THE CHINESE ENIGMA

 THE CHINESE ENIGMA

"Let China sleep, for when she wakes the world will shake", Napoleon Bonaparte

 

Having never been posted east or north of India my knowledge or feel for China is not much ,in spite of newspaper and book reads. Li, La, Chou convey nothing to me.

 

Still there is no choice but to study China , now that it is awake and ponder on its future and the ramifications . In my opinion the jury was still out regarding a soft landing for China ( a phrase Shankar Menon then Joint Secretary dealing with China , used in late 1980s when quizzed ) but I am now inclined towards possible economic and social problems and political turmoil in China's  periphery like Xinxiang and Tibet .Perhaps earlier in the former which adjoins other Muslim and Turkic republics which gained freedom after the collapse of the USSR . China is almost the next bogey attached to 'Runaway US Train' which it is by now agreed is hurtling towards a hard landing leading and an end of  US led West's era of almost total dominance since last few centuries.

 

One can at worst be wrong .Remember western triumphal forecasts at the beginning of this millennium or the failure of the vaunted CIA and a gaggle of Kremlinologists to forecast the collapse of the Soviet Union earlier.

 

I had done my first piece ,"Decline of American Century ' for Asia Times a year after 119 , which many people now suspect was an inside job.

 

The URLs of articles updating this epochal change are as follows.

 

The decline of the American Century  Sept11, 2002 Atimes

http://www.atimes.com/atimes/Middle_East/DI11Ak06.html

 

The US Empire –Beginning of the End Game   24Nov, 2006

http://www.informationclearinghouse.info/article15729.htm

 

The Decline And Coming Fall Of US Hegemony   March 30 ,2008

http://www.uruknet.de/?p=m42600&hd=&size=1&l=e

 

WESTERN MILITARY-CAPITALIST CIVILISATION IN DISARRAY September 25, 2008

http://www.uruknet.de/?p=m47513 , http://www.boloji.com/analysis2/0386.htm

Corporate Culture and Greed Sink the American Republic  17 May, 2009
by K. Gajendra Singh http://www.boloji.com/analysis2/0442.htm

Confirmation of Pressure on Dollar and US Decline  8 October, 2009

http://www.boloji.com/analysis2/0493.html

 

So how about looking at what some knowledgeable experts say on China's future.

 

Is China headed toward collapse?

—

http://www.politico.com/news/stories/1109/29330.html

 

Some say a much-vaunted Chinese economic miracle is nothing but a paper dragon.

 

Wrote EAMON JAVERS in Politico on 11/10/09  

"The conventional wisdom in Washington and in most of the rest of the world is that the roaring Chinese economy is going to pull the global economy out of recession and back into growth. It's China's turn, the theory goes, as American consumers — who propelled the last global boom with their borrowing and spending ways — have begun to tighten their belts and increase savings rates.

The Chinese, with their unbridled capitalistic expansion propelled by a system they still refer to as "socialism with Chinese characteristics," are still thriving, though, with annual gross domestic product growth of 8.9 percent in the third quarter and a domestic consumer market just starting to flex its enormous muscles.

That's prompted some cheerleading from U.S. officials, who want to see those Chinese consumers begin to pick up the slack in the global economy — a theme President Barack Obama and his delegation are certain to bring up during next week's visit to China.

"Purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past," Treasury Secretary Timothy Geithner said during a trip to Beijing this spring. "In China, ... growth that is sustainable will require a very substantial shift from external to domestic demand, from an investment and export-intensive growth to growth led by consumption."

That's one vision of the future.

But there's a growing group of market professionals who see a different picture altogether. These self-styled China bears take the less popular view: that the much-vaunted Chinese economic miracle is nothing but a paper dragon. In fact, they argue that the Chinese have dangerously overheated their economy, building malls, luxury stores and infrastructure for which there is almost no demand, and that the entire system is teetering toward collapse.

A Chinese collapse, of course, would have profound effects on the United States, limiting China's ability to buy U.S. debt and provoking unknown political changes inside the Chinese regime.

The China bears could be dismissed as a bunch of cranks and grumps except for one member of the group: hedge fund investor Jim Chanos.

Chanos, a billionaire, is the founder of the investment firm Kynikos Associates and a famous short seller — an investor who scrutinizes companies looking for hidden flaws and then bets against those firms in the market. 

