What Happens in China Doesn't Stay in China 40 comments
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My previous article ended with a very insightful conclusion: “Need I say more?”. I received a dozen emails that said – you DO need to say more. So here I am saying more:
What do we take out of this? The Chinese ascent over the last decade has lowered the degree of separation between China and the global economy. What happens in China doesn’t stay in China (not anymore); it spills over to the rest of the world.
Today, Chinese economic growth is the force pushing the global economy. The quality of this growth, however, is low as it is predicated on massive (forced) lending and thus it is unsustainable. As Chinese growth slows, the impact will be felt in many, often unsuspected places.
It will tank the commodity markets, commodity producers and commodity exporting nations. Let’s take oil, for instance. As incremental demand from China collapses, oil prices will follow, taking the Russian economy with it, as Russia is for the most part a one-trick petrochemical pony. According to GavKal Research China accounts for 15% of Brazil’s exports (up from 1.5% a decade ago), significantly impacting the economy of that South American nation.
Demand for industrial goods will fall off the cliff. China consumed a lot of those goods - $550 billion worth annually (also according to GaveKal Research). So if Caterpillar (CAT) expects to sell more of its yellow earthmovers to China, it will have put that thought on hold for awhile. (Side note: CAT’s CEO expects CAT’s earnings “$8 to $10 per share within five years if the world economy recovers”. Let me put it into a proper context: in 2007-2008 circa when its margins and sales were at an all-time high, double their historical average, CAT earned about $5.50 a share. Good luck!)
Finally, the Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5% mortgages and 6% car loans.
Identifying bubbles is a lot easier than timing them. An astute observer could have seen the Japanese bubble developing in 1986, 1987 and 1988, but he would have been “wrong” until 1989. Now sprinkle on top of this the Chinese government’s willingness to do anything in its power to postpone the bursting of the bubble and the complexity of timing increases exponentially.
Those of you who are familiar with my writing on this subject may rightfully accuse me of beating a dead horse – or in this case a dead dragon. But I firmly believe that those who invest in China or ignore the consequence of very likely Chinese economic malaise do so at great peril.
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On Aug 26 05:25 AM China Interest wrote:
> For those who state that China will continue to grow at break neck
> speed - I speculate they have only been to Shanghai or Beijing, and
> really don't understand the overwhelming issues in China that need
> to be reckoned with. That is my two cents.
Read your other excellent blog on the Clusterstock yesterday - "Forget About The Chinese Stock Market, The Whole Chinese Economy Is A Bubble Waiting To Burst". You should publish this article on SA as well.
What I foresee is "collapse" in PRC stock market sending shock waves thru out the world markets starting with emerging markets in Asia. US market built on hopes of recovery lacking fundamentals like corporate profit, poor employment and lest we forget tons of bad debts do not bode well. What I fear is another down leg and even depression or more like stagflation next year driven mostly by artificially created "excess liquidity" from money printing presses all over the world.
History repeats and there is no free lunch.
Since when did China with 3rd world GNP per capita become the all mighty economy? Where typical factory workers toil in gritty factory making $100 per month plus room & board?
On Aug 26 05:25 AM China Interest wrote:
> For those who state that China will continue to grow at break neck
> speed - I speculate they have only been to Shanghai or Beijing, and
> really don't understand the overwhelming issues in China that need
> to be reckoned with. That is my two cents.
Could CAT be subsidizing the sale by extending credit like what Lucent/Nortel did back in the halcyon dot com craze?
And are there more companies like CAT manipulating the numbers? My gut says yes and there are plenty more out there and it will be exposed in Q3 & Q4 earnings once they run out of magic bullet "cost cutting" one time gains and reality of declining revenue and profit come into play.
BTW - excellent price to go long on double short ETFs SDS, QID and TWM (my fave against junk Russel 2k index chock full of smaller banks).
Please describe 'forced lending'. If you point at the chart that you displayed in your original piece, I'd counter that what China is doing rhymes very well with what we are attempting to do here - **stimulate lending**. In China, it's actually working, because people there do not have the debt overhang that they have here in the US. You can't 'force' anyone to borrow (although you could make a strong case that inflation essentially does this), so it follows that you can't really 'force' anyone to lend.
'What happens in China doesn't stay in China'. What about what happens in the US? Or Europe? Or Japan? Russia? Brazil? The Middle East? C'mon...it's embarrassingly naive to think that China is the only player that affects others in the international arena.
Outside of much of rhetoric in this strongly biased piece, your points about China contributing an out-sized portion of global growth, and that the foundations for that growth are similar to whatever foundations are seen for US growth, are indeed good points to make. However, I'd counter that due to China's strong equity position (i.e., low debt overhang relative to just about any other nation in the world), its foundations are indeed strong, whereas in America, and especially in Europe, they are pitifully weak.
