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February 28, 2012

Michael Schuman is not an economist . . .

. . . but he's absolute right: "Why China Will Have an Economic Crisis". Just wait and see.

The problem here is that prices can’t stay wrong indefinitely. There is a good reason why classical economists are always so focused on allowing markets to find the correct price level. In that way, markets send the proper signals to potential investors on where money should or should not go. If those price indicators are skewed, so is the direction of resources. The Asian model, by playing around with prices, eventually creates tremendous distortions, in which money is wasted and excess capacity is generated. Subsidized companies don’t have to generate returns in the same way as unsubsidized firms, and that leads them to make bad investment decisions to build factories and buildings that are unnecessary and unprofitable. As a result, loans go bad and banking sectors buckle. That’s exactly what happened in both Japan and Korea. Though their crises were tipped off in very different ways — the bursting of an asset bubble in Japan, an external shock in Korea — the reason both countries collapsed was the same: weak banks, indebted companies, silly investments.


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The main thing one has to remember about China is that they lie. They are a communist dictatorship and anything that comes out of there collective mouths needs to be deeply scrutinized. We can get a general idea of the strength of there economy, but like the Soviet Union, we can never really be sure.


With China you had a classic case of a nation following a mercantilist pattern in order to achieve rapid industrialization. The combination of debasing the currency as well as high tariffs to boost internal sales does work, for a while.

It works while there are a lot of workers who are moving from low wage agriculture to better paying industrial jobs. But what happens is that after a while the high growth rates must decline and then the factory workers begin to notice that they are paying too much for everything with their degraded money. They start to demand more. China is right about at that point.

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