His most famous call came in 2001, when Chanos was one of the first to figure out that the accounting numbers presented to the public by Enron were pure fiction. Chanos began contacting Wall Street investment houses that were touting Enron's stock. "We were struck by how many of them conceded that there was no way to analyze Enron but that investing in Enron was, instead, a 'trust me' story," Chanos told a congressional committee in 2002.
Read more: http://www.politico.com/news/stories/1109/29330.html#ixzz0gK7IVo1W

http://www.scribd.com/doc/21544021/PIVOT-CAPITAL-MANAGEMENT-China-s-Investment-Boom-the-Great-Leap-Into-the-Unknown

 

wallstreetblips.dailyradar.com/story/is-china-headed-toward-collapse/

 

PIVOT CAPITAL MANAGEMENT - China's Investment Boom the Great Leap Into the Unknown

China's Investment Boom: the Great Leap into the Unknown

We conclude that the capital spending boom in China will not be sustained at current rates and that the chances of a hard landing are increasing. Given China's importance to the thesis that emerging markets will lead the world economy out of its slump, we believe the coming slowdown in China has the potential to be a similar watershed event for world markets as the reversal of the US subprime and housing boom. The ramifications will be far-reaching across most asset classes, and will present major opportunities to exploit. There are three key reasons why we take this view:

China's expansion cycle surpassing historical precedents: It is widely believed that China is still in an early development phase and therefore in a position to expand capital spending for years to come. However, both in its duration and intensity, China's capital spending boom is now outstripping previous great transformation periods.

Policy actions not sustainable into 2010. This year's burst in economic activity has been inflated by a front-loaded stimulus package and a surge in credit growth. Given their exceptional and forced nature we believe growth rates in government-driven lending and capital spending will collapse in 2010.

Overcapacity and falling marginal returns on investment: Analysis of industrial capacity, urbanisation and infrastructure development shows that China's industrialisation and structural modernisation are largely complete.

Combine this with falling returns on investment, and it becomes obvious that China's long-term investment needs are grossly overestimated.

Read More…

 From Short-Term Trading Saturday, January 30, 2010

 

"Is there a China Bubble

 

The idea is that capital spending in China cannot continue at this rate.  The coming slowdown will have global consequences.

 

Let's see the main points supporting this thesis:

 

- China' s investment boom is unprecedented with growth highly dependent on capital spending.  However, decreasing marginal returns on investment will lead to a pullback in capital expenditures. This can happen in a soft landing scenario or a hard landing one where a banking crisis would occur.

 

- Credit has played an important role in Chinese growth. Credit has expanded 50% more than GDP. If loans continue at this rate, in 2010 credit to GDP ratio will be 200% (similar to Japan in 1991 and US in 2008).  Credit is going to luxury property and stocks, but not much into the real economy.  

 

- Some say that China can afford this level of spending because of the low debt (23% of GDP) and huge reserves.  However, the size of debt is understated. There are also other off-balance sheet liabilities that would bring the debt to GDP ratio to 62%.  Moreover, inflows of money into China cannot fuel further capital expenditures.

 

- Capital expenditures went into manufacturing, real estate and infrastructure in the past years.  Further expansion will not impact as much on growth as in the past. 

 

- The manufacturing capacity is at developed country levels.  The manufacturing base is mature with few areas for further expansion especially in traditional sectors (steel, cement, aluminium, energy).  There is excess capacity in many sectors.

- Urbanisation rate is actually low in China.  Moreover, the lending boom has boosted housing construction. There is an excess housing construction compared to the household formation.  The price to income ratios are at extreme levels.

 

- China infrastructure is relatively well developed. Economic justification behind latest infrastructure projects is questionable. 

 

- Consumption growth cannot replace the investment boom. Private consumption would have to grow 3 to 4 times faster than in the past decade to compensate for the imminent retraction in investment.

 

A slowdown of China would have global consequences (China Economic Growth And Global Risks). As signs of weakness appear, other governments would introduce further stimulus.  This may prolong the top.  However, the transition from a model based on investment to one based on consumption, although with a slower rate of growth, cannot be avoided.  The crunch could come in H2 2010.  The issue is when markets will start discounting the slowdown.  The impact would be on cyclicals, industrial commodities, equities and credit.  There would be a move toward more defensive assets.  What is the role of China in the debate on deflation vs inflation?  The slowdown should be deflationary, given their overcapacity.  However, depending on how aggressive the policy response will be there may be inflationary risks again.         

