odin

Two More Myths About Business in China

The telling comment is: "I want to enjoy life now before I get old. My salary keeps rising, and spending will help me get the career I want."

Havent we heard this tune before? Perhaps in this country -- when a hourly wageearner gets the McMansion on a ARM? There are a lot of assumption this young lady is making about the future.

The standard of living is undoubtedly better than it was in the years past. How could it not be? China has grown its aggregate wealth (in latter years, at the expense of the deficit-producing nations) faster than its population. But the question we ask is not if things are better today but if they will be even better tomorrow to the extent that they satisfy people and keep those 86% people equally optimistic? Is this growth sustainable? There are vast expecations that underlie any rise like this. That is the disconnect between what the author is saying and the complaints about China. As news of this young lady's lifestyle and research from experts like Shaun reaches more and more people in China (including the rural areas), they, too, will want to dine at Pizza Hut and get weekly pedicures. Any departure from realizing those expectations is a recipe for unrest. Even with the breakneck current rate of growth, China adds 12M unemployed to its roll. This is not to compare to the level of un/underemployment in the past. Those people in the past had very different expectations for their future and hence did not think that a life spent never having eaten at PizzaHut was such a terrible thing.

Sure there has been growth...but has it resulted from wise investments?. I remember highways just outside of Beijing packed as far as the eye could see from trucks carrying construction equipment. Will the houses and offices that got built find occupants that justify the cost? Is the $200B being spent on railways similar to the money spent in the US on highways after WW2? Only time will tell. There are people, like Shaun, who are in a different profession and take the optimistic view. I ask, realistically speaking, what is the probability that they are wrong? And even if its low, what the cost of being wrong? I risk losing the upside (as I have this year) but I tend to err on the side of caution.


On Nov 14 02:14 AM huangthomas wrote:

> I want to make my criticism as transparent as possible, let me explain
> that "Anna move from Tokyo to Shanghai". Japanese sociologists describe
> the "Anna phenomenon" decades ago. The young single female get free
> loading of room and board from their parents and freely spending
> their income to promote their life style. The same phenomenon move
> from Tokyo to Shanghai or Beijing as the economy develops in China.
> I do not wish to impose any moral judgement to the life style, but
> I do call attention to the fact that the life style is not sustainable.
>
>
> How about the unmarried single male? Well, they are not as lucky
> as single female. They have to consider three zi. They are fang-zi
> (house), che-zi (car) and ying-zi (silver ingot, which means money
> in China) before they can attract any niang-zi (young lady) to marry
> them. I don't really care how and how much money Anna make. It is
> simply a social phenomenon that we have to pay attention to.

China's Economy: All GDP Is Not Created Equal

China faces difficult challenges - while rebalancing is desired, it MUST grow. The short term incentives are heavily skewed towards providing continued employment -- even if it is on digging or filling holes. Just as the US is kicking the can down the road regarding inevitable slowdown in consumption, China is delaying the bitter medicine of shifts in employment patterns.

Continued structural imbalances and nascent signs of conflict within the governing structure (Xi Jinping failure to make it to the Central Military Commission) do not bode well for the well-being of the world.

China’s August Data Confirms Both Optimists and Pessimists

I am curious as to the breakdown of retail sales. Where is this growth concentrated? It is clear that asset prices in China have skyrocketed in the past few months. Is it possible that this has made a small segment of the population feel wealthy and splurge (just as rising house prices in the US led to better times for the luxury market)?

When I think of and hope for rising domestic consumption in China, that is not quite the rise I trust. Consumption by a small segment of the population based on paper wealth is likely to come down just as fast. The consumption that global companies get excited about is broad-based -- driven not just by buying cars and luxury goods but by spending on mass-marketed goods (appliances, apparel etc) -- and based on rising wages and consumer confidence. To some degree, that is the hallmark of Chinese growth story (and while export subsidies did transfer away wealth from the workers to the exporters, its also undoubtedly true that a significant portion trickled down).

As to the risks facing the Chinese (and global) economy due to its export orientation and a point that Prof. Pettis has been making for a while (nations running a surplus are a lot more vulnerable than those running a deficit when there is overcapacity in the system), read these shades of Smoot-Hawley: www.ft.com/cms/s/0/f67...

