Seeking Alpha contributor John Lindauer wrote a couple of articles about China that have us somewhat puzzled. The first one, titled 'Why Investments In China Will Eventually Be Worthless,' seems an inquiry into different effects of Chinese currency movements (at least for most of the article). According to Landauer, the most important question is:
Is it safe to rely heavily on Chinese imports and make Chinese-related investments?
Lindauer then goes on explaining that if the renminbi (the Chinese currency) moves up, the US balance of payments would initially tilt even more out of whack (he's describing the so called 'J-curve' effect here) as the likes of WallMart (WMT) have to pay more in dollars for sourcing products in China, increasing the US import bill. However, as Landauer explains, over time, adjustments will be made and they will buy less in China when it becomes more expensive.
Indeed, but then we fail to see the problem here, to be honest. Businesses react to price changes all the time. But still Landauer argues that the effects of a rise in the renminbi would be all bad:
Inflation, a bigger U.S. balance of payments deficit, and few, if any, additional jobs and profits in the United States.
How about a devaluation, then?
So he seems to think it's a mistake to force China to revalue their currency. Landauer is against a forced revaluation (which, by other means, is happening anyway) as it will have bad effects only, but he's even more against a renminbi devaluation, which he argues is "more likely."
This because, according to Lindauer, recent reports suggest a major economic downturn may be underway. In order to keep their unspoken contract with the public (Communist rule in exchange for economic development), they will be likely to devalue the currency.
In a rather surprising twist at the end of the article, he then goes on to predict some kind of revolution in China like the Arab Spring (Rumania is also mentioned). This would make gold go up and all Chinese investments rendered worthless, is his parting shot and conclusion.
How this follows from the currency analysis isn't clear, at least not to us. In fact it rather baffles us so we add a few remarks here:
- Landauer misses the most important thing about the currency effects. It's not the nominal exchange rate that is the most important. The few percentage point change in the nominal exchange rate is nothing compared to the 15-20% wage cost rises in China. What matters is the real exchange rate, the one corrected for difference in price movements. And make no mistake, that one is rising inexorably as wage cost rise much faster in China than they do in the US. So China is slowly becoming more expensive.
- Whether there will be a revolution in China that will render all investments there worthless has little to do with what happens to the currency
- In case of an economic slow down, why does Landauer predict mayhem? Something like this happened in 2008-2009, and rather than devalue their currency or a political explosion, the authorities reacted with a stunningly sized stimulus program that quickly got the economy going again. One could argue that China is in a somewhat less favorable position to repeat this now but we haven't found any arguments against it in the Landauer article.
China on the break of collapse?
With respect to the latter, perhaps we were looking in the wrong article, he's now written an update called 'Gold Confirms Investments In China Will Eventually Be Worthless.' In it, he argues that:
China's Social Contract is breaking faster than expected. Recent indicators and activities suggest the investment collapse and end of Chinese producers as reliable supply sources may occur sooner than was initially expected. The people's social contract with the Party appears to be rapidly breaking down.
As indicators he uses the "huge increase in the Chinese demand for gold," the "apparent unwillingness of the man-in-the-street to deposit money into Chinese banks," rich Chinese buying property abroad, Apple and WallMart diversifying their supply changes away from China, Chinese oppression of freedom of speech, and social unrest.
While we do not dispute that some, or even all of these are happening, we really don't think they warrant the alarmist conclusion. One could basically come up with similar indicators of just about any country (bar Switzerland or Norway, perhaps) and draw the conclusion that it's doomed. This is the second biggest economy of the world we're talking about, one that on many metrics, is quite a bit more economically sound than much of the rich world.
For instance, that Chinese are buying more gold and property abroad doesn't mean anything apart from that they've become much richer. This is good, not bad. That WallMart and Apple (AAPL) are diversifying their supply chain (the extent of which we really doubt, but anyway) is a natural consequence of the rise in the real exchange rate and also a consequence of China becoming more developed and richer.
There has always been oppression, as well as social unrest, so we're not sure this necessarily predicts imminent gloom and doom. While not problem free, Chinese banks seems sounder than many in the West, where most of them had to be bailed out and/or are still on some form of central bank support.
In short, while China might very well experience an economic slowdown of some form, we're really not convinced by Lindauer's case that it is on the verge of implosion and revolution, to such an extent that all your Chinese investments are about to be wiped out. This is an economy that has shown that it can swiftly deal with economic problems, has still has ample means to do so. The last time we looked, it's the Europeans begging for Chinese help, not the other way around.
Apart from some of the weaknesses, we also see enormous fundamental strength in the Chinese economy. They have a rapidly growing domestic market, that is already the largest in the world for some goods and services. Wealth and salaries are rising fast. Whatever you think of the government in terms of human rights (no, we don't like them either), it is economically rather competent.
China is investing massive amounts in science, technology and education, the foundation for future wealth. Unlike India, it has mostly first-rate infrastructure. It is home to many industrial clusters that will be able to compete for quite some time to come, despite wage and cost rises.
Basically what Lindauer has done is predicting the proverbial 'Black Swan.' Apart from the shaky and rather one-sided foundations of these predictions, the problem is that Black Swan's are notoriously hard to predict, hence their name.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
