Use access key #2 to skip to page content.

JakilaTheHun (99.94)

The Great China Bubble and Why It Will Collapse

Recs

49

March 10, 2011 – Comments (35) | RELATED TICKERS: FXI , EEM , GLD

Recently, I’ve been reading Edward Glaeser’s "Triumph of the City." It’s an excellent read and looks at how cities have thrived, failed, and have created greater economic and intellectual prosperity that would have been unachievable otherwise.

While reading Glaesar's work, I could not help but to notice parallels with modern China. China’s central planners might be in agreement with Glaeser’s basic thesis, on one level. After all, has any nation in the history of the world promoted more rapid upward urbanization than the People’s Republic of China? China’s urban population percentage more than doubled from 1980 to 2010; an astonishing figure.

Detroit

While "Triumph" points out the great efficiencies of urban economies, it also sets out to expose some of the great failures of cities, with Detroit being the classic American example. While it’s simple to look at what China’s built and be amazed, it's also simple to ignore some of the underlying realities. Diving deep into those realities suggest that China might not be creating the urban paradise that the media has conveyed over the past few years.

In "Triumph," Glaesar examines Detroit in detail in order to try to understand why it failed in the latter 20th Century. Detroit’s population fell from about 1.8 million down to 775,000 in a matter of 60 years. No American city suffered more than this in that timeframe.

What went wrong in Detroit? According to Glaesar, several things. In the 19th Century, Detroit had a rich entrepreneurial culture and was filled with innovative small businesses. By the mid-20th Century, Detroit had three lumbering goliaths, burdened by inflexible labor unions, a poorly educated populace, a lack of entrepreneurship, and had little interest in innovating.

In essence, Detroit’s great success became its failure. By allowing its economy to become completely dependent on one industry, Detroit had made itself very susceptible to economic shifts. Moreover, its one industry relied on a high volume of uneducated, low-skilled labor that lacked the entrepreneurial drive that was so common in Detroit in the late 19th Century.

Detroit only made further mistakes from there. Its police force developed a reputation for both racism and brutality, which eventually led to race riots by the late 1960’s. Detroit turned around its racial problem, but also scared away most of the wealthy whites at the same time, through boneheaded policies that tried to redistribute wealth from the rich to the poor. It didn’t work. The fleeing of Detroit’s capital base only made it poorer.

Next on the agenda was to build more things. There’s nothing that solves economic problems like building things, right? Well … this is where Glaesar’s harshest criticism comes. Detroit was a contracting city trying to build itself into prosperity, but building where there is no demand is only bound to lead to further disaster. Detroit has such an excess supply of buildings now, there’s no hope it could ever fill a significant percentage of them. Yet, Detroit even neglected its neighborhoods that were still alive; demolishing one neighborhood for a silly, expensive project for which there was no demand.

Reading about Detroit, I couldn’t help but to think that many of the same criticisms that Glaesar throws at the "Motor City" might apply to another place: China.

The Great Building Boom

China’s rising economic prosperity over the past several decades is not all that different than Detroit’s. China has made its fortune by becoming the world’s manufacturing center and it's biggest cities have thrived as a result. While many Americans lament the loss of American manufacturing and view China as capturing America’s lost glory, it might be worthwhile to take a look at how those who have adopted China’s policies have failed in the past, including Detroit.

While I’m here to write about why I do not view China’s economic miracle as sustainable, I do think it’s worthwhile to explore some of their successes. In many ways, China’s great growth came as a realization of its poverty. Market liberalization of the ‘80s and ‘90s produced major gains for China. A common theme throughout history is that the greater level of trade a nation engages in, the more prosperous it can become. China learned this and quickly became a manufacturing hub.

What attracted manufacturers to China was not a mystery: a large populace and cheap unskilled labor. While a modern economy needs more than manufacturing to be great, China’s manufacturing boom at least set the stage for increasing gains.

The Currency Peg

Where China went wrong was precisely the same area that Japan went wrong: not allowing its economy to evolve beyond exporting industries; and for China, it is dependent on cheap manufacturing, in particular. To be sure, manufacturing could be very beneficial, but increasing productivity gains, coupled with a better educated populace should produce further economic gains in service sectors of the economy.

