Lots of blogs (MR, Yglesias, Drudge) have been linking to another bearish article on China. I find these articles to be very annoying, but not because I disagree with their specific predictions. Rather I don’t see the point in making these sorts of predictions. For example:
May 3 (Bloomberg) — Investor Marc Faber said China’s economy will slow and possibly “crash” within a year as declines in stock and commodity prices signal the nation’s property bubble is set to burst.
The Shanghai Composite Index has failed to regain its 2009 high while industrial commodities and shares of Australian resource exporters are acting “heavy,” Faber said. The opening of the World Expo in Shanghai last week is “not a particularly good omen,” he said, citing a property bust and depression that followed the 1873 World Exhibition in Vienna.
“The market is telling you that something is not quite right,” Faber, the publisher of the Gloom, Boom & Doom report, said in a Bloomberg Television interview in Hong Kong today. “The Chinese economy is going to slow down regardless. It is more likely that we will even have a crash sometime in the next nine to 12 months.”
An indextracking Chinese stocks traded in Hong Kong dropped 1.8 percent today, the most in two weeks, after the central bank raised reserve requirements for the third time this year. The Shanghai Composite has slumped 12 percent this year, Asia’s worst performer, as policy makers seek to rein in a lending boom that’s spurred record gains in property prices.
What are we to make of this? I’m all for inferring predictions from asset prices, so I do concede that the modest fall in Chinese stocks is interesting. But what are the investment implications of that? If you are using asset prices to predict economic growth, that’s fine. But it makes no sense to use asset prices to make predictions that you imply will be useful to investors.
And what’s with the Vienna World’s Fair of 1873? I presume that’s a joke, but since I don’t recognize humor without smiley faces attached, I’ll proceed as if he was serious. The US also had a depression in 1873; was that also caused by the Vienna World’s Fair? And how about the strong economic growth that occurred in the US following the 1933 and 1964 World’s Fairs?
China is “on a treadmill to hell” because it’s hooked on property development for driving growth, Chanos said in an interview last month. As much as 60 percent of the country’s gross domestic product relies on construction, he said.
What exactly do they mean by crash? And what is the theory that links high levels of construction with crashes? But here’s my biggest problem with the Chanos prediction; it seems to be based on false information. I wasn’t able to find current construction data for China, but the construction sector was only 7% of Chinese GDP in 2003. I’d guess it is about 10% today. Services are currently 40%, farming is 11%, and I’d guess manufacturing, mining, and utilities are close to 40%. I’d say if you are predicting a crash based on construction being 60% of GDP, and it’s actually only about 10%, that’s a big problem.
Rogoff said in February a debt-fueled bubble in China may trigger a regional recession within a decade.
In its entire 230 year history, the US has never once gone 10 years without a recession. So I’m willing to concede that China “may” experience a recession within 10 years. And since the other East Asian economies are heavily dependent on China, and Chinese recession would certainly depress all of East Asia (just as American recessions impact Canada and Mexico.)
Would the Chinese recession have been caused by the debt-fueled bubble? Well I guarantee that if a recession does occur, everyone will assume it was caused by a debt-fueled bubble. But how can you tell? I just read an NBER article that discussed the market for real estate bonds in the interwar period. These bonds fueled lots of skyscraper construction in NYC and Chicago during the 1920s. But unlike the authors, I don’t see much evidence that this was a bubble, or that it in any way contributed to the Great Depression, or that lenders were foolish in making those loans. Instead, I think the Great Depression was caused by NGDP falling from $106.7 billion in 1929:3 to $49.8 billion in 1933:3. When NGDP falls in half, it becomes very difficult to service debt on brand new skyscrapers built under the assumption that NGDP would not collapse. I just don’t see irrationality here, nor do I see causation running from debt bubbles to depression. But I am in the minority regarding the Great Depression; indeed I recall that Rogoff also thinks the Depression was caused by a financial crisis. If China experiences a recession I will again in be in the tiny minority who think debt has little to do with the problem.
