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World Right Side Up: Investing Across Six Continents by CHRISTOPHER MAYER

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Chapter 5

China: Crisis and Opportunity in the Middle Kingdom

No anecdote puts the China question in a nutshell better than this one I heard from one of my contacts there:

“I was in an antique store, negotiating for this antique knife,” he told me. “I was about to make the deal when the guy looked at my Rolex watch and offered to exchange. I was ready to do it, but I knew my Rolex watch was a fake, and I didn't want to take advantage of this guy. So I told him that the watch was a fake. He said to me, ‘That's okay, this knife is fake, too.’”

I think that is the one thing about China that is tough to untangle, figuring out what's real economic growth and what's fake. Walking around in Beijing, seeing all the new buildings, the traffic and the bustling stores, makes you wonder how much is due to natural demand and how much is artificial stimulus. If it's more of the latter, then much of what we see is unsustainable.

There are two important parts of the macro backdrop that are important to understand about China. First, there has been a tremendous increase in bank lending since the end of 2008; it's up fourfold. We know from experience that when banks grow that fast, bad things tend to happen later. What happens when banks grow too fast is that they slide down the credit-quality spectrum. In short, they make tomorrow's bad loans.

Second, we know that the Chinese government has put in place a huge stimulus plan. Again, we know from experience that when governments invest money, you ...

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