China’s currency peg was initially a device used to let foreign capital know that China was a good place to invest. By tying itself to the dollar, China was trying to gain credibility. And China got it. However, there was an obvious side-effect of the currency peg; China’s great economic gains should have been reflected in the rising value of its currency. Instead, Chinese policymakers realized that the currency peg, by artificially preventing the Yuan from rising, increased manufacturing exports even more. In essence, the peg ceased to be about "gaining credibility" in order to grow, and more about guarding its current gains.

The major problem with the policy forced the central bank to print an excess supply of Yuan. In the real economy, the effects of China’s currency peg have been inflation, negative interest rates, and a constantly declining purchasing power. What happens in an economy where the currency is artificially being devalued over time? People flock to hard assets like real estate and gold.

China’s economy has not evolved as rapidly as it should to the service sector due to the problems associated with the peg, which has left it dependent on manufacturing. However, the peg did create another vibrant industry: construction.

Of course, there’s nothing wrong with construction, when there is demand for it. Unfortunately, there’s not a shred of evidence that supports the idea that the Chinese economy needs anywhere near as much real estate and infrastructure as is being built out.

An Economy Dependent on Building Stuff

Jim Chanos, the famous short-seller who exposed Enron, has been one of the first and loudest critics of the economic policies that have allowed China’s real estate industry to grow well beyond its function. Chanos has pointed out that over 60% of China’s GDP is now related to fixed-asset construction; a frightening number, especially when you consider that only about 15% of the US economy was construction-related at the height of the housing boom.

China is now loaded with "ghost cities" and large empty buildings that dot its urban areas. China bulls have countered that China’s rapid demand growth will eventually fill these cities. It’s also frequently pointed out that while Tier 1 cities might have overvalued real estate, Tier 2 cities are more reasonably priced. Yet, new reports suggest that does not appear to be the case at all.

What is missed by the China bulls is that there is no demand being created to fill these buildings. China’s economic growth over the past few years has been impressive, but only because they keep buildings things they don’t need. When you delve down deeper, China's economy is not growing all that much beyond construction. You could argue that China is already in an era of stagnation and only construction is masking it.

China’s currency peg has increased its dependence on manufacturing, which has deterred other service- and consumer- oriented segments of the economy from growing as rapidly as they should have. This is further complicated by the pressures created by the real estate bubble, which have driven up the cost of living significantly in China’s major cities.

As workers are increasingly getting squeezed, they demand higher wages and better labor protections. They are right to do so, of course, but this further undermines the manufacturing sector that is based around low-wage unskilled labor. As Chinese wages grow, more manufacturing shifts to Southeast Asia and other lower-cost areas.

In other words, China is stuck. The currency peg has created a situation where China has prevented its economy from expanding beyond manufacturing. Meanwhile, it’s created a credit-fueled bubble that has undermined the low costs of that manufacturing industry. The only thing that’s left is to keep building things that no one needs.

Triumph of the City?

Shifting back to Glaeser’s analysis of cities, China has created an interesting trap for itself. It has created the exact type of urban, upward city that Glaeser suggests allows for innovation to occur. Its closely-connected cities that allow people to share ideas, form small businesses, and create innovative products that stimulate economic growth. This is why places such as New York thrive!

Yet, China has also committed the cardinal sin of building massive amounts of stuff that it doesn’t need, based on economic growth that doesn’t exist. Eventually, this will led to an undesirable outcome such as either a real estate crash or hyperinflationary pressures.

All the same, China’s "economic miracle" does leave me wondering what will happen in the future. My personal belief is that there is a significant likelihood that China experiences a major real estate crash in the next few years. However, my additional question is, will China rebound if that happens? Maybe I’m putting the cart before the horse with that question, but what China has created in a short-time is very interesting; even if unnecessary right now.

The Consequences

As for my bet, I have made many moves towards a "bearish China" thesis in my portfolio. The most obvious implications of a Chinese real estate crash would be a commodities crash. In fact, I view a commodities crash as even more likely than the RE crash, because even if China is somehow successful at shifting its economy towards a more consumer based one, one of Premier Wen Jiabao’s primary goals over the next five years. This will still destroy demand for industrial commodities such as copper, silver, and possibly even palladium.

I’m willing to go a step beyond that, however, and suggest that China can’t engineer the so-called "soft landing" that they desire. A recent Fitch Ratings gauge suggests that China faces a 60% chance of a banking crisis within the next few years. While my viewpoints are based more on qualitative research, I’d agree with that assessment.

My main question is not whether there will be major issues associated with China’s building boom; but rather, when those issues will truly begin to manifest themselves in China’s economy. It’s possible that this situation could churn on for a few more years, even all the way up to 2016. The longer it goes on, however, the more devastating a crash will be when it happens.

The other issue is that it's not completely clear that the crash will be deflationary. While one might reason that it would almost have to be deflationary, it’s not actually clear how the PRC would respond. There are, of course, equally and more undesirable outcomes possible, such as hyperinflation. Recent moves suggest that China prefers not to go this route, but only time will tell what happens in a case of stress.

Regardless of the timing issues, I have begun to buy into puts that would profit from a crash within China over the next two years. I am primarily using this as a way to hedge my exposure to U.S. banks and homebuilders. While a China crash would not necessarily harm the U.S. all that much, it would put short-term pressure on all world markets, in all likelihood.

Disclosure: I am short and/or own puts on a "bearish China" thesis, which includes various commodities, Chinese ETFs, and emerging market ETFs. I may initiate additional positions based on this thesis in the future.

 

-------------------------

Economics Blog:  Btw, this article is from my new economics blog, Malthusian Nectar.  I haven't been publishing everything to CAPS, but all my economics stuff should appear at that blog. 

Hunnish News Invasion:  I'm finding maintaining a Hunnish News Invasion blog a burden.  Instead, I've created a page on Facebook that allows me to post the articles much more easily.  If you want to read HNI, just "Like" the Facebook page: Hunnish News Invasion

 

35 Comments – Post Your Own

#1) On March 10, 2011 at 2:03 PM, chk999 (99.97) wrote:

Excellent blog post! I now see I need to read The Triumph Of The City.

Report this comment
#2) On March 10, 2011 at 3:01 PM, ETFsRule (99.94) wrote:

Great blog.

The Economist is showing that China's housing prices are up by about 50% over the past decade, even after adjusting for inflation.

I agree that a crash could be in store for China... but I believe there will be an even worse crash in Australia. The Aussies are highly dependant on commodities... and they have an even worse housing bubble than China.

Report this comment
#3) On March 10, 2011 at 3:09 PM, ikkyu2 (99.32) wrote:

Thanks for the great, well reasoned and thought-provoking post.

Unfortunately, there’s not a shred of evidence that supports the idea that the Chinese economy needs anywhere near as much real estate and infrastructure as is being built out.

This is an idea that comes up a lot.  After watching the behavior of various markets (equity, sovereign debt, corp debt, commodities, and forex) and their participants over the last 10 years, I have come up with a semi-explanation for it.

You are a country.  You know that in the next 50 years in order to sustain growth you will need X amount of infrastructure.  Housing, roads, power lines, power plants, wirelines, whatever countries build to serve their citizens.

Now in order to generate X infrastructure, you need Y amount of raw goods and inputs.  These inputs are energy and materials, basically - commodities.  Oil, steel, copper.

In 2007 the world tested the elasticity of the supply curve for oil and came up with some disturbing results, but I believe these results have been anticipated by smart money and policymakers for some time.  Look back a bit, into the 90's, and think along these lines:  "I am a country.  I have to build X amount of infrastructure in the next 50 years.  All else being equal, do I want to do it with $20 oil and $.80 copper, or do I want to do it with $200 oil and $10 copper?"  The answer is pretty clear.

Writ large, this line of reasoning explains a heck of a lot of otherwise incomprehensible behavior over the last few years. 

Report this comment
#4) On March 10, 2011 at 3:48 PM, SkepticalOx (99.44) wrote:

#3 Would it not make more sense to stockpile these commodities, buy up resource-firms around the world, etc. etc. instead of actually building things you don't need in the forseeable future? That's a far simpler option no?

Report this comment
#5) On March 10, 2011 at 4:20 PM, JaysRage (88.77) wrote:

#3 Would it not make more sense to stockpile these commodities, buy up resource-firms around the world, etc. etc. instead of actually building things you don't need in the forseeable future? That's a far simpler option no?

Um, they are doing this too.  

Report this comment
#6) On March 10, 2011 at 4:29 PM, SkepticalOx (99.44) wrote:

#5 :P I know they are... I was just making a point. 

If you use the line of reasoning provided in #3, why continue to building empty buildings if that was just it? 

Report this comment
#7) On March 10, 2011 at 5:18 PM, Melaschasm (55.11) wrote:

Great post.  I agree with your reasoning and conclusions about much of what you wrote.

However, there is one item where I strongly disagree.  If China can somehow convert towards a more consumer based economy without a major crash, this should put more upward pressure on commodity prices, not less.

 When it comes to the China RE bubble, I am not as pessimistic as you, although I do agree that some sort of crash seems likely.

In my opinion, China is going to suffer even more from continued commodity inflation, than the USA will.  Rising commodity prices could pop China's RE bubble, just as they helped pop the USA RE bubble.

Report this comment
#8) On March 10, 2011 at 7:55 PM, Option1307 (29.70) wrote:

Fantastic thoughts, +1.

Report this comment
#9) On March 10, 2011 at 8:14 PM, Valyooo (99.45) wrote:

You definitely know more than I do about this, but:

1) They are not leveraged.  The down payments on housing is like 50%, theres no outside debt, etc.  Its hard to be a bubble without leverage.

2) I don't think the eventual unpegging will ruin them.  They will just shift from exporters to consumers.  I think it will hurt us (although obviously Obama doesn't) becuase we won't have cheap stuff anymore.

3) Despite their population control they are still growing, so the real estate will eventually be used

4) Everybody seems to be flocking to gold, not just China.

If there is a bubble, I don't think it will be that big, and I don't think it will be in all sectors of China.

Report this comment
#10) On March 10, 2011 at 10:28 PM, JakilaTheHun (99.94) wrote:

Valyooo,

I'd strongly disagree with the idea that there is little leverage in China.  A recent Cullen Roche article examines the growth of credit and money supply in China vs. the US:

http://www.businessinsider.com/the-myth-of-the-exploding-us-money-supply-2011-3

It's true to buy a house, you need a high down payment, but this isn't *just* a housing bubble.  It's an all-around debt-fueled bubble, with loans for not only housing, but also commercial RE, and businesses.  The highest percentage of loans going to manufacturers in the Yangtze River Delta region. People might end up being surprised that the banks will still get hit, even if housing loans might have higher down payments than the US. 

Unpegging won't ruin them.  People make that mistake with Japan:  assuming that the Plaza Accord was the driver of the real estate crash.  Rather, it was a combination of an undervalued currency, then coupled with easier credit that caused Japan's RE bubble.  The bubble would have bursted whether they unpegged or not.  

China would actually alleviate their problems if they appreciated their currency 10% per year and then un-pegged once it was close to fairly valued. 

Whether their population is growing is irrelevant.  The US population was growing fairly well in the 1950's, but it didn't save the Rust Belt and it certainly didn't save Detroit.   The bigger issue is that there has to be someone who can afford the property.

Report this comment
#11) On March 11, 2011 at 3:22 AM, checklist34 (99.71) wrote:

jakila, this is great. 

I have never written a great missive about it, because save FEED from Jan 2009 to Feb 2009, and STP for part of 2009, I have never been long or short a chinese stock and I simply don't care about them.  

However, if Chanos argument is even somewhat factual (and I am sure it is) then China's economy is simply destined to experience considerable difficulties at some point.  In his most recent commentary he offered that 70% of the economy was now fixed asset construction.  That is beyond anything that I think has ever been seen, and so far out into left field that I simply cannot imagine how it could end well.

I have been a skeptic on China, and Taiwan et al in the 90s, and so on, for one simple reason:

Asian cultures have for centuries lack something that European cultures haven't:  they don't invent stuff.  

