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rele ubli
Chapter 10
IDNT we learn this from the Soviet Union during the great battle between communist and
capitalist economies from the 1960s through the 1980s? The Berlin Wall finally fell in 1989
because the Soviet Union could not compete with the U.S. and other western countries that
thrived on a combination of free market capitalism and democracy.
Well, clueless economists are now increasingly touting the Chinese model of state-driven capitalism as
the new model for the future. But the Chinese, just like the Soviets before them, are not performing
many of the essential functions for which a state should be responsible. Theyre not representing the
people and making sure that gains from capitalism pass down appropriately to the populace; theyre
not setting rules for the game of capitalism; theyre not providing a legal system to enforce such rules,
regulations and fair play; theyre not regulating things that cant be taken into account by the free
markets, like pollution; theyre not providing common infrastructures that foster greater economies
of scale than individual enterprises could accomplish alone in fact, they are way overdoing that.
Theyre not doing a lot of important things, and they are doing some very harmful things long term.
But if we take an honest look at ourselves, we see that most of these things are not even happening as
much in the U.S. or Europe anymore. Central banks and governments have hijacked our economies in
the name of preventing a banking crisis.
Government is necessary and has been since the first agricultural revolution thousands of years ago
prompted us to start living in towns, cities and, ultimately, nations. Now the challenge is living in a
global world, so governments need to evolve accordingly. But such changes are not happening fast
enough to keep up with the rapid change, especially as that pace has increased since the boom of the
So yes, governments are killing the Golden Goose of free market capitalism that is the price
of QE, not the inflation the gold bugs have been predicting. Theyre doing this by taking over the
economy and manipulating interest rates, all with an eye toward preventing a short-term mess from
escalating into a long-term crisis. Its all about keeping the greatest debt and financial asset bubble in
history going as long as possible, so that the next guy is the one left holding the bag. Could they be any
more short-sighted and irresponsible?
Unfortunately, no government or collection of governments can prevent a massive bubble from
deflating. They may succeed in delaying it for a bit, as they have for the last five years. But I see this as
the limit.
Governments see no option to a painful banking crisis other than simply keeping the bubble
going forever. Do you know how insane and ridiculous this will appear when history looks back
at it? No one can keep a bubble going forever!
I believe were nearing the limit, as only one bull market in the last six decades has lasted longer than
five years. That was the 1990 to 2000 bubble, which was driven by the peak growth rates of the baby
boom spending wave; the acceleration of Internet, broadband, cell phone and wireless technologies;
and falling inflation and interest rates from such rising productivity.
But even with overexpansion and increasing debt, you can only stretch economies and such bubbles so
far until governments lose control and the bubble bursts again.
In 2008 to 2009, the trigger was the U.S. subprime crisis. This time around it is likely to start with
southern Europe or China. The news in late 2013 was all about a modest recovery in Europe. But that
was primarily in the U.K. and less so in Germany. That was partially because the U.K. went through
some minor austerity measures in its budgets. But France is still faltering, with growing consumer
sentiment against the euro. Thats not a good sign, because France is supposed to be benefitting from
the strongest demographic trends in Europe. So there is no excuse here except for low and falling
Portugal, which hovered near depression, is still struggling. The best-selling book of 2013 was Why We
Should Exit the Euro, not Fifty Shades of Grey.
Meanwhile, Greece has not improved much since its last bailout. Bad loans at banks in Greece keep
Spain still has unemployment rates above 25%, while unemployment rates in Greece remain close to
And the rest of the continent isnt much better. Overall, total government, private and entitlement debt
in the euro zone is about 25% higher than in the U.S., yet its population is aging faster. Only Japan is
in a worse position when it comes to debt and aging. Theres no way this ends well.
Southern Europe could easily be the trigger for the next global financial crisis, as one country
after another slide back into drepression. Still, the 800-pound gorilla in the room is China, the
second largest and fastest growing economy in the world. It is riding the greatest bubble of all,
and when it falls there will be no way for government stimulus programs to put Humpty Dumpty
back together again.
I have learned the hard way that once governments and financial institutions create a bubble to
enhance economic performance, there is no way they will back off. I used to think that bankers and
central bankers were more conservative and fiscally responsible and that they would only go so far, but
I have changed my mind. Back in 2008 I thought there would be a strong stimulus program followed
by a few years of bounce before the next great depression set in. I never would have imagined anything
like what we have seen. Stimulus was unprecedented.
Governments were simply saying: We will not let this debt and financial asset bubble deleverage. We
will not let the banks that made bad loans fail. We will not take the consequences for our past actions.
That was insane, irresponsible and unforgiveable!
Yet governments continue with their efforts, and they will until they simply run out of ammo. When they
do, the over-stretched debt and financial asset bubble will burst around the world, just like it did when
the sub-prime crisis triggered the previous global meltdown. Thats when the debt deleveraging process
will finally set in again as it did in late 2008. I think that will start to happen in the first half of 2015.
Germany and southern Europe are likely to be the first trigger. The Continent has lagged since Greece
first got its bailout three years ago, causing sovereign borrowing rates to spike. Although we are used
to weakness in this region, further weakening would be at least a minor shock or trigger. But if that
deterioration magnified the downward spiral in global trade and commodity prices that is already
creating a vicious cycle in China and emerging countries (described in Chapter 6), we could see China
start to collapse. That would be massive enough to overwhelm central banks ability to stem the natural
deleveraging and deflation process. Lets look at why China is so vulnerable, despite being the fastest
growing large country in the world.

