Is China Heading for a Bubble Bursting Downturn?

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By Chris Devonshire-Ellis

Oct. 22 – One of the curious things about living and being involved in a country is often expressed in the silver birch alluding expression “can’t see the wood for the trees.” Having spent the best part of twenty years in China, it can be difficult to shake off preconceptions about a country first experienced as it began to open up. Since those days, China has without doubt been an express train of delivery, transforming itself into a global powerhouse and apparently steaming ahead with all whistles blowing. It can be difficult, when used to such a situation to imagine it could be any different.

Moving away from a country however, as I have to India, provides however a different perspective. Gone for me now are the uniquely Chinese characteristics that marked every day, gone too are the diehard Sinophiles, with an opinion on everything. The air, the language, the people are all different. In washing away 20 years worth of painted canvas of experience, one finds it doesn’t just vanish, but that you look at that painting in a rather subtler way, as if the light has changed. It just looks different from afar.

Consequently, I’ve noticed small differences in the China that I knew and the China that I now see. I have the space to do so. I have mentioned my misgivings about a strong continuation of China’s “inevitable” growth in previous articles – see my most recent missive “The China BRIC: Questions Ahead for Global Manufacturing’s Bride.”

In it, I make the case that actually, China has been rather caught out by the global retrenchment of capital, and that the almost instant withdrawal of US buying power and investment that had previously gone hand in hand with its economy is causing an almighty shift in the way China now has to balance its economic and fiscal modeling. While the headlines have looked attractive this year – much ballyhoo was made of China reaching GDP growth of 8.9 per cent while the rest of the world remained in recessionary doldrums, I have had my doubts, not least because a US$1 trillion injection of cash into your economy is bound to have a stimulating effect. But for stimulating, read manipulative, and I suspect that if the Chinese had not injected those funds, the actual GDP would be wallowing at about 3-4 percent growth.

Now that’s not bad compared to recessionary figures that have been coming out of the United States and Europe, however a growth rate of less than 8 per cent is generally considered to be bad news for China. The country still has a lot to do to open up its central and western regions to education, infrastructure and opportunity, and China’s hands are tied somewhat – in a one party state, you’d better keep the population masses happy or trouble can be on the horizon. I actually surmise that instead of a return to spectacular growth, it is a more likely scenario that to shift China’s economic model to one better balanced towards domestic consumption and less on exports will take three-five years. An economy the size of China’s simply doesn’t have the ability to change overnight, and China’s politicians and financiers need time to recalibrate their business model.

Accordingly, it’s been interesting to note that my theory appears to have some merit. In a piece entitled “A bubble in Beijing?”, The Economist have been reaching a similar conclusion, although having taken a slightly different road to get there. In quoting the doom merchants, The Economist’s describes their premise is simple: “To support demand, China’s government has created huge quantities of credit. That lending is leading to unsustainable asset-price inflation, while wasteful investment is producing oodles of excess capacity. As a result, China’s stimulus will inevitably be followed by a bust down the road.”

Now I’m not quite as aggressive as that in my comments, however the Economist itself then takes up the lead. “Few things matter more for the global economy than whether this argument is right,” the magazine writes. “With America and other economies in the English-speaking world weakened by their own asset busts, the pace of global growth over the next couple of years will depend heavily on China. A painful asset slump or banking collapse there would further slow the pace of global growth. No one doubts that credit has been growing dramatically in the Middle Kingdom. Lending grew by 34 percent in the year to August, around four times faster than nominal GDP.”

This has undoubtedly occurred. I disagree with The Economist on where that credit has been going – massive amounts earmarked for infrastructure have found their way into the stock market and the development of unnecessary housing schemes and property speculation. Just as China has been lending money, so it too has been disappearing – it’s the principal reason that mainland travel to China’s own gambling haven of Macau has been severely curtailed over the past few weeks. China’s supply of money to deal with its economic problems has been filtering out like sand through open fingers – the State alone contends that about 20 per cent of that US$1 Trillion stimulus scheme has gone AWOL. The problem with that is that it highlights a massive problem – the State aren’t fully in control of the money they are spending to direct the economy from its previous over reliance on export manufacturing to boosting domestic consumption. China is in a very real danger of spending on unnecessary projects, theft or sheer wastefulness the very money they should be using to boost consumption. It’s being consumed alright, but in a manner akin to setting it on fire rather than using it for sustainable development.

