Sober Realist

China and Emerging Market Investing: Real Basis

More interesting is this WSJ article
online.wsj.com/article...

---U.S. Treasury Secretary Timothy Geithner heads to Beijing this weekend to urge Chinese leaders to fundamentally alter the export-oriented economy that has created years of trans-Pacific trade tensions.
---... he is also planning to press Beijing to take drastic measures to turn China's economy into one that depends heavily on sales to domestic consumers and less on sales to the U.S. and other foreign markets, according to a senior Treasury Department official.
---The message signals that Treasury is beginning to look beyond the current crisis toward preventing a return to ever-mounting trade deficits and the constant political tensions they generate between the U.S. and China.

China and Emerging Market Investing: Real Basis

On May 30 08:18 PM Danny Furman wrote:

> Just presenting the other side because this is such a 1 sided crowd
> (not something I wrote):
> seekingalpha.com/artic...


I followed the link and read the article, but what I found more telling was the single comment at the end of the article from an American living and working in China:

"drDimick.com
From my three years throughout China, although not bilingual, what I hear and see indicates a lack of market (or macro) orientation regarding economic cycles. In effect, most here assume that "the crisis" has done its worse and the world is now on the mend.

Although not exactly what folks in the money business care to consider at this point, notation may be at least made as to the last time that the global economy experienced a down cycle in the absence of the Glass-Steagall Act...

There was a bounce after the 1929 crash. Less than two years later, a second, even worse drop occurred. Those who invested during the bounce did not see even-money until the early 1950's.

I am not a doom and gloom type -- actually, not much of a bull either. I only call attention to the historical significance because of exactly what China lacks... context of the past seven years (2001 to 2008) of rapid grow.

Here in Beijing, near Tsinghua University, I frequent street markets. Illegal street vending is my parallel indicator to Rockefeller's shoeshine.

The story goes... One morning, Rockefeller stopped en route to the office for a shine. During the polish, the young, enterprising man said, "Hey, I got a great stock tip for you this morning." Back in the office, upon reflection, Rockefeller began liquidating his portfolios -- some two years before Black Tuesday.

The rationale? Rockefeller was reported to say that if shoeshine boys, nurses, and 9 to 5 workers were boasting hot stocks, it was time to get out of the market. It was, in effect, over bought.

My indicator here in China is the "Street Vendor Factor." Although SOE's continue to dominate China's economic landscape, a nonscientific bellwether is who and what is being sold on the street, namely sidewalks.

Here in Beijing, during the last three months, I have noticed two anomalies. First, horse-drawn vegetable wagons; yes, here in Beijing, I am seeing more of them -- five in a row the other noon. Didn't see one six months ago.

Second, vendors selling clothes from the trunks of cars. The only time that I have seen this before was in Shenzhen last year -- one car, a guy selling ladies shoes. Surprised, I called my girlfriend in Wuhan to see if she wanted me to buy a pair for her right there, right then.

That second observation may indicate how the economic decline may be advancing into the government proclaimed middle class. Most of my Chinese streetwise sources, I note, usually poo-poo this supposed 350m amassing of a four-door sedan driving, franchise consuming demographic.

Both factors constituting my indicator tell me that, although the central government's $500b stimulus may be propping up the mammoth state banking and industrial complexes, the ice may still be melting beneath.

I have spent three years now here in China. My China business and investment book was published last month by Wuhan University Press Beijing. The text offers nothing new in terms of investment banking precepts and strategies; my hope is to offer context and orientation... namely hedging inbound and outbound considerations of China related propositions.

That said, I remain cool, at present, to the idea of following Chinese players any further away from this pond's shoreline, regardless of how big the body of water "appears" to be.

dr

China and Emerging Market Investing: Real Basis

Mr. Gamble,
You actually pretty much answered my question about the "potential rise of a sizeable middle class in China" with a comment you gave on a previous article of yours (if you have anything to add, please do):

On April 28, '09 William Gamble said:
"I agree with Jun Ma about the peak and the next valley. I am just not sure that China can change its model. This is the same reason why I am not sure that what economists often look at as great fundamentals necessarily translate into sustainable economic growth.

Latin America's per capita income in the 50’s was 25% of the US. Asia’s was 10%. It was thought that the mineral wealth, sophisticated society, education, and people would allow Latin America to catch up in 30 years. Today Asia’s per capita income is 25% of the US, while Latin America is 20%.

Africa has enormous potential and had had since I was born almost 60 years ago. It has never lived up to it.

