Cup of Cha
This is China

The longer I spend in China, and the faster the country grows, the more skeptical I have become it can really dominate the international economy. Keep in mind I say this as someone with quite a bit of time and money invested in the country’s future. However, I cannot help but think that much of the country’s success is, if not a house of cards, at least one built on a foundation that needs some tending.

For a long time I have pointed to NPLs as one of the potential problems. Banks have been bailed out at least three times on a ridiculous scale, for what are essentially corrupt loans. People have always countered that I’m too alarmist and pessimistic (guilty as charged…I’m a Mets and Jets fan for God’s sake). In recent years banks have supposedly cleaned up their act somewhat, primarily as they look to go public. I have to wonder if you can just make bade debt disappear. Let’s put that one aside for a second.

The next concern, which is exactly what crushed Japan in the early 1990s, is a property bubble. There is a housing bubble. Let me repeat that: there is a housing bubble. Sure, if you’re in a nice Beijing or Shanghai neighborhood, there are always going to be people to buy things, but when prices in Chengdu are going through the roof, something is amiss. Now the ratios certainly aren’t skewed on the scale as they were in Japan, and America is entering its own crisis now, but this could turn into a major problem. I’m not saying it will, but it’s another factor to consider.

But let’s get down to the fundamentals, the real problems I see in the economy. There are sectors that are based on Chinese ingenuity. When the door opened up, many Chinese knew exactly how to make money. The country has a history of people knowing how to do business, and you can see the pragmatism in effect every day. This is one of the factors that has spurred double-digit growth for a decade (or two): when people know how to do business, and they are coming from poverty, odds are you are going to get serious growth.

The problem is that, aside from a not-small number of very bright, very opportunistic capitalists, much of the growth has been export and cheap-labor driven. This is where you are already starting to see cracks. The currency valuation has always been a red herring from the American point of view. People say that an undervalued Renmenbi was costing America manufacturing jobs. That’s a bunch of nonsense. It was costing Mexico jobs (US manufacturing hasn’t been competitive in a generation). However, for China, it was still helping the economy boom. One of the problems is that the low costs came at the expense of quality in many circumstances. The people taking these jobs are not the country’s best and brightest, it is the most abundant and cheapest. This is why we are seeing the quality control problems that keep cropping up. It’s not that Chinese people are evil and not to be trusted, it is that factories have problems because the workers are cheap and poorly trained. Why use a safe adhesive when you can use a toxic chemical found in date rape drugs? After all, Chinese companies typically earn 2-3% profit margins, so cutting corners keeps companies in business.

The point is that soon we will hit the time when labor costs will be a very minor consideration, and this will not bode well for a country that already is seeing jobs go to southeast Asia. As the boom at the top, from the real entrepreneurs, begins to slow, what will be the backbone of the economy. Up until now it has been manufacturing, but poor quality controls are already beginning to create a stigma, and a fix will likely price China out of the market. When that happens I wonder if some factory owners are going to be looking for someone to buy their shiny new homes.

Like I said, I’ve never been an optimist.

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