The Greatest Bubble in Modern History: Chinas Urbanization

Strategy on Steroids
I want to start this conversation with a simple reality: even though Chinas stock market only
contracted from 12% growth to 6% growth during the 2008 global crash, that drop represented one of
the biggest plunges. The Shanghai Composite (shown in Figure 10-1 below) saw one of the most rapid
bubbles in history from 2005 2007 and then collapsed 70% in one year! This is a classic bubble
peak! Such a bubble peak is not likely to see new highs for decades. The first insight here is that Chinas
market took the biggest plunge because it had the greatest bubble! This is because bubbles tend to
return to where they started (or a bit lower), as the chart shows.

But here is what is more important. Chinas rebound after the crisis was the most feeble and shortest
lasting despite some of the worlds strongest growth rates. It limped into February of 2010 with the
smallest gains of any major country and then fell back to near its late 2008 lows. Meanwhile, the U.S.,
Germany, the U.K. and many other countries saw new highs.

How could Chinas stock market be so weak when it is the second largest and fastest growing
country in the world? The answer is its governments policy of overbuilding capacity in everything
in an effort to accelerate growth and urbanization (i.e., a B.S. economy). Overbuilding creates
excess capacity with high fixed costs and debt service. That kills profits and that is what the stock
market values most.
So, lets look at the economic realities in Chinas growth over the last few decades. First, it is not fueled
by consumer income and spending, as is the case in all other developed countries. Instead, it is largely
government-driven. Consumer, or personal, consumption as a percentage of GDP has declined from
near 70% in 1986 to 35% in 2009, as shown in Figure10-2.

Figure 10-3 shows changes in government, export and consumer spending. The huge swing represents
government investment shifting from 26% to 56%. Net exports decreased from 16% to 8% and
consumer spending dropped from 58% to 36%. There is no way you can call that healthy. The
government has simply taken over the economy and is dictating its growth.

Now it is natural for emerging countries to have more government involvement at first. It is like a
parent raising its children. Governments need to invest in the infrastructures that will allow increasing
urbanization. This is the greatest leverage to income growth, productivity and growing consumer
demand but the consumer demand comes last. So, targeting export industries that can help fuel
such urbanization and job growth is also critical to fueling such consumer growth in incomes and
demand. Hence, it is natural for emerging countries to support certain export industries as occurred
throughout East and Southeast Asia for many decades.

Thats why Chinas government investment and net exports have increasingly driven its growth in the
last decade or so. But why has consumer demand not risen yet, even on a lag, as it should? Its because
of the long tail of corruption in a top-down communist (I prefer the word mafia) government. But
before I get to that, lets look at Figure 10-4.

In this chart, you can see that Chinas government-driven investment boom has been more exaggerated
and has lasted much longer than the export-driven expansions in Japan, South Korea and Germany.
Figure 10-5 shows it even more clearly. Chinas investment boom has grown at about twice the
intensity and for twice as long as any past emerging country. And the last surge of such countries in
Southeast Asia and South Korea ended up in a major financial crisis and currency devaluation during
1997 and 1998 that continued off and on into late 2002.

I cant stress this enough any bubble or major expansion will see a peak at some point and then a
contraction to follow. That will stimulate new innovations and drive growth again, especially when the
next generation comes into its spending cycle.

Figure 10-5 best summarizes the extremes of Chinas government-driven expansion model versus
its neighboring countries. This chart does not show Chinas larger size, only its relative government
investment versus the overall economy and how long it has dominated. This is not good as almost any
government will over-expand to create jobs and please the people, especially an un-elected one.
The point here is that China, like most emerging countries throughout history, has overinvested
most dramatically. That forebodes a crisis ahead, as in Southeast Asia from late 1997 into late
2002. But Chinas overinvestment bubble is the greatest in modern history. Hence, it will be the
greatest burst when it occurs. And it will occur. All investment bubbles burst, especially when
debt and asset bubbles get so high they cant continue anymore. Its like adding grains of sand to a
mound until one grain finally causes an avalanche!
Before I go further we should review where China is on the demographic cycle with regard to
workforce growth. China is the only emerging country that will peak in workforce or demographic
spending growth for decades ahead. As shown in Figure 10-6, it will plateau at best around 2025. After
that, it will age faster than most developed countries, including the U.S., while its fellow emerging
countries continue growing. Latin America and Southeast Asia should peak around 2040, India and
South Asia between 2055 and 2065, the Middle East and North Africa around 2070, and Sub Saharan
Africa more like 2100. Why the big difference?
Its thanks to Chinas one-child policy that started informally during the mid-1960sand is just now
starting to impact peak spending. Chinas birth rate per 1,000 women dropped from around 6.0 in the
mid-1960s to about 1.8 well below the replacement rate in 2000 where it remains today. That
should have been predictable like all other demographic trends.

