Jim Trippon's  Instablog

Not a day goes by without something more negative being written or said about China. While we touched recently in an article about China's inflation, as well as its import-export trade situation, along with its prospects for a soft rather than hard landing in its economy, there are still plenty of China bears if not downright doomsayers. The most notable doomsayer and China bear has been Jim Chanos, the hedge fund investor who runs Kynikos Associates and is a vocal China critic. Chanos first came to prominence with his successful big bet against Enron in 2001, and he's been shorting China stocks for some time now.

China Economy Slowing, But How Much?

Property Bubble And Debt

Chanos has been on CNBC and was quoted in Bloomberg and other media outlets on his contention that China has significant off balance sheet debt related to the area of property and land speculation. Chanos, in a Bloomberg tv interview, said the Chinese central government doesn't directly have a lot of debt, but that it's the Chinese local governments who have invested in state owned enterprises, or SOEs, along with other borrowing entities, and that Chinese regulators "are trying to get their hands around this." Also, Chanos said that the Chinese central government is "trying to rein it in." He points out that China's central government implicitly must backstop this debt.

The Underlying Problem

Michael Pettis described in a New York Times article what the continued property and construction speculation by local governments investing through SOEs could mean. "At this point-at which China may have reached a decade ago-debt begins to rise unsustainably."

Pettis goes on to point out that the underlying debt, not the indebtedness of the municipalities, is the key issue, that such an unsustainable debt burden will, when repayment difficulties become excessive, simply be shifted. This goes to Chanos' point about the central government ultimately being on the hook for the debt. Pettis warns also of the possibility of a sudden "explosion in contingency liabilities," where even liquidated collateral will not come close to matching the debts. There are further complexities to Pettis' arguments, but clearly the key is that he contends there is unsustainable debt, and that debt, no matter what its origin, must face a day of reckoning at some point.

So, Will There Be A Collapse?

Chanos, for his part, has emphatically said there will be a collapse, and that "It will be 1,000 times worse than Dubai." Now, renowned investor and long time China bull Jim Rogers, quoted in Digital Journal, famously said of Jim Chanos more than a year ago, "I find it interesting that people who couldn't spell China ten years ago are now experts on China." Perhaps that's the case of one quotable exaggeration deserving another, but Rogers' contention in a Forbes piece was that Chanos misunderstands the way the Chinese yuan and real estate work. While Chanos was short Chinese stocks, notably its banks, Rogers has been a noted bull on Asia and China. Chanos elsewhere said although he is bearish on China, he later retreated somewhat from his prediction of a total collapse, though maintaining that "the property slowdown has begun." He adds that what he sees as massive debt-he put the figure at 100% to 200% of GDP-"European type figures," will drag down China GDP and demolish growth.

The Problem With The Doomsday Scenario

Much of the scenario with the unsustainable debt premise relies on invoking the "shadow economy" and the admitted lack of visibility which would peg the debt figures at specific levels. Chanos' estimates of "100% to 200%" of GDP is more than a wide ranging figure; how much is the actual debt? Specifics here would be more helpful, maybe even critical for accurate analysis. Also, the contention that the Chinese banks, which are admittedly policy arms of Beijing, are going through a shoring up process similar to the massive infusions and write downs of the past when non-performing loans, or NPLs, were de rigueur in China, also doesn't show the evidence. The few millions recently invested by China Investment Corp, CIC, were by any measure the proverbial drop in the shoring up bucket. So the numbers, the facts, certainly don't confirm the scale or scope of what Chanos sees ahead.

Food Inflation In China Is Real

Another View On China

Stephen S. Roach, non-executive Chairman of Morgan Stanley Asia and a faculty member at Yale University, was recently on CNBC and said that the China doomsayers are wrong. Roach pointed out that China is managing its situation through globally treacherous economic waters well, and that not only is no collapse in store, a soft landing is on the horizon. Roach has written elsewhere, at project-syndicate.org, that while growth is slowing, the non-performing fixed investment problem will be manageable. The growing influx of rural population into urban areas will absorb some of the housing build up while the Chinese banks have the liquidity to absorb potential property losses. Inflationary problems, especially food inflation, still exist as a risk, and with the European markets slowing, China's export trade will be dampened. Some help will be gained by increased consumer spending, and economic rebalancing long term will take place, Roach maintains. He points out that successful "strategic transition" has been the hallmark of a developing China, and should continue to be. For us as investors, although we know Chinese ADRs have been hit hard, we still need to be careful but attentive to the opportunities that may present themselves.

---

---