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Why China Won't Save the Day

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This emerging market isn't the answer to recession.

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A lot of bullish commentators are talking about a recovery being in the works, and they may very well be right. But it's not going to look like any recovery worthy of the name. This week we look at what I'll call The Statistical Recovery. But first we take a look at what China's doing, as we continue our look at the rest of the world and ponder whether it's time to brace ourselves for an extended bout with the Muddle Through Economy.

Can China Lead the Global Recovery?

China is growing by about 8% a year, which is amazing on the surface of it, as their exports are down about 20% (more in some sectors). How can that be? I continually read how China is going to lead the world out of its global funk. And 8% growth in GDP does seem pretty strong. But we need to look a little deeper.

If I told you the next US stimulus package would be $4.5 trillion dollars, mostly given to banks that would be forced to loan out the money quickly, do you think that might jump spending and GDP in the short term? Would you start looking for a few bubbles to be created? What about the dollar?

That's the equivalent of what China's now doing. The volume of credit that's flowing into the country is equivalent to one-third of their GDP. Banks that already have large problem-loan portfolios are now lending even more, in a very short time frame. China has severe capacity-utilization problems, as trade has sharply fallen; and the US consumer is unlikely to return to anywhere near the level of consumption that was the case in 2006.

The Chinese stock market is up 85% this year, and commodity and real estate prices are rising. And no wonder: The money supply shot up 28.5% in June alone. That money is looking for a home. My friend Vitaliy Katsenelson has written a very perceptive essay for Foreign Policy magazine, talking about the nature of the current growth in China.

"But don't confuse fast growth with sustainable growth. Much of China's growth over the past decade has come from lending to the United States. The country suffers from real overcapacity. And now growth comes from borrowing -- and hundreds of billion-dollar decisions made on the fly don't inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.

"This growth will result in a huge pile of bad debt -- as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much."

I'm going to quote at some length from Simon Hunt's latest note. He travels very frequently to China and is one of the world's true experts on the copper market. Copper, we're told, is the metal with a PhD in economics. If copper prices are rising, then the economy is booming. And historically, that's more or less been the case. But there may be reason to believe that a PhD may be no more useful this time around than a regular Ivy League degree.
No positions in stocks mentioned.

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