 

I find the report interesting.  All points have a merit although I am not an expert about China, so I cannot really judge the data presented.  Provided that the scenario presented is correct (but I am sure there are many who see things quite differently), I think, however, that there are some areas that should be further discussed:

 

- Systems of these complexity and size continue to run with an impressive inertia and do not change direction until the inevitable happens. I do not believe in a soft landing scenario.  There would be a crash some time in the future (Global Bear Rally: Apocalypse Ahead). 

 

- Is it going to have political and social implications in China? 

 

- The strategy to prepare for such an event is not clear. When is this going to happen? Is second half of 2010 realistic (what they continue to go on for another 2-5-10 years)? What are the defensive areas where money should go? What happens to the US dollar and the Treasuries? Will they be a safe haven again or China will be forced to liquidate their assets?

 

- The inflation and then deflation scenario is not substantiated enough.

- What will be the opportunities generated by this crisis if there will any?

- What are the global implications of a slow down in China? Will it be possible for western countries to inject in the system further stimulus? How will western countries react politically and economically to a second round of the crisis? (Through bailouts, nationalizations and protectionism? Will they have the strength to do it given their high levels of debt?) Will emerging countries react better than western countries?

 

All this looks a little bit a fanta scenario.  However, things develop quite quickly once the ball starts rolling. The main problem of these studies is that the number of variables involved is so high that eventually things unfold  differently from what was envisaged. It is very hard to forecast the implications at the various levels.  From an investor perspective it is even more difficult because timing is important. "

 

From Short-Term Trading Saturday, January 30, 2010

 

Jim Chanos Is Wrong: There Is No China Bubble

Shaun Rein, 01.11.10, Forbes .com

He misunderstands basic facts about income, real estate and the currency there.

The famed short-seller Jim Chanos has been making waves lately by saying he thinks China is in a bubble and ready to collapse in 2010. He argues that easy credit has let real estate and stock market prices shoot upward. He also says the Chinese government is cooking the numbers to show 8% growth in gross domestic products, when actually China can't keep growing when the rest of the world has been hit so hard by the financial crisis.

Chanos called it right on Enron and Tyco ( TYC - news - people ) before they collapsed. He is no lightweight observer of the economic scene. However, he is wrong about China. For once I agree with the famed investor Jim Rogers, who cofounded the Quantum Fund with George Soros. He says China is not in a bubble and adds that he finds "it interesting that people who couldn't spell China 10 years ago are now experts on China."

Betting against China in 2010 is a bad mistake for investors and companies alike. Here are three reasons why Chanos is wrong and Rogers is right about the strength of China's economy:

Chanos' first error is his belief that China's real estate sector soared in 2009 because of speculation triggered by a loosening of credit by China's banks. Lending in China doubled to $1.35 trillion in the first 11 months of 2009. Real estate prices rose sharply throughout the country and almost doubled in cities like Shenzhen. Chanos calls that a bubble--"Dubai times 1,000--or worse"--that could lead to fallout like the subprime mortgage mess in the U.S.

There are, however, fundamental differences between China's real estate and consumer finance markets and those of the U.S. and Dubai, which Chanos compares them to. First, when buying residential properties, consumers in China have to put down 30% before taking out a mortgage. For a second home, they have to put down 50%, no matter what their net worth. Therefore, China doesn't have the reckless consumer behavior that occurred in the U.S., where people with bad credit were taking out huge loans from Countrywide with no money down, or were buying 10 homes without deposits in the hope of flipping them in a few months. People who buy homes can afford it.

Also, mortgages are not being spliced up and packaged and securitized by the likes of Citigroup ( C - news - people ) and Bank of America ( BAC - news - people ). Instead mortgages are held by the original lenders, the way they were in the U.S. before financial innovation and lack of regulation broke down the old rules.

The Chinese government also has no qualms about overseeing the market and has not been run by Ayn-Rand-loving free marketers like Alan Greenspan, who seemed to believe that no government intervention at all was best. The Chinese government is gravely concerned about social stability because of the widening gap between the rich and the poor. It is therefore limiting the sizes of new apartments and restricting the construction of stand-alone luxury villas. (Most people in China's urban areas live in high-rise apartment buildings. I myself live in a 60-story building.) The government is also forcing developers to build low-income housing. And to prevent flipping and excess speculation, it is heavily taxing sellers who unload their properties within two years of buying them.

The real estate business to be concerned about is commercial building. There has been way too much construction of large office towers, especially in Shanghai, which is gearing up for its World Expo this year. Too many gleaming skyscrapers sit empty of tenants. The glut of office space has already caused rental prices to drop in places like the Shanghai financial district, Pudong.