Car?

Train?

Plane?

Video game?

Computer?

Cell phone?

Internal combustion?

They copy and improve well enough, but what have they ever really created that was visionary and new?

I can't claim to be a cultural expert, but in my experiences in business working with Asian companies ... I was struck, truly, I mean floored by how slow they move.  So many questions, so many tests, so much tinkering, so much back and forth.  And nothing gets done.  

Thats in line with what you are saying above I think.  Just a personal observation, I am not disrespecting asians or asian culture, in fact the opposite is true.

But, and correct me if I am wrong, what I offer above seems to ahve been almost completely true throughout the industrial revolution.  

And china in particular seems to have at this point almost no rate of innovation.

And, also, the "THE SKY IS FALLING" crowd loves china and loves to sit and make bold statements over drinks in social settings about how doomed we are and how clearly they are going to take over everything.  

I always tend to assume that things in vogue with those prone to bold statements of dire events soon, and certain, to come are not correct. 

Thats always been my case.  I just don't buy china at all and I haven't in my whole almost 27 months of playing around in the markets.

This chinese construction situation... however...  may be a harbinger of a future commodity deflation epsiode.  

Report this comment
#12) On March 11, 2011 at 3:41 AM, JakilaTheHun (99.94) wrote:

I agree, Checklist, both on the 'lack of innovation' thing and the 'future commodity deflation' argument.  (In fact, that might be my next article --- that a China crash, coupled with excess US debt could coalesce to create a major commodity bust --- US debt problems are deflationary, not inflationary, in my view).

The lack of innovation in China, IMO, has little to do with Chinese culture, and everything to do with the Chinese government.  It's not an open society, quite frankly, and those societies do not produce innovation.  They never have, because they intimidate those with new ideas --- who then flee to places like the US. 

I posted this article on Seeking Alpha, as well, and one of the most idiotic implications I constantly encounter is that the Chinese are much more intelligent than Americans and place an emphasis on education.  Mostly, Americans think this because they see Chinese (and East Asians, in general) in the US tend to be very well educated and successful.  Yet, they fail to realize why that's the case --- it's not because they are genetically bred to be brilliant --- it's because a lot of the intelligent, innovative, and entrepreneurial people over there actually come to the US, because they feel their talents are more likely to be rewarded here. 

That's the big thing to me.  The US has its share of flaws, but more than most other nations, we actually empower innovators and entrepreneurs, whereas, nations like the PRC have a much less impressive record on that front.  So maybe China does produce a lot of intelligent people, but many of them end up becoming "Americans." 

Report this comment
#13) On March 11, 2011 at 3:56 AM, checklist34 (99.71) wrote:

Jakila, thats been the great power of the USA for over 200 years.  The worlds best, brightest, and most ambitious come here. 

Why are Indian people (form India) so exemplary as Americans?  We got some of the very best Indians. 

I think the asians have cultural impediments...  or maybe you're right, and i'm not wrong, and its the central planning aspect sort of common to all of their cultures thats the problem, not the people themselves or their habits.  I'll go along with that.  

I agree we are not headed for hyperinflation, that the massive debt is ultimately deflationary EXCEPT for the fact taht the fed knows this, and may actually eventually print money if it was necessary to escape a deflationary spiral.  That has not occured as of this time, no matter what almost half the blogosphere wants to state.

But anyway, in my view, combine the possibility of real problems in Japan, the probability of them in China, the deleveraging need (and in places realitiy) and I do not think that we can escape a third deflationary scare.  hopefully its mild like 2010 and not like 2008...

Report this comment
#14) On March 11, 2011 at 3:57 AM, checklist34 (99.71) wrote:

i applaud you for taking on seeking alpha.  I read it once or twice a week, check an article or 3.  I check Jeff Saut sometimes, couple others. 

but the comment section there can be so full of negativists who venture so far from reality and fact... that usually I just don't visit it.  

Report this comment
#15) On March 11, 2011 at 4:08 AM, GreenCollegeGrad (79.31) wrote:

Thumps on my own chest

I knew I was right when I had Jak as one of my favorites.