Unlike our nation, which struggles with the choice of issuing a second stimulus, China could easily do so, and fund it almost entirely from past surpluses. Not only that, the stimulus would again be a sizable chunk of its economy, unlike what was issued anywhere else in the world. Something to think about before you 'beat a dead dragon'.
I must thank you for writing this article. I had some doubt after reading a lot of opinion biased against continuing the China play (with reasoning along your lines, and how easy money is leading to an asset bubble), but countering your paper-thin points has given me more confidence to continue the play.
If I were you, I'd stick to other topics...it seems most of the commentators here are beating a dead horse rebutting your points.
I'm also beginning to think that SA needs a new editor. I've read far too many editor's picks that pass the readability test, but fail in content.
Speaking of bull, this article was crap.
Who doubts that Shanghai stocks are a bubble. They've even been described as a ponzi scheme waiting for collapse.
It would be better to anticipate as Vitaliy is doing, the consequences of the inevitable. I am sure "the Geithner" is watching. I am sure China will fake results till coordinated US policy is ready to accomodate (when the fed has to "extinguish" money supply).
PS is call-girlie behaviour legal in Macao? Hangover--the sequel is going to be set in Macao?
The whole point of reserve ratios initially was to ensure the stability of banks. In other words it ensure that they were not creating too much money out of thin air.
In China's case they actually use them to control the money supply, in a similar way to which both we and they use interest rates to control the money supply. If Western nations had as interest rates and reserve ratios as high as the Chinese their economies would sink without trace. This simply underline the real financial strength in China and shows that, however, much of a bubble you think the Chinese might have on their hands their ability to unleash money into the system without getting a penny into debt is almost unlimited. Of course the reason they have this power is that they make things and they make things very competitively. This is why we are lead to believe that their economy is on the point of collapse!
Do you guys have any idea how silly you sound?
On Aug 25 07:46 PM odin wrote:
> I'm not sure what reserve ratios have to do with viability of banks.
> However, while believable data is hard to obtain, something is amiss
> when during times of export slowdown, and exponential loan growth,
> non-performing loans go down. Subprime crisis anyone? It makes
> sense if people use credit productively. Otherwise, speculation
> in financial assets in China is no different than speculation in
> real-estate or internet stocks in the US.
>
> China can also import all the commodities it wants (and doesnt want),
> but someone will have to buy the products it creates with those commodities.
> There are some who believe that the vast middle class in China will
> replace the US consumer. I, on the other hand, do not believe that
> that middle class is as able or willing to consume like an US consumer
> (we are not talking about people making $40-60K/yr). Granted that
> there is more car-buying and appliance-buying at the upper end of
> the middle-class, but that is not where the bulk of the population
> is and that segment will be massively hurt in any real-estate or
> equity pullback to demand much of anything.
>
> I am also not sure how anyone can "afford" bubbles or policy mistakes.
> One could actually say that the US with a bigger, more diversified
> economy can better withstand systemic shocks than smaller, export-centered,
> centrally planned economies with a lot less wiggle room when it comes
> to providing growth (employment) to its population.
>
> While a 6% growth rate is stellar for the US (on a $14T economy),
> if China grow at a rate much lower than 7-8%, it has a stability
> problem on its hands. The massive number of people entering the
> workplace and finding no employment will create an explosive situation.
> Even with 8% growth, China will add about 12M job-seekers to its
> unemployment figure.
>
> However, I am not sure that a fall in Chinese buying equates to a
> $-fall. If China buys less USD, it is because the US current account
> deficit has gone down (US net imports to China have gone down).
> Now, China can unilaterally appreciate the RMB against other currencies
> (which will devalue the USD of course) but the value of USD (against
> most global currencies) will be fine. In fact, that revaluation
> will point to a further collapse in US imports and as pointed out,
> if this is coincident with a crisis, the global demand for USD will
> go up and not down.
Dave Wrixon made a very important about bank reserves in China which apparently Vitality knows nothing about when he spoke about "forced lending."
And Vitaliy apparently knows nothing about China's "Go West" program which is putting most of the government's growth push on areas away from the large,export-oriented, eastern cities in China.
This push is raising the standard of living of living in the rural parts of China and increasing consumption in the country. That is why China's price-adjusted trade surplus has SHRUNK by one-third in the last year - they are importing and consuming much more.
Vitaliy, if you are interested in identifying bubbles, no need to look so far away in China. All you have to do is look to the Fed-generated reflation that is sending US stocks back up to bubble levels again.
Goldman, Morgan Stanley etc... all have vested interest in China and thus are extremely bias in reporting anything to the public. It would be like asking a real estate agent about property prices. Of course they are only going to say everything is fine!
On Aug 26 09:39 AM coreopsis wrote:
> You're right, Goldman, Morgan Stanley and Credit Suisse -- what do
> these guys know about China? You might try sending your CV to them
> as they need your 'help'.