The Shanghai Market Calls the Tune

The story about the attacks is significant not so much for its contents (after all, I'm sure more people get hurt by more violent levels of crime in areas bigger than Urumqi) but as a reflection on the state of the people. The fact that fear (especially rumors) gets wings like this among a large section of population (enough to get international attention) and rapidly gets transformed into anger against the GOVT (www.timesonline.co.uk/...) is significant and worrisome.

From a psychological perspective, it reinforces the idea that despite other signs that may be impacted by governmental interference, the ordinary people are concerned about their future, nervous about the changes that may come and distrustful of the government to solve their problems. It is in such environments that random rumors grow bigger than life and cause headaches for governments and force them to make sub-optimal choices.

Of course, this is just one incident and I wouldnt want to let the imagination run wild solely on this story but I keep my ears open for similar signs of discontent and fear (which to me portend tougher economic times)

What Happens in China Doesn't Stay in China

Its perhaps the years I have spent practising this trade that makes me sound silly but reserve requirements are one tool -- a blunt tool -- to manage the money supply. China CRR is 15.5%, the US is 10%. Furthermore, you will find that the US pays interest on excess reserves and the actual reserve ratio is much higher (lending is depressed). Given these levels of reserve requirements, perhaps you will be kind enough to explain how bank stability is much superiorly managed in China. Comparing to what happened during the credit crisis, as loans go sour, I doubt you are claiming that extra 5 1/2% reserve cushion is what makes the difference for financial stability.

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?

What Happens in China Doesn't Stay in China

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.

Debate Continues About the Validity of China's Economic Data

There is a lot more unity in views that the market is bubbling but are quite a few unanswered questions re: who is speculating in these markets. The more interesting questions are what happens after there is a large correction in China. I dont claim to have the answers but the right questions are just as important.

If the Shanghai market unravels, will there be contagion effects in commodities and real estate in Asia (undoubtedly)? Will this contagion spread to neighboring or other emerging markets (shades of the Asian crisis)?

And what impact will this have on local population (esp. if the average Wang or Lee has been speculating in these markets and borrowing to fund his position)? Unrest in China? Military adventurism in the Pacific?

What about the impact on US retailers whose profits are largely derived from labor arbitrage (Walmart)? What impact on consumers who have gotten used to cheap goods?

China's Helicopter Wen: World Champion of Money Printing

This is trade protectionism by another name. While China is not officially devaluing its currency, its certainly trying to dent its high intrinsic value (the value if the RNB was traded in the open market). The goal ostensibly seems to be support of the "exporter" classes -- so that the worker classes remain employed and happy. (Chinese form of trickle-down economics?)

However, the reality seems that the easy money is getting channelled in financial speculation (equities and commodities). Inventories are building. This seems to be causing some demand "push", as this is being interpreted as "green shoots" by the entities in the middle of the chain (or even supporting consumer optimism).

However, it is the sustainable consumer demand that matters and it is yet not clear to me that it is there -- whether from the Chinese consumer (which is ultimately NOT the auto-buying upper middle class nor the nouveau rich speculating in real estate nor is it the workers and students who are borrowing to buy stocks but the vast majority of Chinese households who would want to spend _earned income_ on various goods and services) or from the deleveraging and increasingly frugal US consumer.

Every good decision-maker (and investor), as MacroMan aptly points out, should consider the possibility that he is wrong and hedge accordingly. I wonder if the Chinese establishment has considered this case where they are wrong and the easy money does NOT trickle down to the workers, that jobs do not get saved, and whats worse, causes a crash in financial assets where people are playing with borrowed money. Anyone remember the agitation for govt support of the markets in 2008 when Chinese markets were falling?

What Does the Lack of Volatility Mean for Markets?

For the record: I do not believe that the US and China will start a war over any issue in the foreseeable future.

But I do believe that if the status quo in China were to be threatened, an external conflict is one of the key levers that the government and the army can push to drum up nationalist fervor. Still, the US will hardly be the first target.

Japan, given its economic and demographic trajectory and the historical context between the two nations, lies square in those cross-hairs. (It is no coincidence that at no point in the long history of these two ancient civilizations have they _shared_ power at the top in Asia. One or the other has dominated).

