• The global economy is built on a lie
  • China’s boom is politically motivated, not economically
  • It’s the sub-prime and PIIGS’ property boom all over again

No doubt you’ve noticed the sudden influx of news reports about China’s stumbling economy and wobbling financial markets. Deflation, bankruptcies and bizarre economic policies to try and counter the decline all feature.

We covered China’s struggles in last month’s edition of The Fleet Street Letter, including what to expect next for stocks. But in this three-part series for Fortune & Freedom, I want to focus on something a little different.

Just promise me one thing: if you read on, you’ll read the last few paragraphs of part three on Wednesday, which will reveal a shocking twist about what you’re going to discover below.

If you agree to this, read on…

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Benefiting from a relationship is something we all strive for. But being dependent can be dangerous. It leaves us open for more than disappointment when things go wrong. And when it comes to emerging economic superpowers, things do go wrong from time to time.

Over the past few decades, the global economy’s relationship with China has gone from consisting of healthy economic ties to dependence and reliance. Unfortunately, it seems we were relying on an artificial economic dream.

The symptoms were clear enough. For example, in four years of construction, the Chinese created more office space in Beijing than exists in all of Manhattan. And despite occupancy rates of around 50%, foundations for more buildings continued to be laid.

Where this construction boom has been completed, entire cities, including police stations, schools and malls, stand empty. But massive oversupply is only half the makings of a bubble. Outrageous prices feature in China as well. Apartments in Shanghai were priced higher than Manhattan per square foot.

These are the stories investors heard about for years now. But what was the cause for the bubble?

Artificial demand, stimulated supply and a debt “time bomb”

‘China’s expansion is politically – not economically – motivated. This is NOT about economic growth; it’s about political stability … stability at ANY cost.’

– Exit The Dragon report, Port Phillip Publishing

In China, “political stability” is a metaphor for jobs. Without jobs, the Chinese take to the streets. As China sceptic Gerald Celente often reminds his Trends Journal readers, “When the money stops flowing down to the man in the street, the blood starts flowing in the streets.” The easiest way to create the jobs that will avoid social unrest is to commission construction. And so that’s what Chinese officials did.

A Societe Generale report highlights the results:

  • China is building almost 2 billion square meters of new housing per annum, enough to accommodate 60 million people while around 20 million are migrating to the cities every year.
  • Growth in [the supply of] Chinese real state has averaged 25% [per year over a ten-year period].
  • China’s cement consumption exceeded 1,800mt, representing around 55% of global consumption and about 25x more than US consumption. With average consumption of1,400 kg per head, China stands well above the world average ex-China of 300kg. History shows that such high consumption is hard to sustain for a number of years and ultimately leads to a construction crisis sooner or later.
  • With around 1.8bn square metres of new residential floor space completed in [a single year], China has built the equivalent of Spain’s housing floor space stock.

According to analyst and author Gary Schilling, “houses are now being built at about twice the rate they’re being sold.” Economist Nouriel Roubini claims almost 50% of China’s GDP was fixed investment, of which construction is a major part. Much of this phenomenon is fairly recent, with a 25% expansion in fixed investment in just the first five months of this year!

Standard Chartered economist Stephen Green calculates about 50% of China’s economy is “linked to the fate of the real-estate market.” All this has resulted in more than 64 million vacant properties according to the Australian Dateline television programme’s Adrian Brown. (With an average of 3.63 people per household, this equates to spare capacity for 232 million people, or 17% of their population!)

But the oversupply from endless construction isn’t the only misallocation of capital. China’s remarkably high savings rates have led to a glut of investable capital. As interest rates were suppressed lower to stimulate borrowing and spending, the Chinese responded by saving more, not less, as mainstream economics would predict. But the suppressed interest rates forced Chinese savers to look outside their bank accounts for a place to stash their cash.

One of the main considerations was keeping up with the rate of inflation – another symptom of suppressed interest rates – which savings accounts weren’t doing. Historically, property investments tend to serve this inflation hedging purpose. So, Chinese savers became Chinese property investors.

The combination of state commissioned construction and a glut of investable savings flowing into property set the scene for a bubble of epic proportions. Once this kind of bubble gets going, it soon turns into a mania. Despite empty cities being found throughout the Chinese countryside, more heavily populated cities saw property price gains of enormous proportions.

Sound familiar?

The whole story is remarkably similar to what the US, UK and many of the PIIGS (Portugal, Italy, Ireland, Greece and Spain) experienced in the 2000s. A bubble formed by lax monetary policy was directed into property by government incentives, all as a political ploy to keep voters happy. You know how that ends. First a property bust, and then a financial crisis, which is narrowly averted by government bailouts. This means the debt is shifted around the economy, but never paid off.

In fact, this life cycle of debt as it moves around the economy seems to be the crucial link between the economic debacles of the past few decades. Understanding it will help put China’s bubble into context.

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More on that tomorrow.

But remember your commitment to read the last few paragraphs of part III on Wednesday to discover the real twist in this three-part series.

Or, if you just can’t wait to discover what The Fleet Street Letter’s investment director Eoin Treacy makes of China’s bubble, you could sign up today.

Until next time,


Nick Hubble
Editor, Fortune & Freedom