The Chinese Economy: Hart-break as bubble looks set to burst

29th November 2010

Talk of a potential bubble in China is not new. For most of this year, there have been fears that the great Chinese success story on which the world economy is depending for future growth may start to implode.

But now the fears have been lent a new legitimacy by veteran hedge fund manager Mark Hart, who has launched a fund betting on the decline of the ‘enormous credit bubble' in China.

Hart has credibility because he successfully bet against the sub-prime market in 2006. He believes market participants are showing similar complacency over the growth of China as they did over the sub-prime crisis.  He believes China's debt levels are much higher than current government estimates suggest and the whole country represents a ‘giant tail-risk' for the global economy.

Hedge fund managers are by their nature speculators and have to look for contrarian positions in the market, but Hart's views have plenty of support.

bedfordfalls comments in this Telegraph piece: "Couldn't agree more with Mark Hart. The Chinese economy has been jerry-built in the mad rush for growth. It is totally dependent on ever-increasing demand from Western economies for the output of its factories. When this fails to materialise – as it clearly must – the bubble will burst and a terrifying reverse multiplier effect will kick in, bringing the house of cards crashing down."

There are also sound economic reasons why China is vulnerable to a bubble. Its currency is pegged to the US dollar and it therefore effectively ‘imports' US monetary policy. The US is trying to create growth through loose monetary policy at the same time as China is trying to contain it. In this scenario, inflation in China is always a risk. These two pieces discuss potential inflation in China: Chinese inflation and China’s twilight economy boosts inflation .

However, there is a flip-side to the ‘China bubble' argument – not least that bubbles rarely occur when they are so widely discussed. The Chinese government is well-aware of the problem. It is has criticised the US for pumping additional money into the system via quantitative easing, knowing that much of it may find its way into the Chinese system. It has raised the Required Reserve Ratio (RRR) by 50 basis points to 18%. This effectively holds back cash from entering the economy and has been seen by many as a precursor to a rise in interest rates.

Equally, fears over a bubble in China have been well-reflected in markets. The Shanghai Composite index is down by approximately 13% this year.  In contrast, the FTSE 100 is up over 4%. Charlie Awdry, manager of the Gartmore China Opportunities fund says that since July he has found more and more opportunities in the Shanghai market, which now looks under-valued relative to its history.

Awdry believes that while there may be pockets of inflation in certain parts of the economy, particularly in property, it is by no means a universal phenomenon and investors can be selective.  This sentiment is echoed by many of the commentators in this Telegraph piece. The view seems to be that China was always likely to be a volatile ride, investors need to be careful, but the long-term drivers are still in place: 

China is not a new technology bubble, but it is not a one-way bet either. Anyone invested in a single country should expect significant volatility. Inflation is a problem, but the Chinese government has some firepower left to control it. Mark Hart may have a good track record, but investors should be wary of following him slavishly.

SEE ALSO: Investors split between China & India

SEE ALSO: Bubble or no bubble, China needs to adress it's currency before inflation takes root

But what do you think? Is Hart right in betting on a chinese bubble or is it just a load of hot air? 

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