>
I live and work in China in finance and there are bubbles. Many of them! It is not Vitaliy that doesn't understand China it is you!
Perhaps some people can make some money on the bubble but be warned not to be the one without the chair when the music stops.
On Aug 26 03:02 PM Tony Daltorio wrote:
> Another article from the China hater Vitaliy - YAWN! I cannot believe
> an article where the author is so clueless about China is an "editors
> pick"???
>
> Dave Wrixon made a very important about bank reserves in China which
> apparently Vitality knows nothing about when he spoke about "forced
> lending."
>
> And Vitaliy apparently knows nothing about China's "Go West" program
> which is putting most of the government's growth push on areas away
> from the large,export-oriented, eastern cities in China.
>
> This push is raising the standard of living of living in the rural
> parts of China and increasing consumption in the country. That is
> why China's price-adjusted trade surplus has SHRUNK by one-third
> in the last year - they are importing and consuming much more.<br/>
>
> Vitaliy, if you are interested in identifying bubbles, no need to
> look so far away in China. All you have to do is look to the Fed-generated
> reflation that is sending US stocks back up to bubble levels again.
>
Your skepticism is illogical.
On Aug 26 09:31 PM China Interest wrote:
> Coreopsis
>
> Goldman, Morgan Stanley etc... all have vested interest in China
> and thus are extremely bias in reporting anything to the public.
> It would be like asking a real estate agent about property prices.
> Of course they are only going to say everything is fine!
>
> On Aug 26 09:39 AM coreopsis wrote:
At best, you might have a microscoptic view of certain aspect and certain layer of this complex galloping giant.
Given your illogical skepticism about all of GS, MS, CS. I suspect that you do not know China as much as you think.
Frankly, given the ignorant equation Vitaliy made between China 2008 and Japan 1989 in his last posting, it is quite clear that he not only knows very little about China, he also knows very little about Japan, either 1989 or 2009. Basically, I am pretty sure he is just an average guy who knows nothing about Asian histories, georgraphy, societies, and would be wrong more than 50% of the time when asked to quess wether an Asian is a Japanese or a Chinese.
On Aug 26 09:36 PM China Interest wrote:
> Tony
>
> I live and work in China in finance and there are bubbles. Many of
> them! It is not Vitaliy that doesn't understand China it is you!
>
>
> Perhaps some people can make some money on the bubble but be warned
> not to be the one without the chair when the music stops.
We wont repeat the level of loan growth in China (the numbers have been hashed to death all over this site) but just as a comparison: the M2 YoY is growing at 28.2% in China. The equivalent number is 8.5% (4% seasonally adj) in the US. In light of these numbers, tell me how China has more of an ability to CUT rates.
The problem with China is not lending -- it is to whom they are lending. Continuing to support and subsidize export-oriented industries is simply building overcapacity and will lead to souring loans. Small and medium enterprises catering to internal demand are actually getting starved for credit. This is not making things competitively. This is a wholesale transfer of wealth from the workers in China (by reducing their buying power) to the exporters in China.
You can continue to keep your currency artifically low, keep interest rates low, and continue to allow asset inflation but we have seen how that script ends.
This is not intended to bash China (and China does have a bright future) but to point out a growing problem that threatens the stability of everyone (again) less than a year after the credit crisis. Now if you have been a "domain speculator", perhaps you do revel in the highs and lows of speculation and undoubtedly many make their fortunes during these times but then lets call it speculation and not couch it in pseudo-economic terms.
On Aug 26 02:06 PM Dave Wrixon wrote:
> Yes, and you are another one that has no clue what he is talking
> about.
>
> The whole point of reserve ratios initially was to ensure the stability
> of banks. In other words it ensure that they were not creating too
> much money out of thin air.
>
> In China's case they actually use them to control the money supply,
> in a similar way to which both we and they use interest rates to
> control the money supply. If Western nations had as interest rates
> and reserve ratios as high as the Chinese their economies would sink
> without trace. This simply underline the real financial strength
> in China and shows that, however, much of a bubble you think the
> Chinese might have on their hands their ability to unleash money
> into the system without getting a penny into debt is almost unlimited.
> Of course the reason they have this power is that they make things
> and they make things very competitively. This is why we are lead
> to believe that their economy is on the point of collapse!
>
> Do you guys have any idea how silly you sound?
On Aug 27 01:48 PM odin wrote:
> Its perhaps the years I have spent practising this trade [sic]
On Aug 26 09:31 PM China Interest wrote:
> Coreopsis
>
> Goldman, Morgan Stanley etc... all have vested interest in China
> and thus are extremely bias in reporting anything to the public.
> It would be like asking a real estate agent about property prices.
> Of course they are only going to say everything is fine!
>
> On Aug 26 09:39 AM coreopsis wrote: