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The China Bubble - You want fortune cookie?



April 30, 2009 – Comments (4)

Ok I thought I'd give my 2 cents about China. I think it's a bubble economy that's getting close to popping.

 OK, a big deal was made about how China has secretly been stockpiling Gold for the last few years. I'm not really concerned that they did, but I was definately concerned that they they could without us noticing. I'm fully aware that they have Gold mines in China, but we would have noticed an output drop even if they siphoned off a fraction of what they stockpiled. They could have discovered new mines that they didn't tell us about, but that would require years of planning, and quite frankly China economists are not what I would call patient. It took me a while to figure out how they were getting it, but I finally read 1 line in a commodities book and figured it out. How did they get it? Believe it or not you and I threw it a way!

The line I read was "There is more gold in a ton of computer waste than there is in a ton of gold ore." The reason that the book says it isn't as cost efective to reclaim the gold in computers, is because it's very time consuming and labor intensive. Well when you throw a computer away, guess where it usually winds up? And guess which country has an endless supply of cheap labor? I find it funny that another country is getting wealthier on our garbage.

Ok, now to suppress your fear about China adopting the Gold Standard. They can't! No matter how much they want to. Why? Because if they did that, they could no longer keep the yaun artificially lower. Think about it! What would keep you or I from selling gold for yuan and converting yaun to the dollar over and over again? They would have to decouple from the dollar to go to the Gold Standard and that would be their downfall. For those of you saying that they will move to a basket of currencies rather than the Gold Standard, What currencies? Most other currencies are in worse shape than ours!. Sadly I think the yaun is tied to the dollar for quite a while.

Why would inflation be such a bad thing for China? The Chinese middle class currently live on about  $5,000 a year. Low by our standards, but in yuan, a family can live comfortably enough to have about all the necessities that we enjoy and a lot of the luxuries as well. (That wage is enough for a family to hire domestic help) China now has a 3 headed monster! First, the current Middle Class has tentively supported the government, but expects their standard of living to keep increasing at the same pace. China's continued growth depends on Chinese farmers to continue to migrate to urban areas, but farmers have seen an increase to their income at a pace that's better than the migrant workers and they are less likely to migrate. Any increase in pay for migrant workers creates more inflation and lowers the standard of living for the middle class. Also Chinese companies operate on such tight margins, that any increase in labor costs, can price them out of the world market. A natural progression would be for China to compete in the services industry, and in technology, but China did not invest in training in those industries like India did.

On to why the bubble will burst! The real interest rate! The real interest rate is the current interest rate minus inflation. China reports inflation at about 6%. A lot of experts say that it's at least 10%, but we'll go with their numbers. China has kept the rate to borrow money at about 3% for quite a long time, but I'm sure they lowered that rate when we did, We lowered ours to practically 0%, and to keep pace China would have to lower theirs to effectively -3% (they couldn't really do that, but 0% is almost a given), again that's if the numbers they were reporting are true, but to be conservative I'll go with the 3% and pretend they didn't lower it. Even in this weak economy most experts will tell you that China is still growing at 7-9%. So for the average middle class China-man, It makes sense to borrow as much money as you can, and invest it all in the stock market. Do you remember from a few years ago that the Chinese Government was trying to stop that very thing? There is even more incentive to do it now than before. Picture your parents or grandparents borrowing everything they can and investing it in the market. How do you think that would turn out? Buying too much US debt! Let's face it, we have written too many checks that we can't cash. Given a (in my opinion) inevitable global depression, we are gonna have to at least partially renounce our debt. Are we gonna renounce the debt to our own pension plans, or are we gonna renounce the debt in foreign hands? China's stock-piled commodities! This one gets to me the most! If you think that gold is the only thing China stock-piled your mistaken! In fact, they are stock-piling everything! They currently produce 4 times more steel than they use, and 1/3 of their steel production is to fabricate more plants to make more steel! In a Global depression, they are gonna be forced to sell those commodities at a huge loss! Given all the other problems that sprout up, they will be lucky if the current government is in control long enough to sell them. They are in the same boat Japan was 30 years ago. They tried to grow too fast and were willing to manipulate their own economy to do it, and just like Japan, the economy will fight back.