Why is China investing for a workforce that is plateauing and slowing ahead? The secret is
urbanization. That is the fastest way to grow GDP, because moving uneducated people from rural areas
to urban areas increases incomes and spending by two to three times. So heres the key point:
Rising urbanization tends to nearly triple incomes and spending as long as there are viable jobs.
But China is putting the cart before the horse moving people first.
A more free-market model would be to create growth in the economy and exports and then attract
rural people into urban areas to fulfill those new jobs. Chinas government-driven model is to build the
urban areas first, then move people in from rural areas and then hope to create jobs afterward as the
newly relocated people become growing consumers. In other words, these new consumers are supposed
to create the jobs for themselves by spending more. Would a venture capitalist invest in this model?
What if the jobs dont flow fast enough to keep pace with the influx of people? And lets not even talk
about the fact that most of these people have no skills to even get a job in the first place.
So which model would you invest in or believe in?

Figure 10-7 is repeated from chapter 6 and shows how rapidly China has ramped up its urbanization
model. As you can see, GDP per capita growth versus urbanization rates tends to progress in a
relatively straight-line in most emerging countries. Basically, this means most emerging countries never
get as rich as the developed ones. China is no exception.
But the key insight into this graph is that between 2000 and 2012, Chinas urbanization took a giant
leap from 38% to 53%. Thats over 200 million people in just 12 years. Can you imagine moving the
equivalent of two-thirds of the U.S. population from farms to cities in just over a decade?
And where are these people now Ill get to that later, but I think you can guess.
In the meantime, there is a bigger crisis ahead as the global economy continues to slow despite
desperate and continuous stimulus policies.

Chinas Unprecedented Real Estate Bubble

Do you think the real-estate bubbles in Japan, or the U.S., or Ireland or Spain were bad? They have
already burst or have at least started to. Or what about the ongoing bubbles in England, France,
Canada, Scandinavia, Australia and most of East Asia?
Well, look at China, my friend!
There has never been a bubble this large in any major country in modern history. Why? Because its
being driven by unprecedented overinvestment by the unaccountable Chinese government and very
high savings rates by the Chinese populace, especially the more affluent. They love real estate and shun
stocks and bonds.
Take growing urbanization, growing GDP, growing savings, growing real-estate investment and
you get a massive bubble, despite growing vacancies and overbuilding. Talk about a paradox!
Where would this happen outside of Dubai and China where governments drive the economy
from the top down?
When I spoke at conferences in Dubai in late 2006 and late 2007, local condo prices were going up
between 30% and 40% a year, compared to increases of between 15% and 20% back in Miami. At
that time, most of the building cranes in the world were in Dubai, so what does that tell you? I told the
people there: This is a bubble that is ready to burst. But they told me: Harry, you dont understand.
The government is supporting this bubble, and it wont let it burst. It will buy when consumers and
businesses dont. I replied: Now I am more worried.
As expected, that bubble started bursting in 2008, just as the tallest building in the world, the Burj
Khalif, was going up. I dont point this out as mere coincidence. In the last century of high-rise cities,
the tallest buildings in leading edge growth regions were completed right near the top of the greatest
30 40-year long-term real-estate and economic booms. And I dont think the bust in Dubai is over
yet, so look for further declines ahead, especially if oil declines as I expect in the next several years.
The Chrysler Building, Empire State Building and 40 Wall Street were completed right around the
1929 stock market peak. Similarly, the Sears Tower in Chicago and the Twin Towers in New York were
completed just before the 1970s crash and downturn. The Petronas Towers in Kuala Lumpur were
completed in 1997 just as that crisis set in, and we already talked about the Burj Khalif in Dubai.
So where are most of the building cranes in the world today? China.
Where are the tallest skyscrapers going up today? China. Not only that, China is now taking the stage
for building more of tallest buildings in the world at the fastest rate, as shown in the chart below. Do
you see how building mushrooms between late 2009 and 2015, mostly after the financial crisis of
2008? Are they nuts?

This is undoubtedly a skyscraper- building bubble... a symptom of the overbuilding in China at

all levels: residential, commercial, infrastructures and industrial capacity.
So, lets see how Chinas real-estate bubble compares to others. Figure 10-9 shows real-estate valuations
in price-to-income ratios for major cities around the world, including emerging and developed

Note that the top four major cities are all in China. Shenzhen is 35 times, Beijing is 32 times,
Guangzhou is 30 times and Shanghai is 28 times. That compares to other pricy emerging world cities
like Singapore at 26 times, or Bangkok at 20 times or Mumbai at 15 times. The highest price city in
the western world is London at 15 times, then Vancouver at near 11 times, then Sydney at nine times
(as high as 10 times in other indicators I watch), then San Francisco and L.A. above eight times. The
average price-to-income for housing in China, including less expensive rural and smaller cities, is 15.7
times, still more expensive on a relative basis than London.
Let me give you another concrete example of the real-estate bubble in China. Figure 10-10 looks at
cement consumption per capita in four countries with major real-estate bubbles. Spain was the most
extreme in Europe, and it went up to 1,600 metric tons at its peak in 2007. The U.S. hit its peak at
a mere 600 tons in 2005 before dropping off. Chinas consumption is still rising and even hit 2,000
metric tons. And this is for a country not nearly as rich as the U.S. and Spain. The extremes in Spain
and China reflect very high home ownership, high foreign investment and strong commercial and
residential expansion.

