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Fundville » GMO’s Edward Chancellor “China’s Red Flags” - Another White Paper on China Bubble



This is the 2nd well written white paper on China’s current economy and ongoing asset bubble. The previous one was from Pivot Capital and can be viewed here on Scribd (download PDF file here).

For people who are not familiar with GMO, GMO is a highly respected institutional asset manager located in Boston. Jeremy Grantham, GMO’s founder, writes a must read quarterly investor letter. Please find Jeremy Grantham’s 4Q 2009 letter here. For people who admire the chef and read the recipes religiously, fundville.com presents you the real ingredients GMO used to cook.  Please find GMO’s 13F filings here. In the white paper, Edward Chancellor argues

In summary, researchers find that rapid credit growth is the most important leading indicator of financial instability. The presence of an asset price bubble is the second most reliable crisis indicator. Low interest rates and strong money growth are also good warning signs. Real estate busts often produce severe and long-lasting economic downturns, while investment booms may result in a misallocation of capital. Classic manias have often been accompanied by a compelling growth story and an uncritical faith in the competence of the authorities. They are exacerbated by moral hazard and accompanied by rampant corruption.

and he concludes

One commentator compares China to the Hollywood thriller, Speed, in which a bus has been planted with a bomb set to detonate if the vehicle slows to below 50 miles per hour. This seems apt. Were China’s economy to slow below Beijing’s 8% growth target, bad things are liable to happen. Much of the new infrastructure would turn out to be otiose; excess capacity would linger in many industries; the real estate bubble would burst and the banking system would face a rash of non-performing loans. Investors who are immersed in the China Dream ignore this scenario. When the China juggernaut eventually stalls, they face a rude awakening.

A must read for all investors, in our opinion. The entire paper can be viewed on Scribd (or download .PDF file here). Users can also go to GMO’s website directly and find many more excellent research reports and white papers.

A very well translated Chinese version of this report by Caing can be found here.

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