Citigroup Inc. warned in March that in a “worst case scenario,” the non-performing loans of local-government investment vehicles, used to channel money to stimulus projects, could swell to 2.4 trillion yuan by 2011.
I wonder how the average reader interprets that sentence. My first thought was: If only the US and Europe could have that sort of “worst case scenario.” Note that 2.4 trillion yuan is about $350 billion, chump change for the Chinese government.
The government has banned loans for third homes and raised mortgage rates and down-payment requirements for second-home purchases. Prices rose 11.7 percent across 70 cities in March from a year earlier, the most since data began in 2005.
Pretty scary eh? Except that nominal incomes are growing even faster, so the price of homes relative to Chinese incomes is actually falling.
Housing prices nationwide may fall as much as 20 percent in the second half of the year on government measures to curb speculation, BNP Paribas said April 23.
Obviously this might well happen, but what justifies this prediction? Earlier we were told that falling stock prices signal economic weakness ahead. Then we were told housing prices were rising rapidly. Asset prices should incorporate publicly known information about the fundamentals of the housing market. Using the logic of Marc Faber, doesn’t this suggest good things lie ahead for the housing markets? Yes, we know from the US experience that markets are sometimes wrong. But then why use the stock market to forecast the economy, but ignore the information contained in housing prices?
I believe that Plato said knowledge was justified true belief. I just don’t see any justification for the predictions made in this article. If people are making predictions based on the 1873 Vienna World’s Fair, or the assumption that construction is 60% of the Chinese economy, then I don’t particularly care whether the predictions come true. Here is an analogy. You are talking to a drunk in a bar. He suddenly says “The huge Chinese trade deficit will cause the Chinese stock market to crash in 2011.” Are you going to file that prediction away and check later to see whether it was accurate or not? Or would you think “That guy doesn’t even know that China has a trade surplus, not a deficit.”
I’m not impressed by predictions that assume the EMH is wrong. But I am willing to keep an open mind on the EMH. I am especially unimpressed with predictions that assume the EMH is wrong and that are based on false or misleading economic statistics. If those predictions turn out to be accurate, it would not make me think more highly of the person who made the prediction, I’d just assume he got lucky.
I understand that predictions are fun, and it’s only human to want to anticipate what will happen next. I’m all for making conditional predictions based on various public policy options. And I’m all for drawing inferences regarding the implied predictions embedded in asset prices. But the sort of unconditional predictions discussed in the Bloomberg article should be placed in the astrology section of the newspaper. Fun to talk about, but not to be taken seriously.
Most economists obviously disagree with me. The top economists are constantly making predictions that violate the EMH. OK, then why not set up a new journal, the Journal of Economic Predictions. Each month they would publish 25 to 30 short predictions about the economy or asset prices. After 30 years we’d have 10,000 predictions, a pretty good track record of whether economists actually had the ability to make useful predictions. Those who think my skepticism is misplaced could set up a mutual fund that invested a little bit of money on the basis of each JEP prediction. With so many predictions it would be highly diversified. If economists’ predictions are superior to dart tossing, then the mutual fund would outperform index funds.
PS. Here is a summary of the Goetzmann and Newman paper I referred to above. There’s one good thing about the commercial property bubble that preceded the Depression. The overbuilding in NYC during the 1920s reduced skyscraper construction in the 1950s and 1960s. With a few exceptions like the Seagram building, the post-war era produced a bunch of boring modernist boxes. Who hasn’t been delighted by strolling around Manhattan in the late afternoon sun, inspecting all the exotic spires on top of the art deco towers. The Empire State Building and the Chrysler building are like the uneven towers at Chartres; built for the wrong reasons, but built by people who still had a sense of wonder and awe. Thank God they were built.
PPS. Don’t take this post as implying that I am bullish on Chinese markets. The Chinese markets are highly volatile—I have no opinion on where they are going, except that we will probably continue to see large swings in assets prices. I am bullish (long term) on the Chinese economy. I think it will continue to grow rapidly for quite some time, albeit with occasional recessions.