Will China Save the World Economy?

The S&P500 inched up 0.9% last week on very low volume.  The low volume is not very bullish because in each of the prior four weeks when the index fell, volume was strong.   It appears that more and more equity holders are looking for the exists, rushing out the door when prices start to slide.

There was very little macro data, but most of what was announced was weak.  U.S. trade figures were worse than expected; this means that the preliminary Q409 figure will almost surely be revised lower.  Retail sales came in as expected.  Initial claims were better than forecast, but the improvement probably had something to do with the massive snowstorms that crippled much of the eastern U.S. from Atlanta to New York City.  Business inventories were lower than consensus estimates, and consumer sentiment fell when it was expected to rise.

Technically, the S&P is still very overbought on the weekly charts.  The downtrend that began in January is fully in place.  On the daily charts, the short-term rally last week was not unexpected.  In fact, it was weaker than many bears had anticipated.  So another push higher would not be surprising before the weekly downtrend reasserts itself.

China has been touted as the savior of the global economy.  It’s amazingly consistent and impressively strong 9%-10% annual growth rates have been the envy of the world. 

Naturally, as the fiscal and monetary stimulus programs of the developed economies starts to fade away, many analysts have begun to look to China to provide a lift to everyone else.  And so far, it has been working.  China’s purchases of raw materials from suppliers such as Australia, Canada and Brazil has impressively boosted these respective economies. 

And now, the hope is that this engine of growth will spill over into other parts of the western world and work its magic.

But can China help the rest of the world?  More critically, is China itself at risk of a slowdown?

The evidence is not encouraging.  When the western world imploded (financially and economically), demand for Chinese manufactured goods plunged.  The Chinese government stepped into the void with a huge fiscal stimulus.  Much of this was invested in infrastructure and real estate.

But the problem is that this extra building is resulting in overcapacity.  Final demand has not returned from the West, and domestic consumer demand has not risen enough to replace the lost external demand.

Real estate prices are skyrocketing and industrial capacity is booming–all financed by government sponsored lending through the banking system.

If this sounds familiar, it’s because it is.  China is in the late stages of a bubble economy where the bubble was induced by government stimulus programs.  In the U.S. the bubble was induced by excessive consumer borrowing, enabled by excessive bank financing and Wall Street securitization. 

The U.S. bubble ended in disaster.  The Chinese bubble will end in disaster.

And when it does, not only will China not be able to lift the fortunes of the global economy, but China will more likely create a huge drag on the rest of the world. 

In fact, the impending Chinese implosion could be so severe, that it could blow another hole in the U.S. economy, a hole from which we may not recover so quickly again.

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