Economists are just beginning to understand something that I think is crucial. The rules. (see Good Capitalism, Bad Capitalism, Power and Prosperity. Good government is the magic ingredient that helps all of the other assets actually produces wealth. It’s like two business firms. One succeeds. The other doesn’t. Good management is the difference.

Still however good a manager is, it is rare that they are always right all of the time. The average age of a Dow company is only 40 years. The average tenure of a CEO is 10 years. Half that for a Fortune 100 company.

The question is whether China can change with the same set of leaders. I am not sure if it can. When leaders everywhere get into power they compensate the people who keep them there at the expense of the economy as a whole. As time goes on the situation becomes worse.

To change China will have to change its model or the W will turn into an L."

China and Emerging Market Investing: Real Basis

An article published in Seekingalpha also highlights the problems discussed by Stratfor that China is really avoiding real structural changes to their economy:
China: Exports vs. Domestic Demand, The Argument Rages
by Michael Pettis
seekingalpha.com/artic...

By the way, China's exports continues to plummet, 23% in April.

China and Emerging Market Investing: Real Basis

Mr. gamble,
One investment thesis that has caught my attention is the following: "China's billion plus people will provide an immense market for Internal growth and consumption."

So I ask, how big is China's so-called "middle class" or does it even exist? Can china convert from an export-driven economy to one more reliant on internal consumption?

I ran across the following article from two days ago:
www.theglobeandmail.co.../

The downfall of the American free spender doesn't guarantee the rise of his Asian counterpart. While there is plenty of support for the China-will-lead-the-way theory of global recovery, which hinges mostly on government stimulus spending, there is less for the Chinese consumer rising to the occasion. Analysts who keep close tabs on how China is faring at creating a strong domestic consumer market warn that the country faces serious obstacles on the road to Western-style consumerism, and it could be decades before these are cleared away.
“There's nothing that really supports a consumer society in China right now,” said Jennifer Richmond, China director with Stratfor, a global intelligence company. “In 10 years, we might see the seeds of it. But the likelihood of the Chinese supplanting the American consumer is quite slim.”
China's consumers account for about 35 per cent of GDP and just over 3 per cent of the global economy. By contrast, U.S. consumers still account for two-thirds of the vastly larger U.S. economy and about 17 per cent of global GDP. “The mathematics are daunting,” said David Rosenberg, chief economist and strategist with Gluskin Sheff + Associates in Toronto. “For every 1 per cent decline in U.S. consumer spending, Chinese consumer spending has to grow by 5 per cent just to keep things where they were.”

And another article from a couple days ago:
www.time.com/time/prin...

"With history books replete with tales of V-shaped recoveries following steep downturns, financial markets have become giddy, hoping that signs of bottoming beget the long-awaited rebound. Nowhere is that more evident than in Asia, an increasingly China-centric region convinced it will lead the world out of its long nightmare.

If it were only that easy. Contrary to the lore of the ?Asia century,? the region continues to suffer from a lack of internal support from its 3.5 billion consumers. The private-consumption share of developing Asia?s overall GDP fell to a record low of 47% in 2008?down from 55% as recently as 2001. In other words, Asia remains an export machine. Developing Asia?s export share rose from 36% of pan-regional GDP during the financial crisis of 1997-98 to a record 47% in 2007. And recent research by the International Monetary Fund shows that Asian exports continue to be underpinned by demand from consumers in the industrial world?especially from the U.S. Despite a surge of trade within Asia, the bulk of these intraregional flows have been concentrated in parts and components that go into finished goods eventually consumed by developed economies.

Little wonder that in the aftermath of a record contraction in U.S. consumer spending in late 2008?4% average annualized declines in the final two quarters of the year in real terms?every major economy in Asia either slowed sharply or tumbled into deep recession. More than ever, the region?s fate remains made in America.

This is where hopes of an Asia-led rebound are most tenuous. After a dozen years of excess, the overextended American consumer is tapped out. The ?green shoots? crowd?those believing global recovery is nigh?drew special encouragement from a 2.2% rebound in real U.S. consumer expenditure in the first quarter of 2009. That encouragement is about to be dashed. Outright contractions in retail sales in March and April point to a renewed decline of at least 1% in real consumption in the current quarter."

I did a little digging over at Stratfor and also found this:

"The Problem of Export Demand
But for China, the real problem remains export demand, not whether they can kick-start manufacturing and subsidize exports to keep product flowing. Exports are the true engine of the Chinese economy, equal to more than 30 percent of GDP. Exports fell 17.5 percent in January, compared to the same month a year earlier. They plummeted 25.7 percent in February, and then recovered slightly to post just a 17.1 percent drop in March. This deceleration of contraction was trumpeted as an improvement. But it is still very bad for an export-dependent economy to see exports drop by nearly one-fifth along with similar drops month after month.