How can this continue? It will be driven by the top 1% to 10% of affluent buyers in these Chinese
cities and, to a larger extent, by foreign buyers. Foreign buyers are the kiss of death to a fragile
economy because they dont actually live in the local market and they pull out their money as soon as
the party is over. Surveys show that over half of the millionaires in China are considering emigrating to
protect their wealth. And for the top 1% to 10% in the rest of the worlds richest cities they are toast
as soon as this endless bubble peaks because they own most of the highest-valued businesses, stocks,
real estate and other assets.
Remember Ted Turner crying over how his dreams for changing the world were decimated when his
net worth went from $10 billion to $1 billion during the tech wreck? Well there will be a lot more
Ted Turners in the years ahead. The only difference is they will be the ones who spent $95 million for
condos in New York City, where as Ted Turner actually did some really cool things with his wealth.
Any way you look at it, real-estate prices in China are more overvalued than anywhere in the
world unless China just keeps growing forever at 10% and the government moves another 250
million from rural to urban areas in the next 12 years. The truth is, while were printing money,
Chinas printing condos!
And guess what? That is their plan. Theyre going to double down on this steroid policy, moving
another 250 million people from rural to urban areas between now and 2025. Thats crazy! At this
point, as much as 24% of condos and houses in major Chinese cities are vacant. And thats not even
the worst of it. There are a number of newly-constructed cities across China, some big enough to house
one million people, that are almost entirely empty.
In Changsha, they are building Sky City. Not only will it be the worlds tallest building (2,749 feet,
202 stories) when it is complete, it will also have been built in record time approximately 90 days!
It is a prefab approach to building skyscrapers and is designed to be a self-sufficient city within a
skyscraper, featuring everything from residences, to offices, to stores, to hotels, etc. Some call it a high
stack of trailers.
Meanwhile, the largest mall and building complex in the world, New Century Global Center in
Chengdu, is almost totally vacant. Under its roof, theres an amusement park and ocean beaches,
but now China is designating it as a tourist area because it cant attract any tenants. Talk about The
Disneyland of Overbuilding.
Finally, there is Tianducheng in Hangzhou. This government-constructed city was designed to look
like Paris with, of course, a 354-foot Eiffel Tower replica at its center. Hangzhou also has replicas of
Venice and other famous cities. Even though this concept city has been a total failure (it has been
abandoned), the communist government has already begun building a whole new city, Luangzhou, just
south of there.
All in all, China now boasts 470 skyscrapers taller than 498 feet, with another 332 under
construction and 516 more planned but not confirmed. China is taking the Field of Dreams
approach: if you build it, they will come.
Wouldnt it be nice if business people could just build what they want, scrape off short-term profits and
be insured that they wouldnt fail long-term because the government has their back? Come to think of
it, we have many large banks and companies here in the U.S. that are deemed too big to fail, and many
of them got big, fat government bailouts. So maybe were not that different after all.
The biggest problem is that Chinas demographic trends have peaked, so now it will be the first
emerging country to feel the effects of an aging populace and falling workforce trends.
The difference is that Chinas top-down communist government has no accountability and has been
pushing urbanization at the fastest and most intensive growth rates in history. The U.S. was an
emerging country in the 1800s and early 1900s, but even then we only grew at real GDP rates of 5%
to 6% compared to 8% to 12% in China during the last few decades.
In fact, there are many parallels between the rise of the U.S. from the early 1900s forward to China in
the last few decades. But there are also some stark differences.
In the early 1900s the U.S. was a rising emerging country, but more because of innovation and a
massive influx of immigrants. The U.S. dominated many radical inventions from electricity to phones
to phonographs to the Model T. Henry Fords assembly line was one of the greatest developments of
the last century and more than any other it catapulted the everyday person into the new middle class
during the decades to follow.
When Europes industries switched over to wartime production at the start of World War I, the U.S.
became the prime supplier of industrial and agricultural goods. That was the tipping point for the
U.S. We started running massive trade surpluses until the war ended and Europes agricultural and
industrial capacities came back on line. That caused an oversupply condition which led to a global
economic collapse and mini depression from 1920 into 1921. But most economists dont talk about it.
Fueled by the falling prices and interest rates of a debt bubble, as well as the emergence of powerful
new technologies (e.g., cars, electricity, phones and radios), the U.S. accelerated faster than ever during
the Roaring Twenties. This was the epitome of the fall season bubble boom in the last long-term
economic cycle, similar to the one we saw from 1983 to 2007.
But such fall season bubbles always end up having to endure a brutal winter season of deflation and
deleveraging the excesses of debt, overexpansion and cronyism. And that is a very good thing long
term, but its painful in the short term. We get addicted to the technologies, processes and lifestyles of
the past, and we dont want to give them up if we dont have to. The winter season, deflationary cycle
forces us to give up the past, as it becomes more bankrupt. That brings reality at all levels: consumer,
business and government. When something looks like garbage, you are finally willing to throw it away!
From the 1870s, when we surpassed Great Britain in innovation, the U.S. was the up-and-coming
emerging country. Our population was only about 50% urban in 1929 at the top of that great boom
and debt bubble. We had trade surpluses and budget surpluses. Just like Japan in 1989 and China
today, not quite as extreme though.
But as the fastest growth emerging country, we took the biggest fall when everything crashed after
1929. We see this consistently throughout history: the greater the bubble, the greater the burst. Who
has the greatest bubble today in GDP growth, stocks and real estate? It is clearly China.
China has been the largest and fastest growing emerging country since 1980. It is now the largest
manufacturer and exporter in the world, given its huge trade surpluses. It is also the second largest
economy in the world, albeit with 4.4 times the U.S. population. But its purchasing power (GDP per
capita) is only about 20% of the U.S. and its actual U.S. dollar GDP per capita is only $5,000, barely
10% of the U.S. Thats why its overall GDP is still roughly half of ours.
But two of the big problems in China are: 1) it has way more debt than the U.S. did at its 1929 bubble
peak and 2) its GDP per capita rate is not advancing enough to suggest it will become a developed
country as the U.S. did from the 1920s into the 1960s. And it still doesnt have a democratic
government or a free-market system to the degree necessary to achieve such developed-country status.
And most important, the U.S. had the strong tailwinds of heavy immigration and the baby boom
driving it for decades, whereas China has virtually no immigration and its birth rates have been falling
for 50 years.

