Why the China bears are wrong


Chinese investorHow long can a boom last? Surely the good times can't roll on forever? When does it turn to bust? These are common questions being asked of the current Chinese success story and, as the Middle Kingdom enters the Year of the Dragon, I thought I'd re-examine the arguments.

China seems to have been growing at breakneck speed for at least the past 20 years. Recently, it has been growing at 8-10% a year, faster than any other major nation in the world.

The bear's view

Almost as long as there has been a China boom, there have been China bears. Prominent among them is the lawyer and author Gordon G. Chang. In 2001, he wrote the book The Coming Collapse Of China.

He was itching to predict a crash, saying that, despite the success, all was not well in the People's Republic: "Peer beneath the surface, and there is a weak China, one that is in long-term decline and even on the verge of collapse. The symptoms of decay are to be seen everywhere."

In Chang's view, time was running out. He believed China had about five years to get its economy in order before it suffered a crippling financial collapse. Stuck between communism and capitalism, "China is drifting, unwilling to go forward as fast as it must and unable to turn back".

So Chang was predicting a collapse in China in 2006. But, of course, there was no bust in China in 2006. Instead, the year came and went, with the country's boom continuing to roll on.

If at first you don't succeed...

Undeterred, Chang revised his prediction. The great crash was not going to take place in 2006, but in 2011. He continued to maintain that China was on the brink of collapse and that the people were one step away from revolution. He argued that the nation was a "new dot-com bubble".

Well, 2011 has come and gone, and guess what -- China's boom is still rolling on. In 2012, China looks far from collapse. In a recent article in Foreign Policy magazine, Mr Chang was still undeterred: "I admit it: my prediction that the Communist Party would fall by 2011 was wrong. Still, I'm only off by a year."

By the law of averages, I guess Chicken Little will eventually be proved right, but you might have to wait a while.

A grain of truth

To be fair, I think there is a grain of truth in what Gordon Chang says. No boom can go on forever. Perhaps we have got so used to China growing by 8-10% a year that we have become rather blasé about it.

And we really are noticing some changes taking place in China. But what I see is a gradual slowdown, rather than a collapse or a crash.

A poll of economists predicted GDP growth of 8.4% in 2012, as opposed to 9.2% in 2011. The main reasons for this slowdown would be weakening export demand as Europe falls back into recession, and a faltering Chinese housing market.

The property bubble is bursting

We are already seeing some pretty major changes in the property market. Real-estate investment rose 28% in 2011, but just in the past few months it has started to decelerate rapidly. The pace at which the real-estate boom cools off will determine how fast China actually does grow in 2012. If real-estate investment growth halves this year, then GDP growth would be at 8%.

It could even fall faster than this, but a growth rate of 7-8% still seems pretty impressive. And the key thing is, the Chinese government still has monetary policy levers it can pull, unlike the US and Europe. If growth falls faster than anticipated, then interest rates can be cut.

By fine-tuning monetary policy, China can strike the balance between maintaining growth and deflating the property bubble. And as the real estate and export booms ease off, there is the prospect of a rapidly growing Chinese middle class eager for a spending spree.

An ideal time to buy?

China's shares have had a pretty awful time of it in the past year, but they now look enticingly cheap. The Hong Kong stock market is on a trailing price-to-earnings ratio of 10.1, while the number for the Chinese market is a mere 8.9.

If you're wondering whether to invest in the Middle Kingdom but have been put off by fears of a hard landing, don't listen to the Chicken Littles. In my view, this might just be the ideal time to buy into China.