While I was out for a walk recently, I met two Asiatic ladies also taking in the fresh air - one was from Singapore and one from Malaysia. We soon found ourselves talking about the air pollution that is drifting from forest fires in Indonesia and is creating a choking haze in Singapore. They mentioned the terrible air pollution in Beijing and the fact that 6000 dead pigs had been found floating down the Huang Po, the river that flows through Shanghai. One of the ladies then told me the following joke: "Two Chinese, one from Beijing and one from Shanghai, are discussing the relative merits of their glorious cities. The Beijing resident, boasting, said "We are so lucky in Beijing; we can open the window and get free cigarette smoke!" The resident from Shanghai just snorts and says, "That's nothing. In Shanghai we turn on the taps and out comes pork soup."
It is interesting to note that the Chinese government has now decreed that some environmental crimes, including bad cases of air pollution, are now punishable by death:1 "The environmental watchdog will strengthen monitoring measures, especially on enterprises that previously used toxic substances and discharged dangerous waste, or are located in environmentally-sensitive areas where major environmental pollution accidents have happened over the past one or two years." However as the lady from Singapore mentioned, "Nearly everything in China is punishable by death." Which was interesting, since Singapore has a higher per capita death penalty rate than China.2
However, worrying about China's terrible air pollution - and whether the gypsum plant manager with a faulty filter bag or a leaky wet end is likely to go off to the gallows or firing squad - might just be the equivalent of playing the fiddle (violin) while Rome burns (as the emperor Nero was said to have done). No, China faces something far more serious: Total financial meltdown.
All bubbles must pop
As regular readers will know, I have been sceptical about China's meteoric development path for a number of years. The construction industry in the coastal cities has been a bubble waiting to burst for a decade, with wild speculation on property driving demand while inflating prices well beyond any global measure of affordability. "China's current home prices have far exceeded a sustainable level that the country's economic fundamentals can support," according to Jianguang Shen, chief China economist with Mizuho Securities Asia in Hong Kong.3 Housing in China, especially in the big cities, can cost 15-16 times a worker's salary, compared to perhaps 3-5 times in the US and Europe.4 Indeed, the Chinese government has taken steps to rein-in house price growth, restricting multiple-unit-purchases and requiring higher deposits and this has had the effect of making housing slightly more affordable. However, when one takes a step back, China starts to look a lot like Spain looked in the months before the Financial Crisis of 2007-8.
For example, the financial sector has made huge loans to the over-heated construction sector, many of which loans may well not be paid back in full. The Chinese government has also started to withdraw some of its monetary support measures introduced in order to boost demand and growth during the Financial Crisis - the 'punch at the party' described by the US Federal Reserve's Ben Bernanke. This has had the immediate effect of causing banks to restrict their business with each other, leading to a spike in the Chinese equivalent of the Libor inter-bank lending rate. You may recall that this also happened directly before the Crash. When lenders refuse to lend, and banks have on their books assets that cannot be priced (since no-one knows how good or bad they are and therefore how much they are worth), then you have some of the ingredients for an almighty crash.5 Add in China's 'shadow' banking sector of trillions of yuan of unregulated loans, and the eye-watering off-balance sheet liabilities of local government6 and you start to see the outline of an iceberg of chaos that would make Spain's difficulties look like an ice-cube in a glass of sangria.
Cast yourself back to the spring of 2007: Only a few far-sighted prophets were suggesting that the music was about to stop at the global party (I wasn't one of them). Imagine if China, the world's second largest economy, suddenly experiences the equivalent of the punch being removed from a swinging party: Everyone will have to sober-up and go home. Or go and find another party.
3 http://www.cnbc.com/id/100768371
