Lately there has been a lot of talk about the true state of the Chinese economy.  China had a succession of potentially destabilizing events; first a political crisis, then a slowdown in growth followed by a huge spike in overnight lending rates.  Additionally, and intrinsically related to all of the above, there are many worries in regards to the growing and largely unregulated shadow banking system (deja-vu anyone?).

Analysts and money managers are split on the future of this economy as the recent showdown between Jim Chanos (a vocal short-seller of Chinese stocks) and Jim O’Neill (ex -Goldman Sachs and father of the acronym BRIC) has evidenced this week.

The recent re-acceleration of GDP seems to be once more nothing more than the result of more credit induced activity.  Long term stability, however, depends on China being able to break this unsustainable loop.  Michael Pettis, a US professor in China, has been very vocal on this subject and he confirms that nothing seems to be changing in the economic model.  Prof. Pettis also reports an interesting trend among real estate companies; it seems they are acting in a countercyclical fashion by hoarding cash as real estate values are once again skyrocketing.  This is a positive as they may help relieve some pressure on the banking sector and they may be able to support prices once the trend changes.

Overall the big concern remains the shadow banking system which, while it has developed with different contingencies than in the US, it could still end with similar damaging results.

We remain cautious about China in the intermediate horizon.