Thursday, February 16, 2012

China Can't Escape the Austrian Business Cycle Theory

China has seen an explosion in economic growth since some liberalization began to take place over 3 decades ago.  While hundreds of millions of Chinese people still live at or near the poverty level, there is no question that the standard of living has gone up quite a bit in China, particularly for those living in the cities.

Unfortunately, not all of that growth has been genuine.  Just as some of the economic growth of the last 3 decades in the U.S. was an illusion, the same is true for China.  When you have a central bank that is inflating at double digit rates per year as the Chinese central bank has been doing for a while, then there are going to be bubbles and busts.

Just as the U.S. had a real estate bubble, China also apparently has a real estate bubble.  The U.S. real estate bubble began to pop about 5 or 6 years ago.  We are still waiting for the Chinese real estate bubble to  pop.

The Austrian Business Cycle Theory can teach us something here.  When the central bank creates new money out of thin air, along with artificially low interest rates, there are distortions in the economy.  Eventually it will result in a bust.  Either the central bank will try to accelerate the monetary inflation in order to keep the bubble propped up or the central bank will not accelerate monetary inflation.  If it continues to increase the monetary inflation rate, then it will eventually lead to hyperinflation and a total destruction of the money.  If the rate of monetary inflation is not increased (it doesn't have to be a decrease in the money supply, just a slowdown in the rate of increase), then the bad investments will be revealed and a bust will occur.

The real estate in China has seen a massive boom.  This has occurred simultaneously with very high monetary inflation, sometimes above 20%.  There will be an inevitable bust.

Bill Sardi had an article at LewRockwell.com the other day.  He said that, "Chinese bankers are more conservative than the colleagues in the US and require 30-60% down payment on home loans."  While it's true that the down payments for housing have been much bigger in China than what is typically seen in the U.S., it still doesn't negate the central bank induced boom/ bust cycle.  You don't necessarily have to have massive leverage for a bubble to occur.

We have seen bubbles in gold and bubbles in the stock market in the past.  There was a massive bubble in the stock market in the late 1990's, particularly in technology stocks.  While there may have been some leverage with futures and options, there were a lot of people who simply bought shares in stocks with money that was saved.  These people were not using leverage.  Yet, it didn't prevent a collapse in prices.

The fact that there are bigger down payments in regards to Chinese real estate may result in some differences from the U.S. real estate bust.  If the bust isn't too bad (which I'm not betting on), then perhaps we won't see as many underwater properties because of the high down payments.  Because of this, we may see less trouble with banks.  But regardless, all indications show that there is going to be a big bust in real estate in China.

Since China's history has been one of mostly poverty, this will be the first big bust that China experiences.  Some people there have gotten a taste of a higher standard of living.  When the bust occurs, it will be interesting to see what happens.  Will people demand less government or more?  Will communism officially fall?  Or will they turn into more of a bureaucracy like the U.S. with more financial regulation, even though the business cycle is being fueled by the central bank?

I don't know what the outcome of all of this will be, but I am fairly certain that there will be a bust in the Chinese real estate market.

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