The Chinese have been effective at dealing with every economic problem they have faced.
~ Byron Wien
On Monday we looked at the bearish side of the China debate. Today, we turn our attention to the bulls. They look at the growth potential in China and see investment there as a long term no-brainer. Not only that, but they believe “The Chinese Miracle” might be just what the rest of us need to pull out of the economic morass we’ve created.
On Monday’s post, Mich from Beating the Index commented that even if China’s GDP halved to 5% as one expert predicted, that still means robust and increasing demand for commodities – just at a slightly slower pace. Again, it’s the sheer scope of the Chinese economy that makes it different. (I know – famous last words. But let’s hear out the bulls.)
Why China Won’t Crash
There are a number of reasons to remain bullish on China’s economy and markets in spite of the exponential growth the country has already seen. Here’s a quick summary of some of the bullish arguments out there:
- Size Matters: The potential for future growth in China is undeniable. There are still millions of people to move from rural villages to urban centres. That means there are still plenty of people who will eat at fast food restaurants, and buy apartments, cars, and gadgets. Many bulls claim that bears like Jim Chanos have not been to China, and you can’t truly appreciate the growth until you see it for yourself. (To which Chanos replies that he never worked at Enron either.)
- Chinese Can Manage the Growth: Byron Wien made the case in an interview at the end of November that the Chinese government has the capability to respond quickly to problems and will be able to cool inflation as needed. They don’t have to jump through the hoops that US legislators do in order to implement policies. There is no such thing as gridlock in China.
- Over-Building Is Exaggerated: Most China bulls will admit that the largest (tier one) cities are a bit frothy, but point out that real estate in second and third tier cities are up to 70% lower. Andy Rothman, the chief China economist for CLSA: “There is no national housing bubble.”
- Personal Incomes & Consumption Are Rising: According to Mr. Rothman: “Rising incomes still support middle-class affordability.” A recent article from the Globe and Mail confirms that “Chinese consumption is, in fact, strong. It has grown by more than 9 per cent a year, after adjustment for inflation, over the past decade.” As incomes and consumption rise, the savings rate (hovering around 30%) will fall, consumers will buy more of everything (including real estate) and that will lead to higher domestic consumption and lower exports. This should ease some of the tensions with China’s trading partners.
- No Securitization: Mortgage debt in China is not securitized into CDOs or other derivatives. There are no liar or NINJA loans in the Chinese market. Byron Wien points out that the Chinese prefer to hold hard assets rather than paper or derivatives. That removes at least one level of risk that exacerbated the US housing crash.
- Less Leverage: I saved one of the most compelling of the bullish arguments for last. Most of the new real estate in China has been purchased with little or no debt, so there’s no comparison to the US housing market implosion there. Mario Cavolo recently observed that US consumers currently hold about $15 trillion in home value. The lower and middle classes of China alone hold the same amount. US homeowners, however, carry about 80% of that value in mortgage debt. The Chinese? Zero. Still, Mr. Cavolo admits that a “close look at the luxury sector of China’s real estate market reveals far higher mortgage levels related to higher risk speculative activity and invites further understanding.”
Why Don’t the Bears Buy It?
With all of these positive factors at play, you might wonder why the bears don’t just throw in the towel. Indeed, markets (especially commodities) rallied on Monday when China failed to raise rates, opting instead to raise the reserve requirement ratio (RRR). Doesn’t that just prove that the bears will continue to lose money?
That’s definitely a possibility, but the market reaction made me wonder whether failing to raise rates will also fail to cool inflation. If the aim of raising the RRR was to cool the market, I would say that it wasn’t overly successful. I know one day’s reaction is not a trend, but it doesn’t seem like the move achieved the desired effect. Although there isn’t as much leverage in the Chinese property market as other locales that have endured real estate bubbles, bears would contend that there’s a lot more leverage hiding on local balance sheets than many realize.
There is still one aspect of the bullish case that I didn’t mention, perhaps because it’s just a little too obvious: The market is still going up. In spite of the many seemingly lucid bear arguments, our ursine friends have (at least so far) been wrong. Of course they might well counter that bubbles can inflate for a very long time, but when they inevitably pop, the drop in prices is usually sudden and precipitous. (See 2008.)
Most bulls will acknowledge that any market growing as quickly as China has over the past couple of decades is bound to have a few setbacks. Perhaps the real difference between the China bulls and bears is a matter of degrees and duration. The bulls think China can engineer an orderly slowdown, while the bears think the risk metrics indicate a disorderly unwind.
Where do you stand? Are you with the bears, the bulls, or somewhere in the middle?