Saturday, February 22, 2014

A Tale of Two Asian Economies...

I’m going to start this by describing a country. See if you can guess who I’m talking about…

This country lies in East Asia. After much turmoil it was able to pull itself out of the gutter by building a huge export economy. Labor cost was low so outside businesses were quick to invest. No one paid much attention at first but before long everyone was intrigued by this nations back to back to back years of double digit economic gains. Money supply came in tidal waves.

View from the outside world

Pretty soon this country is dubbed the next great power of the world. Destined to overtake the United States and then some. This nation begins buying up property around the world including many well known landmarks in the United States. People start saying things like “They own the world” and “everything is made there”.

Meanwhile inside the country

Asset prices are soaring. It becomes so expensive to own property in the major cities that most people don’t even try. The state bank floods the banks with cash and credit increases at a large rate. The currency appreciates faster than anticipated. This makes their export goods not as competitive to the rest of the world and the economy slows down. A major economic crash hits the entire world and the export driven economy is dealt an even larger blow.

Who is it?

It depends on what generation you primarily grew up in. If you’re 35 or over you’re probably thinking this is Japan. If you’re 30 or under you’re most likely thinking China. The truth? You’d all be right.
The Japanese economy in the 80’s was a dynamic powerhouse. Sony bought CBS Records, Columbia Pictures , and Mitsubishi bought Rockefeller Center! Japan was surely buying up the U.S. brick by brick. Archived Article
Pretty soon we’d all be speaking Japanese right? Wrong. The Japanese asset price bubble popped ( and their economy came crashing down. In fact most of Japan’s frenzy of buying up and investing in United States assets came just 2-3 years before the final collapse. Those “in the know” knew this was coming. They were buying and investing in anything they could OUTSIDE of Japan because there was literally no hope on the mainland.

Likewise, the Chinese economy these days is all the rage. And from where it began it’s come a long way. China’s GDP has risen rapidly over a short period of time (like Japan). Right now it sits at about half of the U.S. economy at around 8 trillion. However, this is no different than the rise of the Japanese or even the South Korean economy during their heydays.
If you look at the Japanese problems in the early 90’s and the current Chinese economy you’ll see some striking similarities. Currency appreciation, soaring asset prices, investing out of country rather than in, etc.

Now, each of these Asian economies have had their issues during their rapid rise. China, however has some pretty scarey and glaring problems. To start, their banking system is totally screwed. Check it out. The state runs the bank, the bank gives credit to state run companies to manufacture goods in large bulk. What happens when the world economy is down and no one is buying their cheap goods? Those state run companies don’t turn a profit and default on their state granted loans. In fact net domestic credit (state granted loans to state companies) is said to equal 140% of their GDP. They’re massively overleveraged. To make matters worse China doesn’t include any of this on their balance sheets. As the economy slows down this will become an even greater problem as the state will not be able to pump money into their banks to keep their state run businesses afloat.

A Chinese problem that Japan didn’t have to deal with is a massive social disruption. Foreign companies can’t afford to stay in China. They’re beginning to move their factories to places like Vietnam, Mexico, and Ethiopia. As jobs disappear and cash flow dries up what’s going to happen to China’s 1.3 billion people? Especially in China’s interior where it is the least developed. Civil unrest could reach epic proportions.

You can bet that the Chinese government is watching the current protests in Thailand intently. Likewise, the citizens of China are doing the same. In the past the Chinese government has used nationalism to divert the attention of the populace away from their current problems and toward countries like Japan and the U.S. They’ll most likely do the same in the near future. Look for China to get more aggressive towards her neighbors and for their businessmen to invest heavily outside the country. Those two signs alone will tell you more than “official state released economic numbers”.