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China Interest
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Don’t need to know who I am. My identity will remain anonymous. I am well educated in Economics and Finance, and I have extensive global work experience in Asia, Europe, and North America. My overall purpose for this blog is to cut through the BS, and provide an independent, unbiased, and... More
  • Being Misled about China (Part 2): Unbalanced Growth
    Field of Dreams

    The construction industry has played decisive role in the grand plan to push the Chinese economy forward. In the past 30 years there has been unabated construction of new residential buildings, office towers, highways, bridges, railways, and factories. However, there is now enough overbuilt in China to make an easy statistical eye-ball observation that supply grossly over represents utilized demand. In fact, it is becoming quite clear that much of the current construction will never see the day when it is used. There are many residential units in the city peripheries that have been     unoccupied for more than a decade. This can be verified by walking in almost any city in China and counting the number of apartments without lights on (at night) or without air conditioner units installed. The new office towers in Central Business District of Beijing, Chongqing, or even Shanghai are also vastly under-occupied. For example, perhaps more than 50% of the office tower space in Beijing doesn’t have occupying tenants. And while city roads are clogged with traffic, new toll highways are a joy to ride because they are almost without cars. New airports and other recent infrastructure projects are vastly underused. As well, it is documented that manufacturing capacity in China is well ahead of itself and already has enough overcapacity in many industries (i.e., PV solar panels, shipbuilding) to easily supply any substantial growth from a world economic recovery (that seems now to be a distant likelihood). Yet all this begs the question as to why developers and manufacturers all over China continue to build and construct even more? Fixed investment accounts for more than half of the overall GDP growth in China and consumption accounts for only about 34% of the overall GDP (Y = C + I + G + NX). This means that consumption as a percentage of overall GDP continues to steadily decline (it was about 55% in the early-1980s and 37% in 2008). 

    Consumption depends far too much on the purchases from a small rich elite class concentrated all within the urban cities, and not nearly enough on a middle class. The middle class in China remains relatively diminutive, and undersized, and it is doubtful that it will significantly grow under the current scenario (of corruption favoring the elite; a misallocation of capital resources; subdued service sector; uncertainty about peoples' financial needs for the future; and a lack of white-collar jobs for recent university graduates - all of which will be discussed later). And it is even more unrealistic to believe in the near future that the migrant working-class will be added to the middle class, or those who remain in the smaller cities and the rural regions will be lifted out of grinding poverty.

    Investment Overhang
     
    Without an adequate market to signal when to stop construction, the asset prices have inflated well beyond the market fundamentals. Residential units are listed at prices in the major cities at many multiples above peoples’ incomes. It costs 20 or 30 times a household’s annual income to buy a modest apartment in any major city. But property prices still haven’t even leveled off. Why?
     
    Let’s begin by dispelling some of the common reasons given. Some people have argued that Chinese people are particularly adept at saving their income over an extended time using discretionary income that is often underreported for tax avoidance reasons in the grey market. And while this reason is partly true, this still means that the average citizen in China would have needed to save more than half their income for the last 20 years solely for the purpose of being able to put down the first payment (at least 30% required) on a lease (for 70 years) for their new property. This reason neglects to account for the fact that incomes are much higher today than 20 years ago, and that many people in China are also saving for their own child’s education, and the need to put their own money aside for unplanned sickness and their retirement. A better provided reason given by Arthur Kroeber, a Beijing consultant, argues that lots of people in the major cities already had property (prior to the sharp property price increases), and were then better positioned to trade up despite income being insufficient to support the overdone property prices. But the main problem with this argument is that it still doesn’t explain why so many of the properties remain empty - many of the residential units have been left unoccupied for many years. A more likely, and thorough explanation is that without a property tax and with few alternative investments, the rich investors are motivated to stockpile apartments on an assumption that property prices will continue to go up. If these residential units haven’t been rented out for income (which is mostly the case), then they can only give a positive return to the investor on the notion that the next buyer will pay more. However, because the prices are well beyond the household incomes that first time buyers will ever be able to afford, the residential properties are being traded among these rich investors (who are often the property development companies themselves) on the premise of continuing to find another investor to pay an even higher price. This leaves anyone in the middle class that are without property out of the market. The only reasonable conclusion is that this is nothing other than a Ponzi scheme, in which someone in the game of musical chairs will be left without a seat. The famous short-seller, James Chanos has described it as ‘a treadmill to hell’ and ‘Dubai X 1,000’ for justified reasons.

    Export Dependence

    China    ’s growth has and will still be for some time coupled to the export sector. China’s labor force and economic strength are largely dependent on being an intermediary for final processing in a value chain. China imports semi-processed products from neighboring countries (i.e., Japan, South Korea, and Taiwan) and exports final assembled products around the world, with the dominant markets in the United States, the EU, and neighboring Asian countries. However, these markets have reached near import/consumption saturation in the current economic cycle, and with weak growth are unlikely to substantially increase their purchases in the near future. This leaves China in a quandary as to how to maintain current levels of economic growth from something that will no longer work like it did for the past 30 years.