The Unique Dynamics of the Chinese Real Estate Bubble:

Government Investment and Consumer Saving
The Chinese real-estate bubble has gotten so extreme that even the government is trying to cool it off
with very high down payments on second homes, a new capital gains tax of 20%, and so on. Rich
people are starting to flee as the smarter ones sense a bubble. So, how soon could this bubble burst and
by how much?
You have to first understand the workings of this communist/capitalist system. The central government
wants to grow rapidly, and it does that by funneling money to local communist governments and
standing behind their debt so they can borrow much more to fund infrastructure projects in its areas.
Those local governments naturally have a group of crony businesses and developers that they favor.
The Chinese government also holds down interest rates paid on bank and savings deposits to support
the banks and encourage lending and building. But this has caused a shadow banking system to grow
on the private side, much like the one that helped create the subprime lending crisis in the U.S. Wealth
management firms take money from investors and put it into funds that lend against real-estate and
infrastructure projects at higher yields than investors can get in banks. Figure 10-11 shows how this
shadow banking sector has accelerated.

Since 2007 traditional bank lending declined as a percent of GDP and has barely grown since 2012.
But since that time shadow bank lending has skyrocketed, advancing to 60% of GDP in just two years.
Total bank and shadow bank lending are at 180% of GDP and rising rapidly. This is extremely high
for an emerging country and higher than in most developed countries that have higher incomes and
better credit.
I estimate Chinas total debt at a minimum of 277% of GDP and rising. The breakdown is shown in
Chart 10-12.
That compares to Brazil at 152%, India at 130% and Russia at 78%. Emerging country households,
companies and financial institutions are not as credit worthy as developed countries, hence, any
total debt ratios above 150% should be considered dangerous. Chinas numbers are off the charts for
an emerging country and again shows how much more active Chinas government is in driving its
economic growth through overbuilding.

Figure 10-12: China, Total Debt as % of GDP by Sector

277% Total Combined
Percent of Selected Debt to National GDP

Debt to GDP! 103%


60% Government
40% Financial


Source: The debtors merry-go-round, The Economist, 9/29/2012

More important, what the recent rise in shadow banking debt means to me is that the government
is losing control. They can regulate down payments and such, but if the lending is coming from this
shadow banking system, the Chinese will continue to invest and speculate. The local governments
thrive on these endless building projects, as do their business cronies. And Chinese investors just love
real estate; they have only minimal investments in stocks and bonds.
Lets start with the overbuilding in housing. Figure 10-13 shows the number of housing units built in
China since 2000 versus the number of new household formations. China has been overbuilding for
more than a decade. Between 2005 and 2007 it basically built twice as many homes as it needed, or
about 2.2 million extra homes per year.

The China Household Finance Survey published in 2013 showed 19 million housing starts in China
versus average annual incremental demand of 5.8 million in the first half of 2012. Thats 3.3 times
overbuilding. It also showed that 53% of home purchases were for investment. In a country where
home ownership is nearly 90% (the highest level in the world), whos left to fill the massive void of
vacancies, particularly when most Chinese investors prefer not to rent their properties in order to keep
them pristine and attractive for sale or use down the road Theyre waiting for a big payoff that just isnt
Figure 10-14 shows the breakdown of Chinas world-leading home ownership level. Its 92.6% in rural
areas where housing is much cheaper and likely self-built, its 85.4% in more expensive urban areas and
89.7% overall. This compares to 65% and falling in the U.S. and 60% in Japan. How can this happen
in a country with the highest valuations-to-income in the world? The answer is that the Chinese save
massively and are willing to live in very small spaces. Home ownership is also an extremely important
part of Chinese culture. In most cases, a man in China has no chance of getting a date or getting
married if he does not own at least a condo or apartment.

