2010-01-20

Is China's economy the world's biggest bubble?

Gerard Jackson lays out the evidence.
We are getting numerous reports of massive "over-investment" with factories still being built, steel production increasing and the continual expansion of capital goods even though there appears to be little "final demand". This view appears to be supported by largely vacant office blocks and rising vacancy rates in new shopping centres.

There is absolutely no such thing as general "over-investment". Although this fallacy was effectively dealt with nearly 200 years it still keeps being resurrected by people who simply have not done their homework. You cannot invest without saving*. It is that simple. The problem is that monetary expansion discoordinates production, causing too much investment in the higher stages of production at the expense of the lower stages. One symptom of discoordination is the emergence of bottlenecks. An inevitable event because of the heterogeneous nature of capital.

Another phenomenon frequently encountered but only explained by the Austrian school of economics is the apparent disappearance of investment opportunities. This now seems to be happening in China. But do they really dry up? No, is the answer. Monetary expansion distorts the pattern of production by raising the rate of return in some lines of production at the expense of others which then makes them unprofitable. This gives the false impression that the range of profitable opportunities are narrowing. (F. A. Hayek, in Profits, Interest and Investment, Augustus M. Kelley Publishers, 1975, pp. 34-35).

As a rule this will not present a problem if the monetary authorities terminate the boom in time. If it is allowed to continue then the only way to prevent these 'unprofitable' sectors from going under is to accelerate the money supply. Naturally, more and more credit will have to be injected into the economy to obtain the same level of output. In the meantime this easy money policy will be fuelling more and more speculation. This certainly seems to be the case in China. I was given figures showing that from 2008-2009 it took $1.5 of debt to produce $1 of GDP. A ratio of 1.5:1. The ratio is now $7 debt to yield $1 of GDP. This is definitely not good.
If those figures are true, then they are even worse than the U.S. figures before the bubble began bursting in 2007.

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