It is hard to imagine wars starting openly between nation states in the future. However, there is a lot of potential for small conflicts to get out of hand and the pain thresholds to be heightened. (Austria-Hungary/Germany did not attack Britain and France to start WW I)

On Jul 10 05:17 PM LilBob wrote:

> Regarding the Raytheon and Lockheed comment. The US economy is so
> dependent on China right now, we could never go to war with them.
> We even get the majority of our pharmaceuticals and enormous quantities
> of pharmaceuticals from Japan. The US wouldn't even be able to keep
> our own Hospitals running without cheap Chinese medical supplies.
> With the way that this country has grown so incompetent at controlling
> costs in health-care, JUST a cast for a broken arm would cost $15,000
> without China supplying us. (Currently an arm cast in this country
> only runs around $5000, honestly couldn't believe that when I saw
> the bill a cousin of mine received.)

What Does the Lack of Volatility Mean for Markets?

Dangerous game being played in China: They dont want a weaker dollar, yet dont want to concentrate further in the dollar (increase risk). What they want is a third stronger currency, so that they can both diversify away from the dollar and still keep the yuan weak (and continue to export capacity and build up surpluses against this third currency). Of all things, they would like another superpower that can assert itself economically and militarily against the US. This is not a stable situation.

You cant continue to buy up assets (mining or real estate or whatever) if you continue to build up an unstable world. In spite of the fiscal and monetary stimulus in China, the benefits are not accruing to the rank-and-file. The money is being used for speculation by the noveau rich in China. (Auto sales are up? Hallelujah! But how is unemployment doing? Food prices? Wages? Exports? Are the factory workers buying up these autos? What about new and newly unemployed grads?)

Inevitably, as global appetite for all things Chinese falls (falling trade, falling credit and inability to accomodate a weak yuan subsidy), some of the speculative projects will fail. Bets on rising commodities based on "green shoots" of Chinese demand will fail. Bets placed with renewed enthusiasm in real estate markets will fail. In the foreseeable future of an aging, tapped out consumer, the world will not grow fast enough to accomodate such foolish investments.

(Idle speculation alert)
This is a recipe for great unrest in the future as unemployment rises. And this will not be a Tiannenmen Square composed of disgruntled students or elites. Any bets on what the powers that be in China will do then? Watch out Japan. Its not so much gold, but Raytheon and Lockheed that are in for bumper times.

Chinese Takeaway: Capex Growth Keeps Humming Along

MM: This, of course, begs the question of who the Chinese plan on selling to. It's all well and good continuing to build factories and export capacity, but the real world isn't like Field of Dreams; just because you build it doesn't mean that customers will come

A great point succintly made. I often wonder that myself. While there is a great deal of incentive for the Chinese authorities to keep the factories humming and to initiate New Deal-esque programs, they seem to all target export-oriented industries. While the actual impact on economic recovery is debatable, the New Deal investments (for e.g. in the highway system) produced great RoI over the long run for the nation. This was so because the US is capital-rich and the vast center of the country is very productive. I am not convinced that spending vastly on infrastructure development in barren west of China will produce quite the same sorts of returns.

I have heard that there is a great deal of mineral wealth in the hinterlands but I must admit that I havent dug deeply into that story. However, if true, developing infrastructure will indeed prove profitable -- more so than spending money abroad in questionable areas and on questionable regimes to acquire mineral resources. (If China thinks that property rights in Africa or South America are sacrosant, they are in for a surprise.) But, I dont see infrastructure development targetted towards such growth (highways, waterworks). The energy generation projects also seem to be targetted towards industry/manufacturing. But these are all shallowly researched opinions. Would welcome more of an expert commentary.

China's Statements About U.S. Debt Are Overblown

For the same reason domestically a rich man wants to trade with a poor man in the same country.

Life is mean-reverting in the very long run but we still struggle to maintain our relative advantages.

I dont buy that trade is a zero-sum game. While we export jobs to China, China exports goods to us to raise our std of living (supposedly... those $10 flying choppers ARE terribly entertaining... who would have thought even 10 years ago that you could buy a sophisticated flying toy with a microchip for $10!), Net-net, China has future claims against the US and hopefully will exercise them in the future when they run a deficit and provide employment to a new generation of Americans.