The government will have to keep its fingers crossed that it can meet the official 2009 estimate of a mere 5 percent export contraction. Meanwhile, imports have dwindled by 43.1 percent, 24.1 percent and 25.1 percent in the first three months of the year respectively, despite the government’s strenuous efforts to use fiscal policy to increase domestic demand. Other attempts to create a domestic demand-driven recovery have included the issuance of coupons and vouchers for rural consumption of big-ticket items like appliances and automobiles. And while these have spurred sales, these are not sustainable patterns, they have required a substantial portion of government money, and in many ways, they have simply absorbed surplus goods sitting in the warehouses and on lots rather than spurring new manufacturing.

The government has offered tax breaks and rebates to help exporters keep exporting whether profitable or not. It is offering incentives and threatening punishments for companies to retain workers whether necessary or not. And it is urging banks to loan more money — and the first three months have seen a massive increase in domestic loans to companies (though primarily to state-owned enterprises, not the private sector) to help them fulfill their employment and export requirements — whether profitable or not. At the same time, real estate prices are falling. On the surface, this may seem positive for those looking to buy. But it may have a major impact on Chinese companies that have been using inflated real estate as collateral for loans. So even as China is showing economic activity, it may be digging a deeper hole than before the current crisis.

The problem for Beijing is that the days of 12 percent and 13 percent GDP growth look to be over for quite a while. Moreover, China’s recovery remains heavily dependent upon a major recovery of global consumption (particularly in the United States). But that is by no means guaranteed. While there are signs of hope for the U.S. economy, they do not necessarily mean consumption levels will surge again as if nothing has happened. Even a U.S. recovery in the second half of 2009 followed six to 12 months later by Europe would leave China’s recovery another year or more in the future. Which leads to the dilemma Beijing faces."

And where is the Chinese middle class:
www.thedailybanter.com...

There are those who have been trying to warn us for a while now that China's middle class was merely an illusion. In a 2007 article for BusinessWeek, Arthur Kroeber, editor of China Economic Quarterly, stated blankly that, "China doesn't have a middle class.". He blamed deceptive figures released by the Chinese government for our misperception of the situation, and estimated that total purchasing power in China to be half of what was being reported at the time. And such purchasing power was concentrated among the well-off in a few privileged urban areas. "As far as significant retailers are concerned, out of China's 1.3 billion people, 1.2 billion simply don't count," he stated.

Such views were recently echoed by David Goodman, professor at the University of Technology in Sydney. Goodman argues that the "middle class" that we see in China's urban centres are an exclusive elite forging ever-closer links with the ruling Communist party. "They are neither independent of nor excluded from the political establishment, which on the contrary seeks actively to incorporate them," he states. He attributes this development to former party leader Jiang Zemin, who "opened the doors for capitalists to join the party."

While everyone seems to have an opinion about China, these arguments seem to be supported by recent events. As China's manufacturing sector has witnessed a significant drop in foreign demand, its earnings, as well as the money that in turn pours into government coffers, have dropped substantially. As a direct result of this, the growth of China's domestic economy has plummeted."

And recently a business who lives and works in China made the following comment on SA:

On May 28 10:10 AM
"...As for the specifics cited, all that I can say is that the Chinese banking and SOE-dominated economy is bankrupt. This last stimulus package -- equal to one-third of its foreign capital reserves -- was necessary to prevent the system from seizing into a series of defaults.

If the US and EU decide to halt treasury payments due to the CCP's government sponsorship of the North Korea regime, the social-economic consequence would return China to its cultural revolution era -- overnight.

Chinese people understand that reality relative to the dictatorial structure of the regime under which they live here. As I gather you do not, Chinese people understand Chinese history a la the 14 dynasties preceding the CCP. All 14 are considered by those whom I talk and study with to be dictatorships that repeated patterns of social-economic dysfunction that eventually resulted with demise.

Hence why common Chinese citizenry save (cash, not via financial instruments) at such high rates. The people here live in fear. I mean fear...

Most Chinese people personally experienced some aspect of the last social-economic breakdown of the country (i.e., the Cultural Revolution). They know the craziness, the inhumanity that results from a system, this system that is absent rule of law and those First Amendment Rights of freedom of speech, press, and religion.

Until those systematic inequalities are resolved to the satisfaction of the majority of the Chinese demographic, your article serves as a disparate collection of statistics and analysis."


So my general thought is that there will never be a "middle class" in China without the dissolution of the CCP.