With the Fidelity man off to China in the not too distant future, we have some suggested reading for him.
It’s the latest Popular Delusions note from SocGen’s Dylan Crisis (née Grice).
Like Bolton he thinks there is plenty of long-term upside in China but he reckons China’s looming financial crisis will provide the next buying opportunity.
So what might trigger this financial crisis?
Grice explains:
That the tectonic plates of the geopolitical landscape are shifting in China’s direction is widely acknowledged. Less well known is the coincidence of asset bubbles with such shifts (see table below). Similarly, while it’s well known that bubbles are fuelled by rampant liquidity creation, less well known is that financial deregulation usually primes the pump. The recent credit bust was partly caused by the implementation of Basle risk weights. But the 1920s stock market boom, the 1980s Japan boom, and the tech boom of the 1990s can all be similarly traced to earlier financial deregulation.
China, of course, with one of the most heavily regulated financial systems on the planet, has not started down this path, notes Grice. But with the stated objective of having Shanghai as a world financial centre by 2020, Grice says the writing is now on the wall:
So with financial deregulation, when it comes, likely to stoke China’s already heady bid to become the next global superpower, shouldn’t we be filling our boots with all things Chinese now, in anticipation? Probably not. Two NBER economists recently found credit growth to be the best predictor of financial crisis: more rampant credit growth equals more elevated macro risk.
The paper Grice is referring to is called Credit Booms Gone Bust: Monetary Policy Leverage and Financial Crises, 1970-2008 by Moritz Schularick and Alan M. Taylor of the National Bureau of Economic Research.
Here’s their conclusion:
In terms of lessons for policymakers and researchers, history demonstrates that they ignore credit at their peril. The behaviour of credit aggregates contains valuable information about the likelihood of future financial crises. It is not, of course, a perfect predictor, and there may be fundamental reasons why, in some periods, especially in eras of financial development and innovation, credit expands to support real economic gains. At the same time, the long-run record shows that recurrent episodes of financial instability have more often than not been the result of credit booms gone wrong, most likely due to failures in the operation and/or regulation of the financial system.
For economists, adherence to the money view, not to mention the irrelevance view, has been seriously called into question by the crisis, and the evidence in this paper serves to amplify these doubts amid talk of a “paradigm shift.” For policymakers, a complacent attitude towards the growth in the scale and riskiness of the credit system now looks like a misguided choice that ignored history.
Which in turn leads Grice to his conclusion:
If they’re right [Schularick and Taylor], the following chart suggests such a crisis (or opportunity, as I prefer to think of it) is brewing in China right now …
As a closing thought, it is often said that China’s infrastructure overbuild isn’t something which should be of any concern because the money is being spent productively. But Messrs Schularick and Taylor caution against such a rosy view. They conclude that “crises are no less likely when they have been funding investment booms as opposed to other activity.
Related links:
Bargain Britain – FT Alphaville
‘Deep down, even the fiercest equity bulls must be doubting themselves – FT Alphaville
A Minskian roadmap to the next gold mania – FT Alphaville
Chinese liquidity – and stocks – go BOOM! – FT Alphaville