IN SEARCH OF A PIN

This one is dedicated to Smokey with love.

All booms bust. The only question is when.

by Simon Black

February 8, 2011
Santiago, Chile

Somewhere in China, an economist lost his job today… it was the poor guy who had been predicting manageable levels of inflation despite rapid headline GDP growth and even more rapid monetary expansion.

Yet, staring at reports which show inflation at a 28-month high, officials at the People’s Bank of China realized that they need to do something about inflation. Now. Especially in light of what’s going on in the world… hence today’s 25 basis point rate hike.

Inflation in China is coming from all sides. Certainly there is the country’s speedy economic growth, commonly reported in the press as ‘overheating’. Then there is the constant battle against America’s #1 export (inflation) as many of Bernanke’s trillions of new dollars have found their way into China’s economy.

Moreover, what a lot of people forget is that China has heavily engaged in its own stimulus programs, which, as a percentage of GDP, dwarf the stimulus packages in most developed countries (including the United States).

Given these genuine inflation fears and the brakes that Chinese policymakers are applying in terms of interest rates and property taxes, it is now almost a “consensus view” in the financial markets that China will face an economic crisis sometime in the next few years.

A recent survey of market participants published by Bloomberg indicated that 45% of those surveyed believe it’s inevitable that China’s boom will turn to bust sometime in the next 5 years.  Another 40% said they expect it to happen sometime after 2016.

The arguments for why China’s economy is a train-wreck waiting to happen are not new.  Prominent short-sellers such as Jim Chanos cite forests of empty apartment towers, deserted shopping malls with no stores or customers, and the empty city of Ordos as proof that China has massively overbuilt.

They argue that the economy is built on a foundation of quicksand, as construction accounts for the biggest single slice of GDP, and at some stage there simply won’t be a need to build anymore.

I can’t disagree.  At some point, perhaps in the not-too-distant future, building in China will slow, and subsequent rate hikes will curtail new expansion.

The way I view it, China has compressed 100 years of economic growth into 30 or 40 years, so naturally the annual growth rate has been fast. One thing that history has taught us, though, is that the free market cannot be continually outperformed by a central planning authority that inflates its money supply.

Rapid credit expansions can definitely give the appearance of strong economic growth, but no credit expansion has ever lasted permanently. In the long run, an economy can only continue to move forward at strong growth rates via increases in savings, productivity, technology, and innovation.

China’s technology sector is advancing rapidly– the country has developed the world’s fastest supercomputer and churns out three times as many engineers as the United States. China’s manufacturing sector has also shifted away from unskilled production to high tech manufacturing based on homegrown designs.

Knowledge is cumulative, however, so it will still take some time for China to be the genesis of the next generation of technological breakthroughs… and hence justify its huge growth rates based on innovation and technological advances.

For now, we can continue to marvel at the rapid pace of economic development in China.  But, let’s not make the same mistake people made with Japan in the 1980s and assume that the Chinese have stumbled across some superior economic perpetual motion machine.

The truth is, nobody knows what China’s real growth rate is. I remember spending time in the country’s gray markets– huge roadside, makeshift shopping malls with tens of thousands of people engaging in off-the-books transactions– thinking to myself ‘no way GDP numbers account for this…’

The fundamentals for growth are definitely there… but we would be foolish to not consider the disastrous effects of a cleverly disguised credit bubble masquerading as ‘the Chinese miracle’, or the consequences of an unsustainable exchange rate policy.

Nothing goes up or down in a straight line, and in the words of one of my most influential mentors, “All booms bust. The only question is ‘When?’”

The reality is, nobody knows when… and more importantly, what happens next.

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StuckInNJ
StuckInNJ

In another thread, Jim said; “You can get under his (Smokey) skin with “China is a bubble”, Don’t show weakness. He thrives on it. If he kicks you in the shin, kick him in the balls. Dredge up the foulest response possible and bury him. I know you have it in you. I’m rooting for you kid.”

Okey Dokey.

Here are FIFTY proofs … UNDENIABLE proofs … that the entire Chinese economy is ONE BIG BUBBLE.