Brilliant post friend

Report this comment
#16) On March 11, 2011 at 11:25 AM, JaysRage (88.77) wrote:

What I don't understand is how you can think that China can crash and burn and not bring the entire world economy down with it.    The U.S. market gets the jitters when Greece's tiny economy looks shakey.   If China went down, it would dump the U.S. market right along with it.   Being short China and long U.S. doesn't make any sense. 

Report this comment
#17) On March 11, 2011 at 2:04 PM, PurpleHuskies (99.43) wrote:

Thank you very much for sharing your thoughts regarding to China.  I am not sure what to make of China myself: maybe China is new USSR or Japan or maybe China is the next US.  I wonder if current China's rise matches closer to rise of Japan or the rise of the US in 1900s.

Asians being not innovative is a crazy talk.  After all Chineses are credited for inventing many things that are used in today's society worldwide such as paper, silk, matches, gun powder, and decimal system.  My guess is the current social system and/or govement is a main problem.

Report this comment
#18) On March 11, 2011 at 9:56 PM, Valyooo (99.45) wrote:

How does an increase in M2 have to do with a bubble in China?  If anything, its just a bubble in commodities.  They are already experiencing inflation...theres nothing to burst in that aspect.

Report this comment
#19) On March 11, 2011 at 10:03 PM, JakilaTheHun (99.94) wrote:

How does an increase in M2 have to do with a bubble in China?  If anything, its just a bubble in commodities.  They are already experiencing inflation...theres nothing to burst in that aspect.

Money supply doesn't increase because of commodities.  Commodities increase because of rising money supply.

The extremely rapid increase in M2 suggests excess credit expansion.  It's a complete myth that there is not leverage behind China's bubble. 

Report this comment
#20) On March 12, 2011 at 2:34 AM, mhy729 (32.49) wrote:

Jakila, the argument that the Chinese and East Asian immigrants to America are well-educated and successful because "their best and brightest" head to the US has much truth to it, but I say you are very wrong to dismiss the idea that there is a major emphasis on education in most Asian cultures.  It doesn't compare to anything in the US.  There was a recent article by a Chinese-American mother of two (which stirred much controversy) regarding "Chinese" vs "American" parenting methods, and I would say that the intense focus on academic achievement she pushed on her kids is a fair description for many East Asian families.

The problem, and I agree with checklist on this, is that this educational model and the cultural forces that shape it, ends up stifling original thinking and innovation.  Another people that comes to mind that places a strong emphasis on education is the Jews.  There is a difference though.  An article some time ago which explored cultural differences and parenting styles noted that Jewish parents encouraged their children to try out different things, and screwing up along the way wasn't a big thing.  Japanese parents were less forgiving when their children made mistakes, and Japanese culture in general is very concerned with "saving face" and avoiding embarrassment, which probably makes them more risk-averse and less open to new ideas.

Things are changing from what I can see.  There are many younger Koreans who see a problem with the old ways, and I've listened to a number of radio shows [the only TV shows that aren't mindless entertainment seem to be broadcast late at night] where new parents discuss how to raise their kids, and they seem interested in moving beyond the narrow focus on academic achievement.  You really know very little about East Asian culture if you believe there isn't a hypercrazed focus on education.  As I mentioned though, I'm not sure it's all that beneficial.  There's also the issue of life satisfaction/happiness, but I won't get into that here.

Getting back to investing, I am inclined to agree with JaysRage that a China crash would inflict pain across the entire global economy.  I suppose some will be hurt more than others.  Korea (and Australia) stand to hurt very bad with a China downturn.  With what has happened in Japan, and more recently in the US, there is frequently talk of there being a RE bubble in Korea, but so far it hasn't popped....

Report this comment
#21) On March 12, 2011 at 3:16 AM, JakilaTheHun (99.94) wrote:

mhy,

I haven't made the arguments you've suggested I have, so I'm not sure why you're directing the responses at me. I haven't said much about the education issue (it's irrelevant to me) and I'm not sure why you believe that I think a China crash would not harm world markets, when I've explicitly said otherwise. 