Chinas savings rates are beyond anything we could believe here in the U.S. The average household
saves over 50% of its income. I know of few U.S. families that can save that much And Chinas rich
save even more: 69% of income for the top 5% and 66.5% for the top 10% as Figure 10-15 shows.
The top 10% control 74.9% of the total savings in China. So the Chinese clearly have no problem
making down payments. And given that banks pay nothing on deposits thanks to government policy,
and the Chinese shun financial assets like stocks and bonds, there is a massive amount of money
available for real-estate purchases and speculation!

But these statistics would also suggest that the affluent Chinese own the vast majority of such real
estate and Figure 10-16 bears that out. The top 10% own 84.6% of household assets which mostly
consist of personal real estate. They also own 88.7% of non-financial assets, which include investment
real estate and businesses. If Chinas real-estate bubble does burst which I see as inevitable then
it will be the top 10% that bears most of the losses. Their diligent savings will be wiped out. So what
happens when the group that controls 60% of personal income stops spending and speculating in real
estate? Look out below!

If the top 10% stop speculating in real estate, slow their spending and leave the country, China
will collapse like a house of cards! That economy will reverse like nothing you have ever seen. It
will not be a soft landing it will be like an elephant falling out of the sky!

China has already overbuilt to such an extent that it can keep moving people into cities for the
next decade. But what if the economy slows dramatically because the real-estate and government
overbuilding bubble collapses? Forget the rich people who will high tail it to Singapore, Vancouver, San
Francisco, Sydney or London. What happens to the hundreds of millions of low-skilled people now in

Although the affluent own 85% or so of this real-estate bubble, poorer households have the largest
debt burdens just from buying a little of this overvalued real estate. Figure 10-17 shows the total loan-
to-income ratio for the four different quartiles of the Chinese economy.

So if the economy collapses, the rich will lose massive amounts of wealth and assets, but the bottom
half will be destitute and often underwater in its finances. The bottom 25% of income earners has
loan-to-income ratios of 32.4 times. That is off the charts. The third quartile (25% to 50%) is at 13.5
times. The second quartile (50% to 75%) is at a more normal 3.6 times, and the top 25% is even
better at 3.2 times. Most of these people dont even own their own land. Some own in shoddy hi-rises
in the lower tier cities. Others are renters in the cities. At least the ones still living on farms can support
themselves at the most basic level but what about the unskilled in the cities?
How are those rural migrants going to compete? How are they going to afford a city apartment with
the highest price-to-income levels in the world? The answer is quite simple: they wont be able to
compete when the government-driven gravy train of endless export, building and construction jobs
slows in the face of a contracting global economy. They wont be able to afford those apartments, or
any services, or even food. Can it get any worse? Well, yes, it can. Look at this chart Figure 10-18
shows what I call the Achilles Heel of the China Miracle.

Today 712 million people 53% of the Chinese population live in cities. Of those people, only
69% are registered urban residents. That leaves 221 million, or 31% of the urban population, as
unregistered urban residents with no access to education, health care and any other social benefits.
They are basically illegal migrants, and just like the illegal immigrants here in the U.S., they will
only stay as long as opportunities exist and an economic boom tolerates them. But what happens when
the boom turns to bust? Just as many of our illegal immigrants are returning to Mexico as fast as, if
not faster than, new immigrants are entering, the Chinese illegal migrants are likely to pick up sticks
and head back to their family farms, if it still even exists after being paved over by crony developers.
China is careening headlong into a disaster of epic proportions and the world seems to be cheering
it on. The country has created an insane infrastructure bubble. It has the most overvalued real estate in
the world, driven by the highest savings rates in the world and the peoples love of property ownership.
It also has the highest vacancy rates in cities, at 24% and rising. What happens when tens or even
hundreds of millions flee back to rural areas where they are registered and can survive on the land?
When Chinas real estate bubble bursts and it will burst wealth will evaporate faster than rain on
the sun. Dont look to China as the model for capitalism. Instead, look to it as the prime example of
why top-down government planning and endless stimulus only kills the golden goose of free market
capitalism. Steer clear. The dragon is about to implode.
Again, China has moved from 38% to 53% urbanization in just 12 years. And the government just
keeps moving more rural people off their land and into the cities. That will be nearly 500 million
people in just 25 years. How could you possibly pull that off without something going wrong,
especially in the worst global economy since the 1930s?
And its not just housing but bridges, railways, roads, shopping centers, office buildings and industrial
capacity. Professor Larry Lang at the University of Hong Kong estimates that China has excess capacity
of 50% in electrolytic capacitors, 40% in cement, 40% in solar batteries, 35% in steel, 30% in flat
screens and 17% in copper. Aluminum overcapacity is considered to be the greatest, likely at 50% plus.
All this overbuilding generates debt, as well as pollution. China is by far the greatest polluter in
the world. Figure 10-19 shows the CO2 impact of the largest three economies.