    Thus, to summarize, the Chinese economy is far too dependent on fixed investments and a flawed export model that have squeezed consumers out of the market. The government despite saying the opposite are clinging even harder to supporting more investment and exports. This is causing the imbalances to get larger. This then leads us to the next part of the series on how this is unsustainable.
    Tags: China, macro view, market outlook, economy
    Oct 05 8:49 PM | Link | Comment!
  • Being Misled about China (Part 1): Common Misconceptions
    Illusion of Grandness

    It could be easy to forgive the general public for being unaware that China's economy is unbalanced and unsustainable. Besides the stakeholders (media and the investment institutions) telling us positive hype, the Chinese central government and its leaders covet at every possible opportunity the chance to look unparalleled in the world. This is played out in events like Beijing Olympics, Shanghai Expo, and, Guangzhou Asian Games. The Chinese government showcases the very best that central planning can buy (no matter the cost). For the business visitor or the dignitary it is routine to have lavish banquets be bestowed on them at almost every opportune moment. However, what high-roll spending and over-the-top events do is to create a facade. Because behind the illusion of grandeur on display when either hosting world events or built to awe those coming on a quick stop-over business or holiday excursions to the major cities and package tourist destinations, is shrouded the rest of the nation and people being subjected to environmental degradation; ravaged of resources; and often ignored or neglected, at least until a major tragedy occurs (i.e., earthquake destruction of shoddy constructed schools in rural Sichuan). The current arrangement arguably necessitates maintaining a hierarchy class structure of rule where the state-directed media try to control the minds; the military force protects the most privileged; Hukou tries to keep the unwelcome out of sight and out of mind; and the jobs in factories and construction offer the underclass hope. It is system that has, with a certain acknowledgement, worked well for economic growth in the past 30 years, but it is not suitable for directing a large economy entering the next economic phase that needs to nurture independent business decision-making for selling to a middle class that needs to continue to grow.
    Tags: China, macro view, market outlook, economy
    Oct 04 11:38 PM | Link | Comment!
  • Being Misled about China (Introduction)
    We have heard the countless glowing stories in the media that China is booming - the new America on steroids - and those who land briefly on its shores - in cities such as Shanghai or Beijing - are often likely to reaffirm the positive shine. But is it really true?
     
    Are we being misled on China by the media, the investment banks, and even by the accounting firms (auditors) and credit agencies? In the past several years, you couldn’t pick up a newspaper without reading about the growth story in China. But is it becoming all too good to be true? Is it (now) turning into just a propaganda story to help sell newspapers, improve the banks’ bottom line, and as a means to-an-end for agencies and firms that have conflicts of interest?
     
    I will argue in a multi-part series that the China growth is not only going to rapidly slowdown in this decade, but the Chinese economy is in risk of a very hard landing. I will also argue that this is becoming far too obvious for those that should be in the know, and they should have informed the public a long time ago.
     
    More specifically I have several questions that should be addressed once the evidence is presented. Why is it only now that the media are actually discussing the issue of over-investment in China? Why is it that the investment banks even today continue to deny it? Why is it that credit agencies and accounting firms down played accounting irregularities until this year? Why did it have to be investment blogs and one person crusades (by short sellers such as Muddy Waters) that raised concerns about wrongdoings in China - when the media, investment banks, accounting firms (auditors), and credit agencies have far more resources at their disposal? And why did allegations of fraud have to surface in North America (via reverse merged listings) to finally get over due coverage, and some action to be taken?
     
    I can only accept that these agents – media, investment banks, accounting firms, and credit agencies - are responsible for having said nothing; denying the obvious; downplaying the problem; or at their worst for purposely misleading the general public (and their own clients or customers) for their organizations’ personal gain.
     
    I am going to convincingly argue in this multi-part series that there is an underlying peril in China that is not being told nearly enough. The economy is becoming more and more unbalanced, and the current growth levels are not sustainable. The government directed top-down approach for propping the economy up doesn't work and it hasn't worked. It is irresponsible of the stakeholders - media, investment banks, accounting firms (auditors), and credit agencies - to continue to disregard the gapping flaws that will have serious repercussions for their specific clients and customers.

    The series begins by breaking down the misconceptions that many in the public have about the China growth story, before outlining the evidence about the unbalanced economy, and giving a more intimate discussion about why the Chinese growth levels are unsustainable. This is followed up by looking at broader concerns, before addressing the how and why stakeholders have been an intricate part of spinning this web of misinformed hype. And finally, as a conclusion to this series, it is important to look at what are the implications of how China's slow down (or hard landing) could play out on the world economic stage in the foreseeable future (i.e., commodities).
    Tags: China, Macro view, Market outlook, Economy
    Oct 04 10:22 PM | Link | Comment!
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