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There is a lot of lopsidedly-bullish
analysis on China in the mainstream press and in the "blogosphere".
Less so today than two years ago, but still enough to suggest that China's
problems are not generally understood. To do our bit to counter-balance the
aforementioned bullish analysis, here is a list of 14 reasons to be a China
bear:
1) We regularly read that China's
economy is growing at 8%/year or 9%/year or some other impressive-sounding
rate. These are simply numbers that China's government concocts for public
consumption; they don't reflect what's really happening. It's possible that
right now China's economy is not growing at all and it's certain that a
significant part of the growth of the past several years is a monetary
illusion rather than something sustainable.
2) China is now paying the price for
its government's attempts to grow the economy through currency devaluation.
In a recent commentary we explained
why currency devaluation generally makes an economy less, not more,
competitive. The gist is that a sustained reduction in a currency's foreign
exchange value must be linked to a sustained reduction in that currency's
domestic purchasing power, meaning that any trade advantage achieved through
lowering the exchange rate will be offset by higher local prices.
This applies where a currency's
exchange rate is 'free floating', but China pegs its currency to the US$.
Moreover, about 8 years ago the Chinese government reduced the Yuan's fixed
foreign exchange rate to a level that massively under-valued the Yuan
relative to the US$. This gave China a trade advantage, but it also meant
that the Yuan supply had to be inflated relatively quickly to offset the
upward pressure on the exchange rate stemming from the artificially low peg.
This seemed to work well for many years, but eventually the monetary
inflation brought about a large reduction in the purchasing power of the
Yuan. The Yuan's reduced purchasing power combined with baby-step increases
in the pegged exchange rate has eliminated the Yuan's under-valuation against
the US$. More importantly, the whole process has left China in a position
where investment bubbles wrought by the monetary inflation are bursting at
the same time as the cost of living is rising at an uncomfortably fast pace.
3) Due to China's $1T-$2T
"shadow banking system" (informal lending that happens outside the
banking system), there is a lot more debt-related leverage in China's economy
than indicated by official figures.
4) The Chinese manufacturing sector's
most important customer (the euro-zone) is in recession and its second most
important customer (the US) is either in recession or soon will be.
5) Over the past decade China has
experienced unprecedented mal-investment in property and infrastructure.
There are now millions of vacant apartments, huge shopping centres with almost no tenants, many empty commercial
buildings, spectacular airport terminals with almost no traffic, and
magnificent roads and bridges in the middle of nowhere.
6) In general, China's provincial
governments are in similar financial situations to the government of Greece.
7) China's obvious
"inflation" problem (its rapidly rising cost of living) is limiting
the government's ability to use more monetary stimulus to 'kick the can down
the road'.
8) The cost of labour
in China has been in a steep upward trend (in response to many years of fast
money-supply growth), which means that China is becoming a relatively
expensive place for a foreign company to locate a factory.
9) China's policymakers exhibit the
same short-term approach as their Western counterparts. For example, the
massive stimulus of 2008-2009 succeeded to the extent that it made things
look better in the short term, but it has ultimately left the economy in a
much weaker state.
10) China's major banks are insolvent
and are totally reliant on life support provided by the central government.
This life support is bound to continue, which will add to the inflation
problem.
11) Corruption. The PBOC (China's
central bank) estimated
last year that $120B had been stolen by government officials and sent
outside China since 1990. The actual figure sent outside China is likely to
be much higher, and then there's all the corruption that doesn't lead to
money being sent out of the country. All governments are corrupt, but China's
government, being more powerful than most, is more corrupt than most.
12) The financial protection being
given to State-Owned Enterprises (SOEs) is starving the private sector of
capital. Due to the widespread perception that insolvent SOEs will be bailed
out, investors are favouring the bonds of
inefficient state-run operations with very weak balance sheets over the bonds
of private companies that have far superior prospects and performance. This
crowding-out of private-sector credit by state-backed credit is evident in
many countries, but the problem is more extreme in China. According to the
chief executive of brokerage CLSA in Singapore, as quoted in the article
posted HERE:
"You've got basically 10 times the amount of credit going to the
state sector [in China] as to the private sector to produce the same amount
of output."
13) Wealth accumulation in China is
being seriously hindered by capital controls that make it difficult to get
money into the country and even more difficult to get it out (unless you are
well connected).
14) China is no longer a communist
country, but it still has a command economy. The government has complete
control over the banking system, which results in the total monetary value of
bank loans made during any year bearing no resemblance to the total monetary
value of prudent lending opportunities. The government also exerts
considerable control over the prices of important commodities, the entire
construction industry, the amounts of exports and imports, the movement of
people between provinces, and the number of children per family (the famous
"one-child policy"). This leads to great inefficiency, but it also
means that China's government has more ability than most governments to
maintain an illusion of real progress in the face of major underlying
weakness.
The good news for those who are
looking for an opportunity to exit investments that rely on strong economic
growth in China is that despite the "inflation" problem, the
Communist Party's power transition scheduled for late this year could result
in policies that postpone a collapse until next year.
Steve Saville
www.speculative-investor.com
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