China pollutes the most, then the U.S., and then Europe. Of the three, the latter has the smallest
carbon footprint in the developed world, in part thanks to its higher energy prices, which lead to
smaller cars, appliances, houses, you name it. Since 2000, China has accounted for two thirds of
CO2-emissions growth in the world. The U.S. and Europe are cutting their combined emissions by 60
million tons a year. China is increasing its emissions by 500 million tons a year.
Its just this simple: Chinas unprecedented growth and urbanization is costing its citizens their health
and the world environment dearly.

In January 2013 the air in Beijing hit a level of toxicity 40 times the level the World Health
Organization deems safe. China had to shut down Harbin, a city of 11 million, because air toxicity was
50 times acceptable levels. Many of the countrys industrial cities have a constant haze. In some places,
its so bad you can rarely see the sun. In Northern China, where the population is highest, air pollution
takes 5.5 years off the average life span, almost like smoking cigarettes.

Half of Chinas urban water supplies are unfit even to wash in, let alone drink. Rivers are turning
brown and yellow, with fish floating belly-up. Rivers are vanishing from excess water withdrawals.
Four-fifths of the water is in the south of the country and half the population and two-thirds of the
farmland in the north, so the government is spending massive amounts of money to divert water to
where its needed. Of course this engineering disrupts natural habitats on a large scale. More people are
starting to protest.

The governments response is to jail environmental activists and create a state monopoly over the
judgment of environmental lawsuits. However, the government cant simply ignore the environmental
threat any longer. The problem has reached catastrophic levels. So, the Chinese powers that be agreed
to spend $275 billion over five years to deal with air pollution alone. The country has led the world
in creating new solar and wind-power industries. But is that enough? The answer is clearly no! And of
course, in a corrupt, communistic system, local political leaders keep winning exceptions and lowered
targets for their business cronies. That will only increase in a slowing economy ahead.

Chinas strategy is like that of the West in the past: grow now, clean up later when youre wealthier. The
only problem with that is the world is much more polluted today and Chinas population is already
close to 1.4 billion people. Thats almost double that of North America and broader Europe combined!
All of this is to say: China looks to me to be the greatest economic disaster in the making.

As if thats not enough, China is also propping up third-world dictatorships in emerging countries,
especially in Africa, to supply their manufacturing engine with raw materials.

If there are going to be large geopolitical disasters in the world in the coming decades, there are
two places theyll most likely occur: The Middle East and China. The Middle East is more obvious
with civil wars and political clashes arising everywhere. But China is still a dictatorship, and I see
the potential for massive civil unrest due to the large underclass that has been created in the cities. I
have already shown that Chinas debt has grown much larger and much faster than other emerging
countries. That will create financial problems when the bubble bursts.

The next decade should see a major urban upset from over investment by a top-down communist
government, which should once and for all prove that free market democracies are better. Steer
clear of investments that rely on Chinese support and tread carefully in commodity-based
economies. The ride ahead is going to be hair-raising and dangerous.

More Cracks in the China Urbanization Model

The New York Times ran a series of articles on Chinas urbanization challenges in late 2013.
One article, New China Cities: Shoddy Homes, Broken Promises, focused on the plight of the
unskilled households that are being relocated to new urban centers. Ian Johnson, the author, called it:
the ghettoization of Chinas new towns.
Were talking hundreds of millions who are moving into these places, he wrote. But the standard of
living for these relocatees has actually dropped. On top of that is the quality of the buildings there
was a lot corruption, and they skimped on materials.
Imagine that, a government program that has corruption who would have thought?
Whats the motivation of the central and local (mafia) government behind this urbanization effort?
They sell the farm land to developers and that finances the buildings for new urban residents. Then as
people get better jobs (this is the part they still havent figured out yet), they get tax revenue and new
businesses for their crony business friends.
But outside the new towns, its mostly empty farmland lying fallow as proposed developments remain
in limbo. Many rural households dont want to move and uproot a way of living they have maintained
for centuries. But local governments need this to feed a growth model that is dictated and rewarded by
the communist central command. They will stoop to cutting off roads, water and electricity to force
residents out. Thats what I mean by mafia.
Now I dont want to create a one-sided story here. The rapid urbanization of China has taken many
people out of poverty and raised the average standard of living from $2,000 per capita decades ago to
$9,000 per capita adjusted for purchasing power. Many people in Chinas cities have incomes between
$5,000 and $20,000.
My concern is that China is pushing this urbanization model at such a rapid rate that it will inevitably
backfire. They are creating a massive underclass (221 million and rising rapidly), while fostering a
completely unaccountable upper class of party politicians and crony businessmen.
Again, Chinas stock market tells the real story: A 70% crash in 2008 followed by a brief and feeble
rebound into February 2010 and then a steady decline ever since. This is a B.S. economy, period!
Overexpansion only leads to lower profits.
This is a disaster waiting to happen. China is putting the cart before the horse. It is forcing people into
urban areas and hoping they will earn and spend more, rather than letting consumer demand grow
from natural urbanization and market forces.
That is the ultimate urban disaster scenario: Not only does Chinas aggressive urbanization slow
down or stop and the real-estate bubble starts to burst, but many of the 221 million unregistered
urban citizens start moving back to the rural areas, and fighting to reclaim land where they can
at least provide for themselves.
The simple question here is: Do you trust the Chinese communist government to maintain this
urbanization Ponzi scheme indefinitely?
If you dont, then youd better protect your assets sooner rather than later as this crisis will dwarf the
subprime crisis that triggered the last global crash.