I seriously doubt Smokey will be able to refute EVEN ONE of these proofs. First, he doesn’t know jack shit about economics, or sales, or how-the-real-world-operates. Second, it will take him two hours to read, as he’ll have to look up any and all words with more than two syllables.

Give it your best shot, Mr. Throat Yogurt.

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1. In China there are about 30 billion square feet of space in construction only in the commercial property sector.

2. Fixed investment is forecast to reach 60 percent of Chinese gross domestic product in 2010, up from around 50 percent in 2009.

3. China’s credit boom has increased bank lending by more than 6 trillion Yuan in the period between December 2008 and June 2009.

4. Apart from the dollar weakness, part of the surge in commodity price is being fueled by China’s demand for speculative inventory.

5. In the beginning of 2009 the six-month futures price for oil was US$ 20 higher than the spot price. Investors faced huge losses unless spot prices rose. A wide gap between spot and futures prices increased inventory demand as arbitrageurs sought to profit from the difference between warehousing costs and the gap between spot and futures prices. That demand flattened the price curve and limited losses for financial investors. Without inventory demand, financial speculation doesn’t work.

6. China’s bank lending has driven speculative inventory demand for commodities, Chinese banks lend for commodity purchases, allowing the underlying commodities to be used as collateral. These loans are structured like mortgages.

7. The international media has been following reports of record commodity imports by China. The surge is being portrayed as reflecting China’s recovering economy. Indeed, the international financial market is portraying China’s perceived recovery as a harbinger for global recovery. It is a major factor pushing up stock prices around the world.

8. For four decades before 2003, fine iron ore prices fluctuated between US$ 20 and US$ 30 a ton. As ore was plentiful, prices were driven by production costs. After 2003, Chinese demand drove prices out of this range. Contract prices quadrupled to nearly US$ 100 per ton, and the spot price reached nearly US$ 200 a ton in 2008.

9. China’s steel production capacity has skyrocketed, even though capacity is fragmented.

10. China’s local governments have been obsessed with promoting steel industry growth, which is the reason for fragmentation. Huge demand and numerous small players are a perfect setup for price increases by the Big Three miners, which often cite high spot prices as the reason for jagging up contract prices.

11. Numerous Chinese steel mills simultaneously want to buy ore to sustain production so their governments can report higher GDP rates, even if higher GDP is money-losing. China’s steel industry is structured to hurt China’s best interests.

12. As steel demand collapsed in the fourth quarter 2008 and first quarter 2009, steel prices fell sharply. That should have led to a collapse in ore demand. But the bank lending surge armed Chinese ore distributors, giving them money for speculating and stocking up.

13. Even though China is the biggest buyer of iron ore by far, it has had no power in price setting. The global recession should have benefited China. Instead, the lending surge worsened China’s position by financing Chinese speculative demand.

14. Since September 2008, the tough economy and easy credit conditions encouraged many companies to try profiting from asset appreciation. They borrowed money and put it into the stock market. This speculation spread to Hong Kong.

15. In China, borrowing money for asset market speculation is not restricted to private companies. State-owned enterprises appear to be lending money to private companies at high interest rates, i.e. loan sharking, using money borrowed at low rates from state-owned banks.

16. As China’s economy weakened in late 2008, private lenders began demanding money back from distressed private companies. Loans from state-owned enterprises may have kept many private companies from going bankrupt. It has served to re-channel bank lending into cash for individuals and businesses that were in the lending business. This money may have flowed into asset markets

17. China’s growth model is based on government-led investment and foreign enterprise-led export. As exports grew in the past, the government channeled income into investment to support more export growth. Now that the global economy is weak and China’s exports are not coming back to 2007 levels, there will be no income growth to support investment growth.

18. In May 2009, the question of whether China is presenting a too rosy growth picture came from nor other than the International Energy Agency. The IEA said Beijing’s official 6.1% on-year growth in first-quarter gross domestic product didn’t tally with a 3.5% drop in China’s oil demand in the quarter and also cited “inordinately weak” electricity demand. The IEA floated the possibility that Real GDP data aren’t accurate and shouldn’t be taken at face value.

