"With China's economy continuing to slow, I wouldn't be surprised to see a major financial crisis there in the next three months."This morning Nobel Laureate Paul Krugman writes in The New York Times:
"Yet the signs are now unmistakable: China is in big trouble. We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be."While Krugman points the blame at China's lack of consumption (which is a factor that will keep it from easily righting any downturn), a contributing factor is the persistent and extraordinary growth China has experienced the last few decades. As a result of that growth many investments have seen persistent and extraordinary returns. This in turn spurs greater investment...which we've certainly seen in China.
The problem is that those returns have been so consistent and so extraordinary for so long, that many expect they will continue indefinitely. As a result, But history tells us that extraordinary investment returns do not continue indefinitely. Furthermore, not all investments generate the same returns. My concern is that, like we've seen in developed countries during boom periods, that investors believe that these extraordinary returns will continue leading to overconfidence and malinvestment. Eventually, malinvestment (poor investment choices) lead to lower, even negative, returns. If the investors are highly leveraged (which they are in China), then these declines in investment returns leads to a much more significant financial crisis.
It's certainly difficult to tell what is happening in China as the data is all suspect. But with China's government now reporting that their economy is slowing...a more dangerous economic crisis becomes even more plausible.s
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