Big Trouble In Big China

China is barrelling toward a massive financial crisis
Global investors are bracing for the end of China's relentless economic growth, with 45% saying they expect a financial crisis there within five years. An additional 40% anticipate a Chinese crisis after 2016, according to a quarterly poll of 1,000 Bloomberg customers who are investors, traders or analysts. Only 7% are confident China will indefinitely escape turmoil. "There is no doubt that China is in the midst of a speculative credit-driven bubble that cannot be sustained," says Stanislav Panis, a currency strategist at TRIM Broker in Bratislava, Slovakia, and a participant in the Bloomberg Global Poll, which was conducted Jan. 21-24. Panis likens the expected fallout to the aftermath of the U.S. subprime-mortgage meltdown. On Jan. 20, China's National Bureau of Statistics reported that the economy grew 10.3% in 2010, the fastest pace in three years and up from 9.2% a year earlier. Gross domestic product rose to 39.8 trillion yuan ($6 trillion). Any Chinese financial emergency would reverberate around the world. The total value of the country's exports and imports last year was $3 trillion, with about 13% of that trade between China and the U.S. As of November, China also held $896 billion in U.S. Treasuries.

The trade and investment links between the two nations were underlined with Chinese President Hu Jintao's visit last week to the White House for meetings with President Barack Obama. Worried Neighbors Investors' concern contrasts with Chinese government statements on the outlook for the economy, which is poised to overtake Japan as the world's second biggest. The Politburo said last month that the nation had a "sound base" for stable and fast growth in 2011 after consolidating its recovery. In an interview in Davos yesterday, Li Daokui, an academic adviser to the central bank, said he doesn't expect any "hard landing" and the economy may expand about 9.5% this year. Fifty-three% of poll respondents say they believe China is a bubble, while 42% disagree. China's neighbors are the most concerned: 60% of Asia-based respondents identified a bubble in the world's second-largest economy.

Worries center on the danger that investment, which surged almost 24% in 2010, may be producing empty apartment blocks and unneeded factories. 'Major Dislocations' Jonathan Sadowsky, chief investment officer at Vaca Creek Asset Management in San Francisco, says he is "exceptionally worried" that the Chinese would eventually face "major dislocations within their banking system." Chinese authorities also raised interest rates twice in the fourth quarter in a bid to choke off inflation, a sensitive political issue since the 1989 Tiananmen Square protests, which followed uncontrolled price increases. Food prices last year rose 7.2%, according to the National Bureau of statistics. Haroon Shaikh, an investment manager with GAM London Ltd., cited "rapid wage inflation" and soaring property prices as the financial markets' chief concern. Li said rising real estate prices are the "biggest danger" to the Chinese economy, in an interview with Bloomberg News in Davos, Switzerland. The People's Bank of China should "gradually increase rates in the first and second quarter," Li said. Since peaking on Nov. 8 at 3159.51, the Shanghai Composite Index has slid about 14%. "The market is right to be nervous," Michael Pettis, a finance professor at Peking University's Guanghua School of Management, wrote in his Jan. 26 financial newsletter. Worst Market Some investors remain unbowed. "China can continue to grow over 10% for the better part of the next five years," said Ardavan Mobasheri, head of AIG Global Economics in New York. Still, the poll found other signs of mounting investor caution toward China, where three decades of market-oriented reform has obliterated a legacy of Maoist impoverishment.

Asked to identify the worst market for investment over the next year, 20% of poll respondents say China versus 11% in the last poll in November. Almost half of those polled -- 48% -- say a significant slowing of growth was very or fairly likely within the next two years. Michael Martin, senior vice president of MDAvantage Insurance Company of New Jersey, says the Chinese government "has executed brilliantly" in managing the economy. The government's capacity will be tested as the economy grows and becomes more complex, he says. Export Reliance Chinese officials have said they intend to wean the economy off its reliance upon exports, the source of trade tensions with the U.S., in favor of greater domestic consumption. Peter Hurst, a broker with Sterling International Brokers in London, says he's concerned China will struggle to complete the transition. "Yes, there are 1.3 billion people in China," he says. "But are they rich enough to become consumers?"

If China stumbles, the global economy will feel the impact, says Suresh Raghavan, chief investment officer for Raghavan Financial Inc. in Houston. "If the PBOC is successful at lowering growth rates to 7%, it will still feel like a recession for a lot of people around the world," he says. Political Stability Most poll respondents remained confident of the Chinese government's ability to fend off demands for greater political liberalization. Just 1% expect a political crisis within the next year and 27% expect one within the next two to five years. And by a 60% to 30% margin, those surveyed say President Hu's policies were favorable to investors. Hu tied with German Chancellor Angela Merkel for the poll's top spot. "The Chinese politicians are able to act on all necessary issues. That gives them a huge advantage compared to the Western economies," says Henry Littig, who heads his own global investment firm in Cologne, Germany. The poll was conducted by Des Moines, Iowa-based Selzer & Co. for Bloomberg and has a margin of error of plus or minus 3.1 percentage points.