'Getting' China

Includes: CAF, CNY, CYB, FXI, GXC, PGJ
by: Firat Ünlü

There is a tremendous amount of talk about China with real estate, the yuan and now Google (NASDAQ:GOOG) topping the list.

Let's start of with income distribution. One quirk about China is that aggregate numbers themselves are pretty meaningless since the divergence within the whole country is too large to be reflected properly by a single figure.


GDP/Capita in RMB















Even then there is a large inequality in income distribution within a province. The 19th biggest province by population (Shanxi) boasts a population as large as Canada. In contrast to residents of a nation such as Canada the residents of a province are almost certainly going to try and live in the regional capital. The reason for this includes a much higher lifestyle, Chinese people prefer to live in cities as this is where the opportunities are and are prepared to pay a premium for living centrally.

This means that the regional capital will find itself attracting the richest residents of a large pool. Naturally, if one compares real estate prices with average income one will come to the conclusion that this seems unsustainable. However what matters in determining sustainability is not average income of the whole province, it is the income of those that are actively engaged in the market for the limited number of real estate complexes within the regional capital center.

Another quirk of the Chinese market is that even if by traditional standards, such as that a mortgage exceed a third of monthly income, a borrower doesn't seem qualified the borrower may be willing to pay a premium (such as spend close to half his monthly income on the mortgage) just because of the allure of living in a regional capital.

In the widely-quoted TV series 'Narrow Dwellings' an elder sister convinces her sister of the benefits of city life despite the fact that they need to save most of their income in order to buy a flat even though her younger sister points out to the advantages of living in their hometown which is much more affordable. This holds true for a large number of Chinese people.

The urbanization trend continues unabated and regional capitals are only going to grow in attractiveness and quality of life. Even though there may be a substantial amount of speculation there seems enough substance behind the recent rise to prevent a free-fall.

As far as commercial real estate is concerned. The only explanation I could come up with is that because of low wages for staff and high profit margins on goods they may just get away with it.

However, commercial real estate in China never made any real sense to me. Ordinary middle class folks go shopping in cheap stalls which exist by the thousands and sell the same goods that are sold for four times the price in a Western-style shopping mall. Always looked like a case of 'build and they will come' to me.

Currency Wars

Before we head to the currency we should have a look at trade flows.

Trade in October 2008

China exports to US

US exports to China



China exports to Japan

Japan exports to China



China exports to South Korea

South Korea exports to China



China exports to Britain

Britain exports to China



China exports to Germany

Germany exports to China



China exports to France

France exports to China



China exports to Europe

Europe exorts to China



China exports to Australia

Australia exports to China



China exports to ASEAN

ASEAN exports to China



China exports to Latin America

Latin America exports to China



China total exports

China total imports



If trade were to be rebalanced with Europe or the US the Chinese trade surplus would be almost gone. Excluding Europe and the US China runs a trade deficit with the world.

This may be down to export-processing or other factors however for now it is important to keep in mind that even as a developed nation it is possible to run balanced trade with China as Germany, Japan and South Korea prove.

To lighten things up I decided to illustrate US trade flows by using this bar-chart. It is also based on trade figures for October 2008.

Whilst the US is running a trade deficit with almost the whole world, in fact there's just a couple of nations which run a deficit with the US, it is nonetheless remarkable to note that the export/import ratio for US-Chinese trade stands at around 0.2, which means that Chinese exports to the US are five times bigger than respective imports.

Strangely enough it seems as if from an US perspective the RMB is undervalued whilst from a Chinese perspective the value of the RMB seems perfectly fine, if a little undervalued.

Furthermore when looking at trade figures one has to consider that Americans are still embarking on a spending spree which pushes the deficit with China further into the red since many consumer goods come from China. One reason why free trade usually works is that nations need to use the money they get from doing business with another nation to buy products from that very nation.

China sits atop of 2 trillion worth of dollars which it decided to recycle by buying US$-denominated bonds, in practice this money flows back into the US economy. In 2003 China's foreign US$ porfolio stood at around US$500bn.

It was only in the last couple of years that this mountain of bonds was accumulated, again, mainly due to excess US consumption which was reflected in a negative trade balance. It is because of this reason that it is difficult to conclude that the RMB is 'grossly undervalued'.

There seems to be the prevalent belief in the West that the only reason why China is more competitive is mostly down to them keeping the RMB low. However there are several ways to ruin a nation and as much as it pains me to say, the way most Western nation are run isn't exactly confidence-inspiring. The German example clearly proves that balanced trade with China is possible. There's more to Sino-US trade than the currency, the US comparative advantage lies in exporting products which are of higher quality, but is it down to the exchange rate that physics PhDs are increasingly not employed by manufacturing companies but Wall Street? German competitiveness stems from a couple thousand of superbly-trained engineers and a backbone in quality manufacturing who create so much value that people not on their level can still be employed by them. This is how a mature economy works.

Those blaming excess Chinese savings need to remember that savings are capital, one would think that a capitalist economy could do with capital. I remain dumbfounded that in a world of increasingly scare resources people are begging the Chinese to increase their purchasing power.

A Chinese commodity buying spree would make Japanese acquisitions of US real estate after the Plaza Accord look tame.

Disclosure: No positions

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