Too much leverage, not high prices, caused the problems with real estate in Dubai and the U.S. There just isn't that much leverage in China. So even if prices are too high, a drop of as much as 20% or 30% wouldn't cause anything like the tsunami that hit the American and Dubai markets.

The second way Chanos is wrong about China is that he, like most economists and Wall Street analysts, underestimates income there. I have recently been debating several Harvard economists who worry that incomes haven't risen as fast as GDP in China. They argue that it shows that too much of China's growth has been a matter of government investment in unsustainable infrastructure projects like bridges and highways, as happened earlier in Japan. They point out that Chinese consumers account for just a third of the economy in China, vs. two-thirds in the U.S. However, my firm, the China Market Research Group, estimates that Chinese consumers will come to account for half of the economy within the next three to five years as the role of exports diminishes. (See my "Three Myths About Business in China.")

If anything, incomes are grossly underreported in China. A simple look at how accounting works will show why. Whereas in the U.S. individuals must report their income to the Internal Revenue Service every year, in China all individual tax is reported and paid for by companies, except for that of high earners. Many Chinese companies limit the tax they pay by reporting low salaries and then paying their employees higher amounts while accounting for the difference as business expenses like phone bills. The employees are happy because they make every bit as much as they were promised, and the companies are pleased to lower their tax exposure.

Also, many companies pay for housing and cars for their employees, a holdover from the old system of state-run businesses. Most Western economists don't count those expenses as income, but they should. Deceptive accounting of income is so widespread that the government has announced plans to tax some business expenses in state-run enterprises--the kinds of expenses that let executives pay taxes on earnings of $300 a month while living in multimillion-dollar homes and driving Mercedes.

The third thing Chanos gets wrong about China is the notion that the yuan is likely to appreciate. In the short term, it would be disastrous for China to let that happen, as I wrote in "Why Krugman Is Wrong About The Yuan." It would cause China's exports to plunge, swell the Chinese unemployment rolls by millions, and destabilize the financial system. In the long term, however, once the world's economy stabilizes, appreciation of the yuan might make sense. Getting exposure to Chinese assets now would benefit an investor when that time comes.

Chanos has an excellent track record in divining the future. However, part of his job as a short seller is to make money by causing markets to question good things. That can be useful for keeping companies honest and in check. But in this case he clearly doesn't understand the economic system he's talking about. China is not in imminent threat of collapse, and investors and companies are wise to stay involved with it, as Rogers argues.

Shaun Rein is the founder and managing director of the China Market Research Group, a strategic market intelligence firm. He writes for Forbes on leadership, marketing and China. Follow him on Twitter at @shaunrein.

Alert | China    By RBS ( Royal Bank of Scotland) February 2010

Is there a bubble in China?

Worries about a bubble in China have shaken global

markets. These worries are unlikely to disappear.

GDP growth is forecast at 10% in 2010, inflation is

rising, and policy has yet to be tightened materially.

The lack of published data also makes it difficult to

argue decisively for or against the existence of a

bubble.

 

Bubbles are not new to China. The soybean crushing

sector collapsed in 2004, the auto sector overheated

in 2005, and Shanghai property prices fell sharply in

2006. However, these examples were limited to

specific sectors or cities. Today's worry, by contrast,

is that there is a systemic bubble that threatens the

overall economy.

 

It is the aggressive fiscal stimulus of 2009 that lies at

the heart of concerns. The speed at which GDP

growth slowed surprised many, and officials

responded by easing policy dramatically, Two year's

of credit was pumped into the economy in less than

six months, while fixed investment growth

accelerated markedly.

There is thus good reason to worry about a bubble.

Fixed investment was already the largest driver of

growth prior to the economic crisis and officials were

talking of the need to rebalance the country's growth

drivers. However, fiscal stimulus worsened

imbalances with a large share spent on road, rail,

and other capital projects.

 

The chances of a bubble bursting in 2010 remain

small. The infrastructure needs of the poorer interior

provinces, the fact households put at least a 30%

payment down on their home purchases, or the way

robust nominal GDP growth helps to absorb the

outstanding stock of non-performing loans, all argue

against a short-term bubble today.

However, the medium-term risks of a bubble remain

high if no corrective action is taken.

Rapid credit growth and over reliance on capitalintensive

growth means supply may outpace

demand. Worries about a double-dip in the global

economy may also discourage the government from

tightening. But eventually, aggressive tightening will

be needed producing a sharp, and painful,

correction in growth.