In case any of you want to dismiss me as another raving bear, take a look at my Caps portfolio. I have about 5 or 6 red thumbs. I have about 190 Green thumbs. Don't get me wrong, I'm very pessimistic, but I rightly predicted a bear market rally and I'm taking advantage of a good guess. I was originally loooking at October, as the market correction, but more and more i think that June might be a better estimate.

For my last statement, I'm sure a lot of you are thinking, that if China loses, we win. Not a chance! We've suffered poor government policy too long to recover. We are Britain 100 years ago! There will be a new economic power that takes over. My bet is that it's India, but I'm not close to being sure. We can rebound quickly if our government responds quickly, and I think the best reponse is if we adapted the Gold Standard ourselves. Time will tell.

4 Comments – Post Your Own

#1) On May 01, 2009 at 2:03 AM, zversyp (< 20) wrote:

A lot of money was made in the last couple of decades across the globe.  We made our money by increasing amounts of leverage and by creating asset bubbles.  We also did that while at the same time increasing our amount of debt, both national and public, which is now at historic levels.

China has made their money by selling actual products at prices that were lower than their production costs.  They are now the largest creditor nation in the world.  They have an actual trade surplus, unlike us.  They made all of their money from sound economic principles.

How are they an economic bubble?

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#2) On May 01, 2009 at 2:07 AM, zversyp (< 20) wrote:

Sorry, I meant to say that China sold those actual products at prices that were HIGHER that their production costs.  I apoligize.

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#3) On May 01, 2009 at 1:15 PM, Alex1963 (27.90) wrote:

Good post & well presented thesis

Here's why I don't agree with your conclusion, tho.

I don't believe any country has the resources any longer to adopt a true Gold standard. They'd have to control the majority of the worl'd's supply. Currnently my admittedly quick research has shown their current (as of) end of 2007) Gold as a %of Reserves is 2% (The US has 80)%) thru the end of of 2008 (World Gold Council). So tho I wouldn't presume to challenge TMF Sinch I do question that they have been all that secret or adding massively to their relative supply. Naurally I recognize that as China's currency reserves have vastly increased 2% of that in Gold could be a huge tonnage increase. But not enough IMO to enable a Gold backed reserve currency. Plus they wouldn't need to. They can just do what they've been doing recently by insisting some of their trade transactions are resolved with the Yuan instead of the US dollar. The US having 80% is I believe belied by our trade deficit and far smaller foreign currency reserves.

Plus proposing a basket of currencies to me is a further way for them to make an alternative reserve to the US$ more attractive. Like the Euro where the stronger economies in effect prop up the weaker. It get's China's foot in the door and deflects concern that they would have too much "control". Until they have increased their control and influence and can take over the world! LOL

But as to any China "bubble": 

China has a totalitarian Gov't and can make relaitively quickunilateral adjustments unlike all the other large economies.

China has a lots of room to grow their middle class and in standards of living in the lower class while still keeping the population "controlled".

With this vast pool of some of the world's cheapest labor they can become the bargain provider of nearly anything you can name that has a market for export. Except maybe food.

They have massive fiscal reserves available with which they can aim their export economy at anything they like. I imagine you'll start seeing that surplus steel getting used or exported soon.

With these reserves available they are well positioned to replace or compete with both the US, World Bank and the IMF etc as a political powerhouse. This can, is being, and will contune, to be leveraged in myriad ways.

Because they do not allow their currency to be traded they can, and do, manipulate their currency far more easily than other major economies and therefore have unmatched fiscal flexibility.

They have tremendous national brand loyalty not to mention the benefit of state support, backing and outright ownership of many of their largest, most successful and well positioned industries and companies.

They have the world's 3rd largest economy but only India can claim the same poulation or potential growth statistics.

(By the way India is still a representative Gov't and also hampered with terrible systemic political corruption. Those two factors combined hamper their ability to compete with China for superpower status. IMO)

I believe they play a very long game and are obviously intending to become the superpower. To forge lasting ties and to market goods. I think they are perfectly willing to subsidize steel or any other export until they have ensured a wide "moat" advantage.  

So all in all I like the overall long and short term prospects for current and future China investments. And I don't see a bubble issue at this time.

My fortune cookie reads" Yuan a winnng bet? Try China" :) 




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#4) On May 03, 2009 at 7:33 PM, BGriffinFlorida (26.53) wrote:

Fortune cookies are not Chinese.

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