19. London-based economic consultancy Lombard Street Research, said China’s growth in Q1 2009 was “probably slightly negative or nil at best.

20. China that resides at the very epicenter of global reflationary forces. A $600bn stimulus package and an incredible $1.0 TN first-half expansion of bank lending.

21. Money Supply in China is growing at a Record 30%.

22. In December 2009, new local-currency loans in China totaled 294.8 billion Yuan ($43.2 billion), compared with 253 billion Yuan in October, according to data released by the People’s Bank of China.

23. China’s banking regulator plans to slow new lending to between 7 trillion Yuan and 8 trillion Yuan in 2010.

24. Copper stockpiles held in duty-free warehouses in China, the top user, may be re-exported after surging to as much as 350,000 tons from almost none at the start of the year, according to Xi’an Maike Metal International Group. In addition to the bonded-zone stockpiles, China may also hold 150,000 tons in the Shanghai area, including in exchange- monitored warehouses; 235,000 tons at the State Reserve Bureau, which maintains government holdings; and 200,000 tons with fabricators and private investors.

25. The Chinese economic miracle can be broadly split in to three periods. In the 1980’s, the first stage was unleashed by modest reforms by Deng Xiapoing. The second stage concentrated on rationalization of labor that saw a proliferation of light industries. The third stage has been focused on expansion of heavy industries and infrastructure. In all of the three stages there was a central role for investment as a driver of economic growth. The dependence of Chinese growth on investment is unsustainable.

26. The gradual increase in China’s investment ratio that started in 1998 has now reached unprecedented levels. Capital spending has become the dominant growth driver and GFCF (Gross Fixed Capital Formation) accounted for 70% of China’s growth in 2008 and 90% in 2009.

27. The ratio of GFCF to GDP exceeded 50% in 2009 which is well above the highest GFCF to GD P ratio in any Asian country in their mid 1990s boom.

28. The largest period any country maintained GFCF to GDP in excess of 33% was nine years, China is now at its thirteenth year.

29. ICOR(Incremental Capital Output Ratio in China has markedly deteriorated compared to the previous two decades as well as other high growth countries in their pre-peak investment stages. In 2009 China’s ICOR was more than 2 times higher than the 80s and 90s average.

30. The falling marginal return on investment is symptomatic of the increasingly speculative nature of China’s capital spending boom. Where a self feeding process of credit growth and investments in manufacturing, infrastructure and real estate is currently under way.

31. Since the throw out the first decade of the 21st century, domestic credit in China has expanded 50% more than GDP.

32. In China, the effectiveness of domestic credit in generating growth is collapsing. In the period from 2000 to 2008, it took on average 1.5$ of credit to generate 1$ of GDP growth. In 2009 this ratio reached about 7$ to 1$. The peak of credit in the USA was 1$ to 4$ in 2008.

33. In 2009, China’s trade balance has shrunk 20% and FDI has fallen 18%.

34. China’s government debt is vastly understated. Not included in the public debt are liabilities of the local governments which are estimated at 680bn$. A large part of loans extended this year (approximately 350bn$) went to finance public infrastructure projects guaranteed by local governments. In total, these off balance sheet liabilities are equal to 1.7tn$, which would bring China’s public debt to GDP ratio up to 62%, at a level comparable with Western average. The argument that China can afford capex spending at high levels for a long time since the government has low levels of debt is a myth.

35. M2 monetary aggregate (Money Supply) is 9tn$ in China and is higher than M2 of 8.3tn$ in the U.S.

36. China’s position as the world’s largest aluminum producer is astonishing since it lacks the surplus of cheap energy that is typical of specialized aluminum exporting nations.

37. China reported urbanization rate of 45% is a myth. China’s definition of an urban centre includes population density of above 1,500 people per square kilometer, a definition that will exclude Western cities like Houston or Brisbane. China doesn’t need any more real estate development.

38. China currently producers 500mn tons of steel, more than the EU, Japan, the U.S, and Russia combined. China has capacity to produce 660mn tones per year and still there are 60mn tones of steel capacity currently under construction.

