If you saw the opening ceremonies for last summer’s Olympics, you know China goes big. Like "$300 million for 20,000 fireworks and 15,000 performers" big. So it should come as no surprise that, when faced with the threat of global economic collapse, China's government didn't skimp on fiscal or monetary stimulus.
On top of a $585 billion spending plan, the government told the state-run banks to open the spigots. With new loans running at $1.3 trillion through the first nine months of the year, up nearly 150% from the year before, the Chinese market has been flooded with liquidity to promote growth and cushion local workers from a collapse in exports.
Triumph or facade?
With the latest estimates of China’s GDP growth coming in at 8.9% for the third quarter, it would appear Beijing has pulled off an economic display at least as spectacular as the opening ceremonies. However, just as the ceremonies were dogged by revelations of lip-synching 7-year-olds and computer-enhanced fireworks, skeptics (count me among them) are bringing up potential stumbling blocks in regards to China's dramatic rise from recession.
Where did it flow?
Unlike here in the U.S., when Beijing sent forth this wave of funding, it didn't get locked up in recapitalizing banks like Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM). It actually hit the real economy. However, the bulk of the loans flowed to industry giants, which in China are usually state-owned enterprises (SOEs) -- especially in areas considered strategically important, like manufacturing and construction.
SOEs are notoriously inefficient. So, with billions of dollars flowing toward companies that have questionable track records when it comes to capital deployment, we have a recipe for value-destroying investment in overcapacity.
Evidence also points to this lending being used to stockpile commodities at what were, admittedly, attractive prices. This may have provided materials companies like BHP Billiton (NYSE:BHP) with a tasty rise in demand, but it isn't the nice, sustainable demand recoveries are built on.
A huge amount of the new loans were diverted into equity and real estate markets. This type of investment is problematic for a few reasons: First, it doesn't contribute to actual economic growth. Second, it pushes up asset prices, creating bubbles. Third, should markets collapse again, China's banks would be facing a serious wave of loan defaults.
Calls for reform and restraint
This isn't just a jealous American calling out the potential problems with Beijing's policies. People well up the ranks in China’s system have been making similar noises. The latest (but not the first) call for monetary restraint came from Qin Xiao, the chairman of China Merchants Bank, the country's sixth-largest bank. In an editorial piece published last week in the Financial Times, Mr. Qin called for a shift from loose money to a neutral stance by the central bank. He also floated the idea that "a moderate slowdown [is nothing] to be afraid of."
Now, politicians the world over would beg to differ, but myopic self-interest doesn't negate the underlying economic logic of Qin's plea. As demonstrated in the U.S. by Alan Greenspan et al., moving from bubble to bubble on the back of easy money doesn't provide lasting economic growth.
Catch-22
Until China is able to develop a more balanced economy, one that doesn't rely so heavily on low-cost labor producing cheap goods for export, Beijing will feel pressure to support these industries through tax breaks and an artificially weak currency.
One of the fastest ways to move away from being an export economy and develop a domestic consumer-driven economy would be to allow the renminbi to appreciate. Initially, this would cause significant pain as exporters lost their competitive advantage and were forced to close down, contributing to unemployment. However, as the renminbi appreciated, the famously high savings of the Chinese people would increase in buying power.
This would increase demand for goods, spawning Chinese versions of Wal-Mart (NYSE:WMT) and Ford (NYSE:F) focused on meeting domestic demand and providing new job growth.
What to do
While I am doubtful the Communist Party will be making these changes any time soon, they will come eventually. And some of it is happening already. Companies with an eye toward the Chinese consumer, like Ctrip.com (NASDAQ:CTRP) and Home Inns & Hotels Management (NASDAQ:HMIN), have come onto the scene to serve the needs of an enormous rising middle class.
The key for investors looking to cash in on the immense growth story that is China is to find the companies with an eye toward the Chinese consumer. Some may be tiny domestic companies, others major international players who are able to translate their brand power and have it resonate with Chinese shoppers.
Fortunately, the Motley Fool Global Gains team is ahead of the curve. Advisors Tim Hanson and Nathan Parmelee recently returned from China with a basket of companies poised to grow with China's middle class. To find out which stocks can help you tap into the real Chinese growth story, try a 30-day risk-free guest pass to Global Gains.
Nate Weisshaar still gets scared if he sits too close to fireworks displays, and he doesn't own any of the stocks mentioned above. Wal-Mart is a Motley Fool Inside Value recommendation. Ctrip.com International is a Motley Fool Hidden Gems recommendation. The Fool disclosure policy has more tattoos than regrets.
