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China Watch

Some very knowledgeable and successful investors are making big bets in China. In both directions! Who's right?

On one hand, we have noted detective and speculator James S. Chanos who is calling for a bubble in China, x1000 the size of Dubai. And on the other hand, we have the very successful long term investor Jim Rogers who believes China's ascension to global power is virtually, if not already - assured.

Here's the latest in the saga:
Contrarian Investor Sees Economic Crash in China

Both have very convincing arguments.

For Chanos, I would agree that excess credit is the sign of a bubble. The reason being, is that credit (debt for one party and an asset for another) is essentially "neutral". Much like air. It lacks substance. And it is this credit (air) that is essential to creating a bubble; or more precisely - essential to being "popable". China has already warned about credit excesses in their housing markets and is likely ready to take steps to curb additional speculation.

Soaring home prices become a concern for the Chinese Government as well as aspiring homeowners

Using quite standard metrics we can see their concerns.
  • The home-price-to-rental-value ratio is a common international practice used to measure the health of local housing markets. The ratio between rental value and home prices is usually 1:100 to 1:200.
  • The survey suggested that the ratio in Beijing's housing market has reached 1:500, topping 1:700 in some districts, compared with 1:400 in 2008, a rise of 25 percent.
  • The housing-price-to-income ratio is expected to exceed eight in 2009, compared with a rational range between three and six, the report said.

Over the next several years, certainly this will be a major concern to the growth and sustainability of China's economy and stock market. This is what Chanos seems to be focusing in on. Rogers on the other hand is looking even longer term to the structural demographic and wealth transfer impacts over the 20 years. The rise of a Chinese middle class and the flow money into asian countries is going to buoy the economy in ways much like the USA experienced in their rise to power.

So how do we take advantage of this information to position ourselves correctly? We already know that even if you are six months early in shorting a bubble, the effects can be disastrous. If Chano's is right, sellers will emerge and put pressure on the China related stocks and indices. So far, that has not been the case but there are signs of distribution.

Over the next few months (or years if need be) I'll be watching the news flow and the charts. Should the time come to be more bearish, we're going to see a lot of "long term" speak as we did in the initial 2007 S&P declines. A deflationary cycle (and that's what a popping of a credit excess is) is very difficult to stop and could likely overshoot to inexpensive valuations where perhaps Rogers will ultimately end up being right.

Disclosure: No positions