By MoneyMorning.com.au
The single biggest risk to Australia’s prosperity this year: a bursting Chinese bubble. Hedge fund manager Hugh Hendry, a genuine contrarian, made an important speech some time ago.
His idea is that the comparison between 19th century America and 21st century China is not a valid comparison. That comparison, in brief, is that a rising economic power is, at first, a source of global deflation thanks to its enormous production (commodities exports in 19th century America, manufacturing exports in 21st century China.) They accumulate large trade surpluses, build a middle class, a big military, and shift toward more consumption in the economy to drive growth.
Hugh’s main point is that America’s 19th century boom was governed by the discipline of the gold standard. In the absence of a credit boom, American entrepreneurs had to use capital wisely, assuming they could get it from investors, who had to invest prudently in order to preserve their capital and maximise the return.
The American boom, Hugh suggests, was driven by an investment boom where the return on capital was the main requirement for investment. If you didn’t invest wisely, you went bankrupt. In a competitive market place, this meant losing business models quickly failed and their investors were liquidated (not literally).
China’s boom has taken place in the confines of a fiat money model. Its currency is pegged to the US dollar. And the main requirement of Chinese investment, to the extent its official investment is dictated by the government through State Owned Enterprises, is full employment.
Hugh argues that with full employment as the main driver of Chinese investment decisions over the last decade, massive misallocations of capital are going to be made. In other words, you’re going to get huge infrastructure projects, bridges to nowhere, empty cities, and investment for the sake of employment. When you have several trillion dollars in new credit to play with, you can get a lot of boom for your buck.
Dan Denning
Editor, Australian Wealth Gameplan
From the Archives…
The Stock Market Financial Winter is Coming
2012-03-02 – Dan Denning
Why You’ll Want to Watch This ‘Bad’ Retail Stock Very Closely
2012-03-01 – Kris Sayce
Higher Oil Prices – Government Guaranteed
2012-02-29 – Dr. Alex Cowie
Asymmetric and Economic Warfare with Iran
2012-02-28 – Dan Denning
Why the Greek Debt Crisis Has Nothing to Do With the Euro
2012-02-27 – Nick Hubble
For editorial enquiries and feedback, email [email protected]
