China raised interest rates again and the world yawned while their own banks yawned and winked, for this means nothing to their customers currently playing musical chairs with credit. The move only makes me hate Chinese equities all the more.
There are far more than five reasons for citizens of the US, Europe or the world to hate China -- the nation state, not the people -- and traders need to join that queue right now. Recent events on the sea, on the Korean peninsula, in cyberspace and in Chinese prisons have laid bare the foundation to China’s claim for world power and exposed the nation to harsh criticism.
With this, politicians in the US and Europe have begun to abandon a veneer of tolerance for Chinese trade policies. The trade war, if it comes, will be a trigger for major market problems, but it is not the primary reason traders should hate China. Here are five better ones:
- The Great Chinese Credit Bubble
At the most macro level, China's most pernicious impacts on the world markets stem from a massive credit bubble similar to the one that blew up Japan in the early 1990s and the US markets in 2007-2008. Mark Hart, a hedge fund type way ahead of most people about sub-prime assets, is now focusing on China. He believes that China is in the “late stages of an enormous credit bubble,” and the negative impact on the world markets will be as “extraordinary as China’s economic out-performance over the last decade”. His proof? I cite Art Cashin’s Daily Comments, published daily by UBS, or Mr. Cashin in turn citing material from the UK’s Daily Telegraph interviews with Hart (see here):
- Excess floor space exceeds 3.3 billion square meters and there are still 200 million being built this year.
- The price to rent ratio is 39.4 times versus 22.8 times in America before the housing crises.
- Banks are hiding their exposure in Local Investment Vehicles.
- On a Sovereign level, China’s debt to GDP comes out at 107%, five times published numbers.
For skeptics among you, Chinese state banks are arms of the government and their debts are assumed to be backed by the government (do the names Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) come to mind?). What should traders do? As the bubble blows, Chinese banks will take a hit, short Chinese banks and real estate management companies listed on western markets.
- The Great Chinese Labor Force
According to Chinese data -- which is fun reading and sort of like a numeric version of a Dickens novel (more on that below) -- as well as more reliable sources such as The World Bank, the Chinese labor force available for industry will, in the next five years, add the same number of industrial workers as currently employed in the US and Europe.
This mass increase in the Chinese industrial work force is the single greatest deflationary force on the planet. Combined with non-existent labor laws, non-existent environmental regulations and dodgy loans from state banks and other entities, this labor force has destroyed tens of millions of jobs around the world while reducing the cost of many products.
The end game -- more job relocation to China -- is untenable. Any industry segment targeted by China is subject to massive price deflation, a terrible and unpredictable situation for traders. What should traders do? Follow the growing political debate on Chinese exports and look to short Chinese exporters through puts on the iShares FTSE/Xinhua China 25 Index ETF (FXI).
- The Great Chinese Commodity Gobbler
Chinese imports of commodities are driving the prices of everything from iron and coal to rare earth minerals. It has excess capacity in everything -- 200 million tons of extra capacity in steel, more than Japan and Europe’s capacity combined; they have consumed just 65% of the cement produced in the past few years (data from Mark Hart). This has created false prosperity and inflated asset values in commodity exporting countries.
China bulls say the country will eventually use this capacity and consume these commodities as it builds out roads, bridges and other public works. This kind of public funded consumption can only go on for so long since it is fueled by government credit and that is increasingly already being overextended. What should traders do? Watch admittedly faulty Chinese data and be prepared to short industrial commodities, the Australian dollar and bulk shippers when this all hits the fan.
- The Great Chinese Currency Reserve
The Chinese love to remind the world about their currency reserves and equally love to drop hints about shifting away from dollars if the US does not do this or that. China is now in a trap of its own making by restricting the flow of capital and pegging its own currency to the dollar.
With $2.4 trillion or so in dollar denominated bonds, any revaluation diminishes the value of these bonds. This is what Japan did as it accumulated reserves through tough capital controls and then watched its new found wealth melt away when the world forced it to let the yen appreciate. And as the value of Chinese foreign reserves diminishes, so does the capital base supporting the credit bubble. So, the country will not revalue and the trade war begins. What should traders do? Short Chinese exporters across the board.
- The Great Chinese Nation State
China has the world’s largest population, the sole source of its claim to world power status. This claim has manifested itself in behavior similar to emerging nation states in the middle part of the nineteenth century. China is more and more characterized by its bellicose gesturing and militant statements when anyone steps on a Chinese toe. When a Chinese fishing boat ran afoul of Japanese waters, the Chinese cut off rare earth mineral exports to Japan in less than two days due to “shortages.”
The Chinese control the flow of oil, food and other goods into North Korea. This means the nuclear arms in North Korea, Pakistan and possibly Iran are the direct result of Chinese foreign policy. The cornerstone of this policy is to wage asymmetric warfare against the US to reduce its role in east Asia. Last month, for about fifteen minutes, the majority of the world’s Internet traffic was re-routed through a Chinese telecom provider. And, a couple of weeks, back, this behavior reached a tipping point with the killing of South Korean civilians by North Korean artillery and the creation of an alternate Nobel Peace Prize since the real winner is in a Chinese prison. Good will is gone; trade war talk is up.
What should traders do? Short the whole damned country. Two of the most prescient short sellers in the world, Mark Hart and Jim Chanos, are doing so. Not bad company to keep. You can do so, once things become obviously bad in equities, through puts on ETFs such as the FXI or on Chinese stocks listed in the US. If you misread this article and go long these stocks for longer than a trading day, remember, our exchanges, desperate for revenue, allow Chinese auditors to audit Chinese companies, which is a funny thought
Disclosure: No position