24 March 2010

Riding a dragon without a parachute

Australians generally refer to the Great Financial Crisis as “that thing that’s happening to other countries”.

Much of our smugness is based on our tidy relationship with China. In essence, we dig up raw materials and sell them to the Chinese. Forget clever, forget hard working, forget innovation – we export dirt.

What’s that worth to us? Exports to China in iron ore and coal alone were worth more than $25 billion last year. Our next biggest export – wool, was worth a lousy billion.

In addition, our other two biggest buyers, Japan and South Korea, buy over $40 billion in minerals, but sell a hell of a lot of their finished goods to China. You start to see how much we depend on the Chinese.

So, how far can we ride the dragon?

To predict that, you have to answer two underlying questions: What is China doing with all that ore and coal? And how are they paying for it?

The second question is easy: The Chinese have the world’s largest reserves of US debt, some $755 billion. Since the GFC hit, their government pumped in $586 billion in stimulus spending, keeping their economic growth at a healthy 10% by the end of 2009.

As to where its all going, they seem to be building real estate and making exports for the US.

And that’s where I started getting scared.

China’s property market is not just booming, its exploding. Prices are rising by 20% a year in major cities. It doesn’t take a long memory to recall other economies that were going though a boom like that (big hello to the US, Ireland and especially Dubai).

On its face this sort of growth seems unsustainable and fueled by pure speculation, but people keep piling in.

Their other big and continuing push is exports to the US. In the year to February, the Chinese managed to lift exports by 46% with the US still the number one market.

WTF? The US currently has 20% under employment and 25% of their houses are under water. So where the hell are they getting the coin to buy $25 billion in Chinese imports a month?

I suspect the answer is yet more debt for a country that already has $13.5 trillion in household debt.

So the question that should be keeping every Aussie up at night: What happens if the Chinese real estate bubble bursts or the USA can’t afford any more Chinese widgets?

Pull up a chair….I suspect we’re going to find out soon.


  1. since you predicted Dubai's problems long before anyone else I know, I will have to give this some thought. Don't forget that a very large proportion of China's economy is now not trade oriented. A major issue as we saw with the GFC is simply whether people have confidence, especially in respect of financial institutions.

  2. Hello. Big sister is watching you.

    I was rather nonchalantly reading this until you mentioned Dubai. I only was there for a week but that "when the bubble bursts" thing seems to have made quite an impression on me.

    Trying to imagine that happening on an economy as large and as tightly linked to ours as China's scares me. And I don't even really understand economics!

    Thanks bro.


  3. Careful - this is what might happen to you if you whistleblow and no one listens...


  4. Thanks for your comments.

    Ric, I'm not saying that China will collapse, but I can't see how they can keep exporting $300 billion a year to the US. If you take that much coin out of the economy there must be a contraction.

    On the real estate side, generally the value of property is a combination of the NPV of rent and the estimated capital gains. Is rent moving fast enough to justify the price rises, or is speculation (and hope) of big capital gains? If the latter they have a problem.

    Remember, you don't need credit crunch to trigger a collapse in the property sector, all you need is unsustainable growth. Look at Japan in the 1990s.