How Far Could Real Estate Fall in China?
The central two principles I covered in Chapter 5 are: 1) bubbles always burst and 2) they tend to go
back to where they started or even a bit lower. Figure 10-20 should not be that much of a shock after
the extreme valuations I presented earlier and the extreme growth and investment in China. Shanghai
real-estate prices have gone up about 563% or 6.63 times since early 2000. Thats just 14 years!

Japan has already seen a 60% fall in real-estate prices and Dubai has crashed 40%, but neither of these
countries bubbled as big as China. So what would it take for the Chinese bubble to return to early
2000 prices? The answer: a drop of 85%!
China does have one thing in its favor. Chinese buyers typically put down at least 50% to purchase
a home. So many analysts argue that China can take a pretty big downturn without running into
massive defaults and that is true. Figure 10-21 shows how far real estate prices would have to fall
to create rising levels of underwater mortgages. A 40% drop in prices would only put 10% of homes
underwater. A 60% drop would put 20% underwater (more like the U.S. subprime crisis). That would
cause serious banking and economic problems. Its at 80% that things get really serious, with 43%
underwater. And I think we will see an 80% to 85% fall in the next six years or so.

But that is missing the more important point. If real estate crashes even just 20%, that will mean a
serious slowdown in building and the economy. Not to mention a serious loss in wealth, especially for
those 10% that comprise 60% of income and at least 50% of consumer spending. And then you get
a negative feedback loop with a weakening economy causing further real-estate declines, more failing
businesses and increasing loan defaults.
To summarize: China has created an unprecedented bubble in the last 15 years. It requires constant
overinvestment by the government in infrastructures across the board, high growth in exports and high
investment in real estate by consumers. A slowing in the global economy is already causing Chinas
exports to slow. The government is making up for that by increasing the overbuilding and allowing
debt to approach very dangerous levels for an emerging country. The wealthy are looking increasingly
to move out of China to protect their wealth, health and family. In such a delicate situation, the failure
of a major developer or company could easily trigger a crisis.
Outside China, we are already seeing a vicious cycle of falling commodity prices and slowing growth
in the emerging countries that are Chinas largest market. But as I mentioned at the beginning of
this chapter, southern Europe is just as likely to see another financial crisis, as its unemployment and
youth unemployment rates are at scary levels and bad bank loans in southern Europe continue to
be a problem and economic improvements in northern Europe slip away. I think that the real-estate
recovery in the U.S. is at risk to rising interest rates and excessive speculation again. The Middle East
continues to go from one political crisis to the next. And what if oil prices start collapsing in the years
ahead as I expect?
Chinas number is up. There are many potential triggers for the next global financial crisis given
that debt levels in most countries are now even higher than before the last crisis. All it took was
a subprime crisis concentrated in four U.S. states to trigger that crisis. I think the next crisis
will start in early to mid-2015. If it does, China is the last place you want to be as a citizen, an
investor or a business!
And which countries have the highest export exposure to China: South Korea at 50%, Chile 39%,
Germany 41%, the EU 36%, Canada 29%, Indonesia 25%, Australia 20%, Japan 12% and the U.S.
11%. South Korea is particularly vulnerable with as much as 12% of its GDP directly exposed to
China. So a 50% drop in such exports would cause a 6% drop in GDP. Thats a deep recession right
there. Chile is next at 8.7% direct GDP exposure, then Australia at 4.3%. The U.S. is only 0.8%.
Lucky us!
But the larger implications are that China is now the second largest economy in the world and the
fastest growing. The reverberations of a major bubble burst in China are vast. Like I said, it will be like
an elephant falling out of the sky if its massive real-estate and overbuilding bubble collapse.
We also have to recognize that China is a lot like the U.S. in the early 1900s. The U.S. was the up-
and-coming emerging country. We covered Europes production needs for World War I. We ran trade
and budget surpluses and helped facilitate world trade. China is doing this to an even greater extent in
recent decades, with massive foreign exchange reserves and bond holdings. When the Great Depression
hit in 1930, the U.S. fell the hardest because it boomed the biggest. I see that for China between 2015
and 2019. Dont say I didnt warn you!

Publisher.............................. Shannon Sands
Editors.................................. Harry Dent and Rodney Johnson
Portfolio Manager................ Adam ODell

Dent Research
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