You might be misinterpreting my argument.  Canada, Australia, and Japan could all get hit hard by a China crash.  The US markets will also get hit hard (hence, why I'm hedging US long exposure by going short on this thesis).  But that is the short-term

Long-run, China's economic distortions are causing significant harm to worldwide economic growth.  A China crash would prove beneficial in that it would destroy the distortions. 

Look at the history surrounding the collapse of the Japanese RE bubble and I think there's a great deal of evidence that Japan's distortions were harming the global economy, as well.  The 90's ended up being a period of dramatic growth, in part, because the Japanese RE crash .

It's not that I'm rooting against the Chinese economy here; it's that the PRC has set things up so that China's growth is artificial and destroys worldwide economic growth.  If the PRC is unwilling to reform for the better, then it's probably best that their economic model crash, and the rest of the world return to normal growth.

Report this comment
#22) On March 12, 2011 at 3:20 AM, JakilaTheHun (99.94) wrote:

Btw, here is the one thing I'd asked to those who counter my thesis:

Why is the US economy struggling with high commodity prices, but the Chinese economy is not, in spite of the fact that Chinese markets should theoretically be much more sensitive to price?

To me, that suggests that the US's market oriented mechanisms are saying "commodities are too expensive", while China's distortions are encouraging commodity buying, even at otherworldly prices. The model is not sustainable.  A free market would beat the commodity prices back down, but this isn't a free market --- the currency peg creates a situation where people speculate on real estate and gold, because it's the only way to protect against the artificial devaluation of their currency.  All the construction sends the prices of commodities through the roof. 

Report this comment
#23) On March 12, 2011 at 4:36 AM, checklist34 (99.71) wrote:

#17, it is not crazy talk at all.

last 100 years, 120 years, 150 years, what world-changing new thing came out of Asia?

Its not just me, my old businesses are now part of a big multinational with significant japanese and chinese presence, and they have commitees whose intended function is to try to stimulate innovation in their asian businesses.  I've had talks with management there about how to help them help asia invent and blah blah blah

I'm not saying there isn't, but name one ground breaking concept that came out of asia?  copy and improve, yes.  actually invent, I can't think of it. 

Report this comment
#24) On March 12, 2011 at 4:05 PM, ETFsRule (99.94) wrote:

"last 100 years, 120 years, 150 years, what world-changing new thing came out of Asia?"

I don't think it's an Asian problem. It's an issue of developed economies vs emerging markets.

You could just as easily say that there haven't been many world-changing concepts from Africa, South America, Central America, or the Middle East over the past 150 years.

Japan has actually invented a fair amount of modern things: plasma TV's, the bullet train, DVD's, microprocessors, etc.

http://en.wikipedia.org/wiki/List_of_Japanese_inventions

Report this comment
#25) On March 12, 2011 at 8:25 PM, MKArch (99.67) wrote:

Outstanding post Jakila. I have a much less sophisticated but slightly different angle on China's potential problems that I don't hear anyone else discussing. I remember in the aftermath of the tech bubble bursting at the beginning of the last decade industries in general had grown bloated but got cost cutting religion. There was what seemed to me a massive migration of operations from developed countries to emerging markets, China and India in particular.

I remember almost daily announcements of companies relocating significant operations to China or India for the first few years of the decade. IMHO that was the catalyst for most if not all of the China's growth, later in the decade their customers the U.S. and other developed countries were growing from coming out of recession and then through the bubble and this carried the mantle of growth. Finally as you point out massive construction is carrying the mantle of growth in China.

What carries the mantle of growth when they stop building? Chanos' description of the situation as a treadmill to hell certainly tells you what he thinks. You bring up an excellent observation that all of their growth seems to be coming from construction right now. The China bulls will tell you consumers will pick up the mantle but come on the average salary is something like $3,500.00 per year and this is a culture of thrift.

I don't short so I'm not making any direct bets on China coming back to earth. I do think however that when China comes back to earth it brings commodities with it and this will ultimately be a boon for the U.S. economy and most other economies around the world. I made a conscious decision during the depths of the recession that the U.S. would eventually get back on it's feet as it always does but we wouldn't be in for any more bubbles for a while. That's good for us but I also decided not good for China and the emerging markets. In my personal and CAPS portfolios I went long the U.S. and avoided emerging markets and anything dependent on them particularly commodities. Interestingly I missed a bull run in emerging markets and commodities but still did excellent with my U.S. focused portfolio. I'm not upset I avoided emerging markets and commodities and have no intention of shifting my portfolios. IMHO the U.S. run has just begun and China and commodities are due for a serious correction.

