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Larry Summers: China’s Financial Bubble
Aspire, Thought Leaders | 25 May 2015
By: Vance Wong
Articles (74) Profile

The China market is what many have been constantly talking about lately. Following robust growth over the past decade, the Middle Kingdom appears to be facing a significant economic downturn.

In a recent Bloomberg interview with former US Treasury Secretary, Lawrence “Larry” Summers expressed his concerns that China is facing “a very difficult set of challenges”.

However, as one might note, China’s stock market tells a very different story. More importantly, what does this mean for investors with positions in Chinese stocks listed in both China and overseas?

Chinese Stocks Not Good Indicator Of Economy

As can be seen from the graphs above, China’s GDP growth rate and the stock market are singing a different tune. The GDP growth rate and the Shanghai Stock Exchange Composite Index (SHCOMP) are clearly diverging, at a seemingly dangerous rate.

According to Larry Summers, China is currently facing the “exhaustion” from the rapid growth rate that came from the transition from rural areas to more “productive”, urban areas. This could be one of the main reasons why growth has slowed down so much.

Inevitably, there are optimistic investors that feel that this is the sign of China’s booming economy, but many fail to see that the GDP growth rate does not warrant that claim. Larry Summers definitely sees a problem that China will be facing, or is already facing: a financial bubble.

Larry also mentioned how banks are slowing down their loan issuances, creating a credit-induced slowdown in China. This is essentially one of the measures that the Chinese are taking to fight the bubble.

However, the real problem lies in the fact that China has to fight both a credit-induced slowdown and financial bubble concurrently. Furthermore, the solutions to a credit-induced slowdown would in turn worsen the financial bubble and vice versa, giving China a “very difficult set of challenges”.

Debt-fueled Growth Rarely Ends Gently

The former US Treasury Secretary expanded on his previous point about a financial bubble forming by saying that “debt-fueled growth” rarely ends well. It is clear when one looks at the cases of Japan, the US. This is why Summers is not too optimistic about China and by extension, even Europe.

So, should investors be worried about their Chinese holdings, in either the China or local market? It is hard to tell if a bubble is actually forming in China just through charts, but its GDP growth rate is sufficient to tell that China is facing some problems.

Investors should definitely start to be wary, just to be safe. We are no longer in the bull run where all shares promise good yields.

I think China has a very difficult set of challenges, they have proven themselves, highly competent, so often in the past that you can’t write off the prospect of success. But normal is mean reversion in growth rates. That would mean a very substantial slowdown for them. Normal is that it is very difficult to simultaneously fight financial bubbles and credit induced slowdowns. Because what you will do to reduce the credit-induced slowdown can exacerbate the bubble and vice versa.

You are seeing them moving towards the exhaustion of the easy growth that comes from their moving from rural areas to more productive urban areas. So I think they have a very serious set of challenges ahead of them and that what we had seen again and again, is that when debt-fueled growth ends, whether is it in the United States in 2007, whether is it in Japan 1989, or perhaps whether is it in China today. It rarely ends gently.

With a Communications background, Vance has the passion to write with a purpose - to provide content supported with substantial evidence to vested readers.

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