On Jun 01 03:46 PM infp wrote:

> On a very simple level, I never understood how globalization could
> be broadly beneficial for a wealthy country like the US. If an average
> US worker is making $20/hour and an average Chinese worker is making
> $1/hour, eventually I would expect them both to make $10.hour. I
> do not offer this extremely simple observation as an indictment of
> globalization, I simply offer it as my expectation that some sort
> of global salary equilibrium is inevitable in a global economy.

China's Statements About U.S. Debt Are Overblown

On Jun 01 01:08 PM Donald Ingram wrote:

> First;
> The Chinese don't mind "taking the hit" as you put it. However it
> will be at a time of their choosing. Get ready for the rug to get
> yanked!

Very true. The Chinese central banks (or the ruling regime) may be less concerned about the yield on their fx reserves. The main agenda is the value of the RMB (to keep its factories humming and provide continued employment). However, the Chinese are giving up current consumption by accumulating these reserves -- they should want to consume them at some point as the bulk of their population moves through its productive years into retirement (20+ years down the road) with a much smaller workforce to support them (1-child policy). Low US inflation and safety of principal is not totally irrelevant to them.

> Second;
> "Need these exports"? They would be nice to have, but they really
> don't "need" them to survive and prosper.

Sure they do. Tiannenmen Square happens when you have hundreds of millions of unhappy people. Rising standard of living is what keeps people happy. Pissed off Chinese workers agitating for a revolution is a key "black-swan" event in my play book. It is likely that risks of violent conflict between nations rise in that case to build up nationalist sentiment and deflect attention from domestic problems (Taiwan, Japan look to be the main sufferers in this case. It is not lost on me that many major economic crises have been followed by wars. It is also an important point that in the thousands of years of history -- China and Japan have never shared regional power and there is considerable latent hostility in china towards the former imperial power, which by all measures is collapsing under the weight of demographics.)

However, the export-policy is not sustainable. They need to increase _PRIVATE_ domestic consumption. Stockpiling commodities or growth in state-sponsored behemoths is not the answer. The commodities are only as valuable as the strength of the buyers that the Chinese will want to sell their exports to. And related to domestic civilian growth projects -- someone should _need_ and want to occupy the building complexes that are getting built. It is not clear to me that spending on infrastructure mega-projects in China is the need of the hour. They have a terrible history of inefficient use from a cost-benefit perspective (Three Gorges for e.g.). Growth in China has come entirely from its coast -- I want to go further and cautiously add that it can primarily come only from its coast (interior of china is parched, relatively sparsely population though I am unfamiliar with the availability of other natural resources...). China needs to spend on education, healthcare (with pollution levels having exploded in the past 20 years, its only a matter of time before the piper will need to be paid), social safety nets (domestic harmony -- despite the cultural norms, it is unlikely in the long run that 1-2 productive adults will not be stressed about supporting an additional 4 non-productive adults+kids).

> Third;
> They know EXACTLY what their course of action is and where it's going.
> To assume otherwise would be to underestimate them. Big mistake.

The Chinese government is indeed far-sighte--more so than a democratic one would be--but precisely for that fact, it is also constrained by the politics of their situation. But it would be folly to assume that the decision-makers are not narrowly self-interested.

>
> Fourth;
> They are moving into gold in a big way. The central bank of China
> has already put in a reserve bid for the upcoming IMF 403 tonne gold
> sale. All of it! Good way for them to unload some their US dollar
> holdings!

As pointed out in the article, the supply of gold is very limited and it is not possible for any central bank to accumulate meaningful amounts of gold without moving its price. (And higher gold price implies inflation...something the Chinese do not necessarily want, if they want to maintain Chinese competitiveness).

> Fifth;
> Real estate prices are a fore gone conclusion, they will be in the
> tank for years to come.

While very true that it will take years to recover and may not "bubble" again for decades, "they dont make land anymore". But a growing population will still need to be housed, construction still depreciates and in an inflated future, real estate does maintain its value. Speaking of which, do you think the Chinese central bank will want to buy Las Vegas from us?

