China's Future Economic Power Will Disappoint

Includes: EWH, FXI, GXC
by: Carlos X. Alexandre

I was reading an article published by Caixin in which a variety of factors were laid out, and the potential for another quantitative easing program by the Federal Reserve would add more pressure to commodity prices due to the eventuality of a lower dollar.

But a new wave of dollars in the markets will result in negative implications for China. Inflation, lingering above the country, will be even more dangerous, mainly due to the rise in commodities’ prices. The country will probably answer with tighter monetary policies, probably emulated by other emerging countries.

Then the following quote was added, highlighting the mindset, something that many don't quite get.

International supervision over the issue of U.S. dollars should be introduced, and a new stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country.

Let me get this straight. When the U.S. was happily buying everything in sight, and China was converting its new found wealth into Treasuries and collecting the interest, all was well. Now China doesn't want to play anymore, and to add insult to injury, there’s this aura of self righteousness and empowerment where the international community should take over the sovereign monetary affairs of the United States. Interesting, although not surprising, and for the record, a potential future superpower does not whine when the going gets rough.

Thus, it’s not earth shattering to learn that the wish at the top of the list for Chinese wealthy individuals is to leave the country, which flies in the face of the claimed political superiority by the government, as reported by the Associated Press.

Despite more economic freedom, the communist government has kept its tight grip on many other aspects of daily life. China's leaders punish, sometimes harshly, public dissent and any perceived challenges to their power, and censor what can be read online and in print. Authoritarian rule, meanwhile, has proved ineffective in addressing long standing problems of pollution, contaminated food and a creaking health care system.

And Su, a wealthy individual interviewed by the Associated Press, had this to say.

"In China, nothing belongs to you. Like buying a house. You buy it but it will belong to the country 70 years later," said Su, lamenting the government's land leasing system.

Another Chinese person weighed in on the scholastic superiority.

A millionaire who works in the coal industry, who also spoke on condition of anonymity, said the main push behind his plans to emigrate is China's test-centric school system, often criticized for producing students who can pass exams but who lack skills for the world of work.

Thus, as the U.S.S.R. found the Olympic games a perfect venue to portray the regime’s superiority to the world during the Cold War, China chose the bullet train, which is largely empty, and is showing the cracks in quality. And remember that after the Iron Curtain fell, many were appalled that the emperor had no clothes – and it will repeat itself.

But inflation is potentially the biggest story in China, and looking closely at the data as published by the National Bureau Statistics of China, one can quickly discern that it is a food story, especially “Meat, Poultry and Their Products,” while housing is hardly an issue according to official numbers - (click chart to enlarge).

However, the authorities continue to increase rates and bank reserves as if those exercises actually go hand in hand with food inflation, although we know that it is a central banker’s preferred tool, regardless of the inflation source. I now call it “Spigot Economics,” or it’s either “On” or “Off.”

According to a MarketWatch report in May, China increased pork imports from the U.S.

In the eight months to February, the U.S. had exported 192,500 tons of pork to mainland China, while U.S. pork exports to Hong Kong hit 63,600 tons, most of which was later transported to the mainland, according to a recent report by the U.S. Department of Agriculture. Given pork-price increases in May, which is traditionally the off-season for pork consumption, a new round of price hikes for meat is in the offing, Guohai Securities said in a research report.

More recently Bloomberg also reported on Chinese inflation, and highlighted the fact that pork is a “Chinese staple.”

Inflation was mainly driven by a 14 percent gain in food costs, the biggest increase in three years, and also pushed up by an unfavorable base for comparison a year earlier, an effect that will diminish in the second half. Pork, a Chinese staple, rose 57 percent. Non-food prices climbed 3 percent, the biggest gain since at least 2005.

I don’t mean to be petty, but sometimes the simple facts speak volumes. Let’s put some perspective on the issue: China can build bullet trains, refurbish old Soviet aircraft carriers – the “new” one was bought from the Ukraine in 1998 -- but can’t raise enough pigs to feed its population. As a side note, a lower dollar has no effect on swine breeding because pigs are not picky eaters.

And on that basis, a country that cannot tend to the basic needs of its population, will become the world’s financial center. Enough said. Ivory tower thinking may foster the publication of impressive glossy papers, but I learned pig slaughtering and sausage making from my grandmother, not my MBA.

Lastly, Reuters reported today that Fitch Ratings – I know, these guys are unreliable -- announced that it may downgrade China within two years "as the country's banks struggle with debt loads following a lending surge to help lift the economy during the 2008 financial crisis." Dismissing Fitch is easy, but not the Chinese debt that lurks in the shadows.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.