, the Chinese asset bubble is likely to burst sometime soon.\u00a0 The primary economic effect will be a pressure on global interest rates to rise and a collapse in commodities prices.\u00a0 The psychological effect will actually probably be the largest effect (the only thing we have to fear is fear itself).\u00a0 What is not easy to predict is just when this will all happen.\u00a0 Furthermore, it may be the case that the Chinese find a way to rein in the lending of its banks and mitigate the crisis entirely.<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Jason<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Notes:<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Here is a breakdown of <a href=\"http:\/\/www.stats.gov.cn\/english\/newsandcomingevents\/t20110120_402699463.htm\" target=\"_blank\" rel=\"noopener\">the latest Chinese economic data<\/a>:<\/span><\/p>\n<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Total gross domestic product: 39,798.3 billion yuan, up 10.3% y\/y (this year compared to last year)<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Industrial production: 3,882.8 billion yuan, up 49.4%<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Investment in fixed assets: 27,814.0 billion yuan, up 23.8%<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Consumption: 15,455.4 billion yuan, up 14.8%<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Exports: 10,387.8 billion yuan, up 31.3%<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Imports: 9,182.4 billion yuan, up 38.7%<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Net exports (exports &#8211; imports): 1,205.4 billion yuan<\/span><\/p>\n<p>&nbsp;<\/p>\n<p>&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>I can see that my last post about the building Chinese asset bubble has caused some alarm.\u00a0 To allay those fears let me first start by saying that I think the effect of the asset bubble bursting in China will be much less pronounced on the rest of the world&#8217;s economies when compared to the [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-3015","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/3015","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=3015"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/3015\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=3015"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=3015"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=3015"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}