China’s Bubble Economy Re-Appears

China responded to the late-2007 global financial crisis by pushing a $586 billion stimulus package, while The People’s Bank of China (China’s central bank) continued expanding the renminbi’s monetary base (both to provide liquidity to Chinese banks and investors, and to maintain the fixed exchange ratio with a depreciating U.S. Dollar).  With a second quarter 2009 gross domestic product (GDP) increase of 7.9-percent, many economists and political leaders are expecting China to soon lift itself out of recession.  Surely, the trend continues to suggest that China’s economy is at last recovering from the 2007 bubble collapse.  This remains true only if you solely look at national product figures, instead of taking note on the rapid rise in price inflation in certain commodities.  By taking a more objective look at China’s economic case, one would quickly come to the conclusion that all China has done is formulate another bubble, which will also inevitably collapse.  So, a return to the road of prosperity for China remains far off.  Instead, we are in for another economic shock.  This could prove a forewarning for what is to come in regards to the United States, which is also experiencing another bubble reformulation thanks to the massive monetary boom induced by the Federal Reserve System.

China’s new asset bubble, seemingly forming in such commodities like barley, also seems to offer new evidence to disprove the mainstream theory that vibrant capital markets (or flow of money) can cause instability in growing economies.  The Economist writes:

On November 25th China tightened the rules on foreign-currency transfers by individuals in a bid to control flows of hot money into the country. But signs of frothiness are also cropping up in odd places: garlic has become an unlikely target for Chinese speculators.

Perhaps it is time to take a look at what really drives instability. To be sure it is relevant to money and the monetary base.  But, is foreign capital really the source of instability?  Can a European investor invest in euros, or must he convert to renminbi before making the investment?  The only currency which drives the capital market in China is the renminbi, and the only means by which a foreign investor can make purchases in China is by trading in renminbi.  Therefore, it is nonsensical to blame economic instability on foreign currencies.  We can conclude that the only factor which drives a country’s money market is the monetary base of its currency, and therefore the decisions taken by the country’s central bank in expanding or contracting said monetary base.  This has become obvious in China, recently.  The Economist continues with:

“This sort of thing happens in China whenever you have too much bank lending,” says Jerry Lou of Morgan Stanley. “The liquidity spills everywhere. Garlic is just the area of the moment. We are at an asset-bubble-foaming stage.”

Jerry Lou is half-right.  But, the problem is not too much lending.  It is too much lending on fractional reserves.  Fractional reserve banking invariably leads to monetary expansion, which in turn drives asset bubbles as investors use all this new money to invest into lines of production.  Monetary expansion leads to commodity inflation, distorting relative prices and causing widespread malinvestment.  This is the nature of an economic asset bubble.  Fractional reserve banking is provided a lifeline through the central bank, which can provide liquidity to a bank’s assets by simply adding more money to its reserves.  While this reinforces a bank’s soundness, it does not allow them to correct lending mistakes and eventually causes the recurring boom and bust process.

So one thing should be clear: the sources of financial insecurity are not international capital markets, rather unsound monetary expansion by federally cartelized institutions.  As long as countries slow international trade and instead “solve” economic crises through bubble re-inflations, there will be no end in sight to our current financial woes.  Indeed, we will see brief moments of illusionary financial growth, and then the inevitable bust, and long-term currency debasement and the poverty which comes with it.