> Sixth;
> The Chinese Yuan (Renminbi) will be the next worlds reserve currency.

The reserve currency status is mainly determined by military strength. China, undoubtedly growing in this regard, has a lot of distance to cover before it can lay claims to this. It needs to float its currency to become a reserve currency (causing it to rise and lower competitiveness of Chinese exports). Rationally, the time when China will want to do that is when it is cashing in its claims on world productivity (when its aging population causes a trade deficit and it is no longer accumulating $ and has much weaker _economic_ growth prospects). Remember, the TIC data shows that China even now is accumulating US $ reserves (at a pace not too far removed from the frantic one we saw in 2008)

> This is what the Chinese are working towards. Yes, it will take years,
> but what are years when you plan in generations?
> Seventh;
> This is the most asinine presumption of all - "Work off the debt?"
> Your children, your grandchildren and their children will thank you!
> The only way the debt will be paid is with dollars that are worth
> pennies!

The only two ways to pay off our debts (private or public) is to either inflate it away (very likely in the long run but unlikely in the short run) or to grow into it. I think the combination is the most likely scenario.

Waxing a little philosophical: growth due to technological shifts should not be underestimated -- take any snapshot in time (20 years, 50 years, 100 years) and its amazing to me the exponential explosion in knowledge. Average quality of life is still on a upward trajectory. And the US is on the forefront of such growth. We may not feel that way because expectations of what "average" std of living have been rising faster than the actual rise. I am very optimistic about the future of the US -- by far, it is the one nation that is most open to progress, the most innovative and the most welcoming and nurturing of raw talent. And a part of the "hostility" that Americans sometimes feel abroad is somewhat traced to this I think -- with 24x7 info flows (CNN and American pop culture exports), people in repressed regimes often ask: 'Why do we not have that?' The answer accepted (and sometimes given by their ruling regimes) is not often based on self-evaluation but by deflecting blame onto Americans.

Emerging Market Equities Now Far More Interesting than U.S. Market

This is exactly the point.

While quantity (esp. obtained at a cheap price) can make up some of the shortfall, quality still matters a lot.

The perception that BOTH quality and quantity of graduates is high comes from the fact most of the Indian and Chinese graduates the west encounters are the best and the brightest.

However, in both those countries, because of the competitive job market, having a advanced degree becomes the equivalent of having a HS degree here. It doesnt matter what you know, you need to have the paper credentials (from someone...anyone). Hence the proliferation of low-tier educational institutions that will grant vast amount of degrees. Students (with ability and will) are not the only input in producing high quality graduates. You need other resources as well, which are still lacking.

It will continue to get better, but the myth that there are simply hordes of Indian/Chinese graduates waiting to compete with western grads is simply not true. (However, it is true that a large majority of grads in western institutions do come from abroad--usually the best & brightest--but generally, they add to the workpool in their adopted countries rather than their native lands.)



On May 21 08:56 AM Expat in Tokyo wrote:

> I work and live in Tokyo and have lived here 5 of the last 12 years.
> You are naive to think that every student that graduates in China
> or India have received equivelant educations as American students.
>
>
> I am an engineer manager and have been for 15 years. Only around
> 25-30% of the Chinese engineers are equivilent to US engineering
> graduates They are getting better every year. But the vast majority
> are not nearly as productive as the US or Japanese engineers. Their
> schools as are not as good as US and Western universities and will
> not be for a while. The Indian technical schools are good, but they
> are few in number.
>
> With that fact base on my experience in Asia there still are a heck
> of lot of Chinese and Indian graduates each year.
>
> So the American technical workforce is still the world's best overall
> and will remain so for the next 25 years. Yes, the rest of the world
> is gaining but not anywhere near the rate that many people prophetize
> - who only look at the raw numbers of students!

China: April CPI Comes In Higher Than Expected

Any natural disaster like this is a tragedy and it looks like the toll in terms of life and property will be higher than the first guestimates. However, I dont think it is quite on the order of the 1995 Kobe quake. Chongqing is also inland, away from major export ports so relatively speaking I doubt that the actual damage will be significant.

However, if you try to guess at the sentiment and the impact on the market, you could flip a coin.