39. China’s per capita production of steel is approximately equal to the EU average and higher than the U.S

40. Average residential floor space per household in China is already at high levels compared to other Asian countries. In terms of floor space per household levels, China has overtaken South Korea already in 2003, and since then construction has consistently surpassed household formation.

41. According to the IMF, home ownership levels in China were 86% in 2005, compared to 69% in the U.S at the peak of the housing boom.

42. Currently there are 4.2mn kilometers of paved roads in the USA, of which 80,000 are expressways. China has 2.7mn kilometers of paved roads, of which 60,000 km are expressways. Currently there are 250mn vehicles in the USA versus 43mn in China, yet China has already a comparable size of highways.

43. In total there are 600,000 bridges in the USA, of which 450,000 are in use, there are 500,000 bridges in China, and 15,000 are built every year. The USA has five times more rivers than China…

44. Planned railway infrastructure spending in China for the years 2009-2012 is projected to be 420bn$, which would be enough to build 63,000 km of rail network.

45. In 2009, investments into railway in China where up almost 70%.

46. 37 out of 44 airports built between 2005 and 2010 have been built in sparsely populated west China.

47. China is already at a very advanced stage of industrialization, even on a per capita basis. Room for further capacity expansion is extremely limited.

48. After 2009, it will be hard for investment to grow a further 30% in 2010. Even if investment growth will be 10%, if exports will not rise sharply consumption will need to rise 25% for GDP to reach 10% as expected. Such growth rates were not seen even at the peak of Japan’s boom in the 1960’s or the United States boom in the 1950’s.

49. Since 1978, real growth in private consumption in China has almost always been lower than the overall growth of the economy.

50. In China, the ratio of GDP to household income has declined by 20% in the years 1999-2008. The emerging middle class is a myth.

Smokey
Smokey

What a useless article that doesn’t say shit.

“A recent survey of market participants published by Bloomberg indicated that 45% of those surveyed believe its inevitable that China’s boom will turn to bust sometime in the next five years.”

Like that means something.

“Another 40% said they expect it to happen sometime after 2016.” LOL

Now THAT’S really going out on a fucking limb, Simon. Sometime after 2016 could mean in 2017 or in the year 6839172.

Any survey of market participants is LESS than worthless.

Jim Chanos discovered that Enron was cooking it’s books, so now he’s a global investment wizard.

Simon Black could have saved eighteen paragraphs of vacuous shit by just printing the confession he made in his last sentence.

Where he concedes he doesn’t know SHIT.

Smokey
Smokey

Stuck,

Your line item #7—–China’s ” perceived recovery ”

LOL, the biggest economic boom in the history of the world is a “perceived recovery ”

Like that list isn’t biased. Probably written by fucking deep underwater shorts who are so fucking desperate they’ll try anything.

China GDP $1.1 trillion in 2000 to $9 trillion now. An 800% increase in GDP in a decade.

“Perceived recovery”

I rest my case.

MuckAbout

Holy Shit, Stuck…. I printed out the post just in case someone ever wants to tell me China is the new Japan.

I was living in Hawaii back in the 80’s when the Rising Sun was buying up great chunks of Oahu’s Waikiki and anything else they could get their hands on. Everyone in Hawaii were telling each other that the Japanese had indeed won WWII, it just took 35 extra years to finish conquering Hawaii.

Turns out, except for one or two hotels here and there, they brought in their own managers and drove literally billions of Yen investments straight into the ground. It took about 6 years to get over them but now, what few viable Japanese investments that are left are thoroughly Americanized and you can’t tell them apart anymore.

Mostly American investors bought it all back at nickels and dimes on the dollar as things fell apart.

History will repeat itself yet again, different tune, different players and maybe a different outcome but everyone’s going down the same path.

Good post..

MA

StuckInNJ
StuckInNJ

Thanks, Muck.

Smokey didn’t like the 50 reasons though.

The 50 Reasons contains 1,911 words. Smokey’s pathetically sad response is limited to quibbling about TWO words — “perceived recovery”. bwahahahaha, funny shit, there

Hey, I have two words for you Herr Throat Yogurt —- LAME ASSED!!

Eat shit. (Bonus 2 words for attempting to play.)

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