Simultaneously, high savings rates, tight capital

controls, and a lack of investment alternatives mean a

large pool of trapped liquidity will continue to search

for higher yields. Expectations of higher inflation will

only accelerate the switch out of deposits into other

assets, especially housing, and the risks of an asset

bubble will grow.

What follows are answers to the most commonly

raised questions. The final page looks at likely

triggers of a bubble.

Fixed investment is 42% of GDP. Surely, this is

unsustainable?

China's gross fixed capital investment as a share of

GDP is indeed high. The sudden increase in China's

spending is unsustainable.

 

China's fixed investment is undoubtedly high as a

share of GDP, but the data is also exaggerated.

Having lived in a handful of emerging markets in the

past two decades, I am constantly struck at how fast

China replaces its capital stock relative to the other.

emerging markets. Airports are knocked down, roads

are ripped up, and steel plants are relocated.

 

A good example is Guangdong's cement industry.

The industry suffers from oversupply. However, an

estimated 40% is accounted for by vertical kiln

cement and is heavily polluting. The provincial

government has proposed replacing such factories

by 2011 and thus deal with its overcapacity problems

while also spur more spending. It is for this reason that

the character for demolish, or chai, has become symbolic

 of China's growth over the past decades.

The phenomenon owes in part to the way officials are

measured on the basis of targets. Faced by a growth

target, a county official will be tempted to build

bigger and better public infrastructure or residential

apartments. In many instances, this will mean

demolishing existing structures to make way for

replacements.

Fixed investment as a share of GDP is still excessive

by any measure. However, after accounting for the

country's rapid consumption of capital, there is

arguably less reason to worry about a large build-up

of excess capacity. And while it is not possible to

measure the net capital stock owing to a lack of data,

it is likely lower than popularly believed.

 

Coastal provinces Central and Western provinces

emerging markets. Airports are knocked down, roads

are ripped up, and steel plants are relocated. The phenomenon

owes in part to the way officials are measured on the basis of

targets. Faced by a growth target, a county official will be

tempted to build bigger and better public infrastructure or

residential apartments. In many instances, this will mean

demolishing existing structures to make way for replacements.

 

Fixed investment as a share of GDP is still excessive

by any measure. However, after accounting for the

country's rapid consumption of capital, there is

arguably less reason to worry about a large build-up

of excess capacity. And while it is not possible to

measure the net capital stock owing to a lack of data,

it is likely lower than popularly believed.

 

So isn't fiscal stimulus resulting in more "roads to

nowhere"?

 

Not all such spending is wasteful. For instance,

building a more efficient steel factory reduces its

water consumption. Building a better road to a

coastal port improves the competitiveness of export

factories. Nonetheless, there are also examples of

wasteful spending that amount to little more than

digging holes and filling them in again.

Still, a large share of today's fiscal stimulus is aimed

at the less developed interior provinces..

The statistical bureau of Zhejiang, a large coastal

province, underscored the imbalance in a report

issued last year. The report noted that while fiscal

stimulus spending had prevented a deeper

contraction in growth, it had not benefited Zhejiang

greatly, as the province's infrastructure was already

well developed. A trip around the interior provinces shows

the region's infrastructure has a long way to catch up.

GDP per capita is just 17,500 yuan ($2,600 at today's

rate) against 39,000 yuan ($5,800) in the coastal

provinces. Indeed, the interior provinces only have

the same GDP per capita as the coastal provinces

did in 2001.

The rising nominal value of China's

GDP is fast overtaking Japan's.

.

It is China's size that also makes comparisons with

other emerging economies misleading. Its interior

provinces have a population of over 700 million, or

larger than that of South East Asia combined. This a

major source of demand. Being able to turn to the

interior provinces, each equivalent to another

Malaysia, Thailand, or the Philippines, provides a new

source of investment demand, prolonging the

investment boom.

 

Of course, infrastructure is not the only area of

concern. There are also fears of excess

manufacturing capacity. An excellent report by the

European Chamber of Commerce in 2009 identifies

six areas of special concern, specifically, steel,

aluminium, cement, chemicals, refining, and wind

power.

 

It is important that all are heavy industrial sectors. It

was heavy industry that has benefited most from the

recent investment boom. Light industry, by contrast,

experienced its own bubble in the 1990s, as money

poured into the sector ahead of WTO-entry and after

Deng Xiaoping's economic reforms. However, light

industry has since largely restructured and has

attracted less fixed investment in rece