Finally the Economist, as it always does, comes up with a political argument, and almost inevitably, it’s about the RMB / Dollar position. Now I got into a lot of trouble with a Government Minister earlier this year concerning quotes on this subject, which does at least indicate the extreme Chinese sensitivity of the matter. The Economist concludes that just as the rebalancing of China’s economy calls for a stronger RMB, the ability to avert a bubble requires more flexibility within the currency itself. “The transition will not be easy,” they write. “The specter of a stronger RMB will, temporarily at least, worsen China’s asset-price bubbliness, as foreign capital floods into the country in anticipation of a stronger currency. But this argues for acting quickly and carefully, rather than doing nothing. The longer China shadows the dollar, the bigger the distortions and the risks from any currency adjustment. Without an independent monetary policy China will eventually become a bubble economy. To avoid that fate, Beijing must let go of the RMB.”

Either way, depending on whose position you take, the immediate outlook for 2010 for China doesn’t look as promising as I had hoped a couple of months ago. I’m skeptical of the actual growth rate in the economy, and I think it will take some time for the Chinese to rebalance their fiscal plans. If the Economist is right – and they are in the business of being so – then we need to see an appreciation of the RMB to bail us out of a depressing year in China for 2010, and perhaps beyond.

The unlikely scenario of an ever expanding China was one of the reasons, ultimately, that I hedged my own business against China by moving to establish operations in India three years ago, where export dependency is just half of China’s exposure. The local economy is booming, and the markets are rising as institutional investors pour in money to participate in the country’s infrastructure bonanza. I don’t want to see a downturn in China – my firm has nine offices there and close to two hundred staff depending on it for their jobs. But my business plans as I come to write them in the next six weeks for China will not have as much optimism as I would ideally hope for, and preparation by affected corporate executives is going to be key in dealing with what may be a looming problem on the horizon.

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates and lived in China for 21 years. He is now based in Mumbai and heads up the firm’s India practice. He can be contacted at

4 thoughts on “Is China Heading for a Bubble Bursting Downturn?

    Sunil Dua says:

    It does seem there’s growing disquiet about China’s immediate future this is correct. I also agree with you over analysts. It is hard to get a balance between “wood for the trees” and “armchair commentors”. Congratulations on these sites also they are very good. A real find.

    Patrick Dunn says:


    Thank you for a most interesting and pointed analysis of the current situation in China. It was both insightful and timely, and to those who do not heed the looming bursting bubble, well good luck.

    I have followed most of your articles since coming to Shanghai seven years ago and have found them to be very informative and of high value in understanding the complexities of this very interesting economy. What struck me most about your most recent analysis is that I have been telling anyone who would listen the same things, that the storm clouds have been gathering, and please pay attention. It is as if I wrote your words myself. I cannot agree more. As I have watched this bubble begin to reach its critical tension, I keep my ticket under my pillow and a weary eye on the exit. Needless to say, 2010 shall be a most interesting year, World Expo

    Thank you,
    Patrick Dunn,

    Chris Devonshire-Ellis says:

    Thank you Gentlemen, Now it seems the New York Times and now the Financial Times are now also taking the same position. The New York Times piece is entitled “The Chinese Disconnect” by Paul Krugman in which he takes essentially the very same view. His take, essentially, can be boiled down as follows as regards the position of the RMB: “In fact, the system served China well during the Asian financial crisis of the late 1990s. The crucial question, however, is whether the target value of the yuan is reasonable. Until around 2001, you could argue that it was: China’s overall trade position wasn’t too far out of balance.”

    Exactly the position both myself, the Economist are taking. China is now out of fiscal balance and something needs to be done about it if there isn’t going to be an almighty problem next year. There isn’t much time in my view if we are to avoid a very poor 2010. Krugman’s piece is here:

    The Financial Times are also reporting on the issue today. “Top China Banker Urges Shift In Policy” tells of Qin Xiao’s concerns. He’s head of the China Merchants Bank, and is saying the government “Should not be afraid of a moderate slowdown in the economy”. Their story is here:

    Seems people are listening after all, or at least coming to the same conclusion. My original concerns, dated the end of last month, are here:

    Thanks for your comments – Chris

    Chris Devonshire-Ellis says:

    Also from Invesco, quoted in Forbes: “China As An Export Power Is Yesterdays Story”:

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