China’s Day of Reckoning Looms

Despite the release yesterday of more better-than-expected US economic data, uncertainty about Greece’s bond swap deal, disappointing Purchasers Managers’ Index readings for eurozone countries, and caution over China conspired to bring about a lacklustre day as far as precious metals, equities and commodities were concerned.

As The Wall Street Journal reports, Asian markets have sustained further losses in trading this morning, with one analyst noting that “while China is expected to engineer a soft landing, it remains a decelerating growth story". However, given the scale of malinvestment in China – focused on the real estate sector, as per America and many other developed countries in the early part of the last decade – it’s not easy to be quite so sanguine about the communist authorities’ ability to make a “soft landing”.

Likewise, it’s impossible to know exactly when the China bubble will burst. All that can be said with certainty is that there are serious structural problems with the Chinese economy – reflected most vividly by “white elephant” housing and infrastructure projects – that are symptoms of the kind of artificial credit boom that Mises and other classically-inclined economists warned of. Another thing that can be said with certainty is that when the bubble does burst, it will lead to sharp sell-offs in equities and commodities.

We can also be reasonably confident that when faced with this crisis, the People’s Bank of China – in common with other central banks’ actions in recent years when faced with similar problems – will resort to drastic measures to inflate the currency it issues. This should mean the country avoids deflation, and will encourage investors to dive back into equities and commodities. It will also lead to further gains in gold and silver prices, as increasing numbers of Chinese citizens look to these metals as hedges against inflation and counterparty risk in the country’s financial system.

As of 11.00 GMT, the gold price has broken down below support at $1,700, and is currency trading around $1,685. The silver price is trading at $33.20. Stronger buying support exists for silver around $32.50, though if that level is broken we may well end up (short-term at least) right back where we were before last month’s breakout – trading in a range between roughly $28 and $32.50.