According to Jim Cramer’s blog of February 10th, we should “Load up on China after the Geithner gaffe” specifically the iShares FTSE/Xinhua China 25 Index (FXI). Like many other commentators, Mr. Cramer feels that the US stimulus package won’t work and is light on details. In contrast, China’s massive stimulus package is already working in a spectacular way. It has started to drive the Shanghai A share market higher setting the stage for a new bull market. But is this so?
The odd thing about China’s massive four trillion yuan ($586 billion) economic stimulus package is that it is not using purely taxpayer money. Instead the vast majority of the funds are to come from taxpayer bank deposits. The Chinese central government announced last November that the central government will directly fund only about a quarter of the four trillion yuan ($586 billion) economic-stimulus package. The rest of the funds are expected to come from bonds issued by the local governments, bank loans and the private sector.
In 2005 Ernst & Young issued a report stating that the bad debts in the Chinese financial sector exceeded $900 billion. The report was hotly disputed by the Chinese government and withdrawn by Ernst & Young. Despite that it was most likely true. Over the past few years Chinese companies especially state owned companies with little or no corporate governance oversight have been acting in ways that would make a Wall Street banker blush. Besides speculating in the real estate market they also have been speculating in the stock markets mostly with loans from the state banks. The amount of bad debts in the financial system most likely exceeds the amount of China’s reserves. As I pointed out in my article published in the Harvard International Review four years ago, the legal system makes it just about impossible to collect a debt. So forcing Chinese state owned banks to provide funds for China’s stimulus package would be like the US government forcing Citigroup (C) to provide the bulk of our stimulus package.
The problem with nationalizing banks is that the government can command them to lend without adequately providing for the risks. State banks lend for political reasons not for profit. And lend they have. In January alone, China’s banks lent a record 1.62 trillion yuan ($237 billion). The problem is that all of this money did not go into infrastructure projects as advertised. It may have just gone into more speculation in the stock market. Bloomberg in an article published today quotes Li Huiyong, a Shanghai-based analyst at Shenyin Wanguo. He estimates that “As much as 660 billion yuan ($97 billion) may have been converted by companies into term deposits or used to buy equities” which has helped to drive the recent rally. In support of Mr. Li’s estimates is the fact that the Hong Kong Hang Seng index has not followed the Shanghai A share market. Investors in Hong Kong include many foreign investors who are not able to take advantage of loans from Chinese state owned banks.
Another large chunk of the new lending (39%) has been used by the banks for discounted bills, which supply working capital. Supplying working capital to companies who need it is always a good idea, but in this case it might be wasted. The Chinese economy is overwhelmingly based on exports which are plunging. Exports fell by 17% from January of 2008 suggesting that the fall is accelerating. Imports plunged by 43.1% year on year indicating another disaster. So the question is what are these companies doing with all of the loans?
In China the government can not only use laws to order banks to lend, they can also force companies not to lay off workers. With an estimated 20 million of the 130 million rural migrant workers out of work, the real unemployment rate may be as high as 9% rather than the official figure of 4.6%. To curb potential social unrest from layoffs, the government has simply ordered companies in the eastern coastal regions not to lay off workers without prior approval.
Besides using bank depositor money to provide a massive job creation scheme for companies whose markets have collapsed and to allow further speculation on the Shanghai A share market, the Chinese stimulus package has other problems. Unlike the US stimulus plan, there are no tax cuts to help encourage domestic consumption thought necessary to balance the Chinese economy away from exports. Worse, the Chinese tax system, like much of its regulatory system, is still heavily designed to encourage exports rather than domestic spending.
Chinese law provides tax rebates on imported goods including industrial commodities and machines provided that the finished goods produced with the imports are then exported. This encourages manufacturers to avoid the domestic market or to follow complicated schemes to avoid the rules.
Like the American stimulus package, the Chinese package is not immediate and not as large as it seems. About a quarter of the package included already announced programs for rebuilding of the area devastated by the earth quake last year. Another large part is to be spent on infrastructure, which is to be spread over two years. Infrastructure spending has been growing by about by about 20% annually for the past couple of decades, so it may be difficult if not impossible to increase the rate.
Like the Geithner plan that Mr. Cramer dislikes so much, the Chinese stimulus plan is light on details, which is the problem with all investments in China. Markets are really about one thing, choice. In order to make an informed choice, you have to have good information. To get accurate, timely, and complete information, you need protected speech. The Chinese government, banks and companies are mostly owned by the government who is not answerable to anyone. What they choose to reveal is up to them. Therefore neither Mr. Cramer nor anyone else actually has access to the information necessary to make accurate recommendations.
Besides recommending the iShares FTSE/Xinhua China 25 Index, Mr. Cramer in his blog also recommended Chevron (CVX), Nucor (NUE), U.S. Steel (X), and Qualcomm (QCOM), because these companies where supposed to benefit from the early recovery of the Chinese recesession. Since, as I predicted in my Financial Times letter last fall, this is not going to happen any time soon, I doubt if these stocks will do as well as Mr. Cramer predicts unless they can profit from a recovery by the US as a result of our stimulus package.
Stock position: None.
