China's Problems Intensify

The great economic miracle called China is slowly coming unwound.  Beset by a host of converging economic and financial problems, Beijing is about to face the ultimate test.

Front and center is the housing bubble and an economy that is rapidly overheating.

The problems in China’s housing market are thought to be more severe than those in the U.S. before the financial crisis.  They combine the potential housing bubble with the risk of social discontent, according to an adviser to the Chinese central bank.  In the last 12 months, property prices have appreciated by 11.7%.

China initiated limitations on property speculation recently as economic growth accelerated to 11.9%  in the first quarter from the same period last year.  The State Council said anyone buying a second home would be required to put up a 50% deposit, up from 40%, while the mortgage rate for second homes was also raised. The downpayment for first homes bigger than 90 square meters was increased to a minimum of 30%.

The economy expanded at its fastest rate in nearly 3 years and more quickly than economists had expected, putting new pressure on the financial authorities to consider tougher tightening measures, including an appreciation of the exchange rate and interest rates.

Despite rising fears of overheating, consumer price's dipped to an annualized 2.4% in April from 2.7% in February, according to recently published data.  Inflation at the factory level continued to accelerate, increasing half a percentage point to 5.9%.

Asia’s soaring factory output appeared to have slowed this morning as production data from China, Taiwan, South Korea and Australia showed a decrease in the pace of growth in output in May.

The official Purchasing Managers’ Index (PMI), compiled by the China Federation of Logistics and Purchasing, fell to 53.9 in May from 55.7 in April.  Concurrently, the unofficial but closely watched HSBC China Manufacturing PMI fell to 52.7 from 55.2.  An index reading above 50 indicates an increase in output.

Beijing has been the main driver of commodity prices in the past year, but the markets have been hit in recent weeks by concerns that measures to cool growth will temper the country’s appetite for raw materials.  As a result, oil prices have stalled.

Add to that China's exposure to the dismantling of the Euro-Zone and belligerent neighbor North Korea to the south and the ingredients are in place for an early termination of the China miracle.  As a result, investors need to be careful about taking on too much exposure to Chinese interests.

Marko's Take

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