It helps my confidence when someone smarter than me posts exactly what I've felt to be true though. Keep posting Jakila you make me feel better.

Report this comment
#26) On March 12, 2011 at 8:57 PM, MKArch (99.67) wrote:

Reading a few comments reminded me to add a note from Bob Johnson, M*'s chief economist (love him) in his weekly article he mentioned that China only represents about 1% of total U.S. exports. I see some responses questioning how a collapse in China would not hurt the U.S. and while I can see markets tanking creating a short term bump in the road (ala Greece) I don't see that lasting long and the popping of the commodity bubble with China should be a boon to the U.S. economy. I actually get the feeling that when the collapse does happen the markets will quickly see the same thing, we export very little to China, they'll keep making cheap stuff for us and commodities coming back to earth will way more than offset the little hit exports to China represent.

Another benefit I see to China coming back to earth is when they stop being the best place to invest your money the U.S. becomes the new focus. I'm already seeing articles about funds shifting focus to the U.S.  On a side note I can verify from personal experience that there is definitely a strong almost fanatical emphasis in Asian culture on educational achievement. I do think there is something to the argument that an extreme emphasis on the sciences in Asian culture comes at the expense of creative thinking.

Report this comment
#27) On March 13, 2011 at 7:00 AM, JakilaTheHun (99.94) wrote:

MKArch,

The 1% figure is definitely a thing that the US gloom-and-doomers overlook.  My basic thought is that if there is a China crash, US markets get hit initially, but it will be because people are under the false belief that it will cause significant harm to the US.  It won't.  

Moreover, the idea that the prices for our goods will skyrocket is nonsense.  Sure, the prices for some goods go up, but people seem to forget that China mostly manufactures low-value, commoditized goods that any Southeast Asian nation (e.g. Vietnam) could do just as well.  The only real advantage China has over Vietnam is that the Chinese government provides de facto subsidies (via the currency peg) to its manufacturers.  If it weren't for that, the manufacturing would simply go elsewhere a lot of the time. 

So we'll lose "the subsidy", but it's not going to cause prices to skyrocket.  The 'Chinese holding a bunch of US debt' thing is likewise, another big canard.  Truth be told, in a China crash, US debt is going to be the only good asset the PRC has.  They might dump some holdings for cash, and rates here will jump a bit, but it's not going to go from 3.5% interest rates to 9% interest rates, or anything absurd like that. 

Report this comment
#28) On March 13, 2011 at 10:26 AM, MKArch (99.67) wrote:

Thanks Jakila I'm definitely on the same wavelength as you. I've got a couple more random observations to throw at you. I think you brought up Japan and I've read a number of articles debating different policy issues that may or may not have caused their malaise. Here's what I think caused it (or at least was a major contributor): In the 1980's just about everything I bought had a label that said "made in Japan". Starting in the 90's everything I bought had a label saying "made in China".

Looking back on the past decade the U.S. made it through a massive bubble in technology, then a massive bubble in land and housing prices as well as a consumer credit bubble all of which lead to a meltdown of the banking system that eventually took down most of the world economy. The result of this has been a deep recession that's taking longer than normal to recover from however we are recovering from it. Is this the sign of an empire in decline or of a tremendously resilient economy? While headlines seem to see this slow recovery as a sign of weakness, I look back at all the hits this economy has absorbed and see the recovery as a sign of strength. Particularly when you realize that when new home construction gets back to normal it's going to create a ton of jobs as will the construction industry in general and the auto industry has some upside before it gets back to normal as well. We're recovering with one hand tied behind our backs right now. Look out when the other one gets free.

I guess the tie in to your China article has to do with comparisons of more and less managed economies, dependency on manufacturing and the ability of the people in an economy to deal with change. We're certainly not perfect but we seem to be able to handle our screw ups. If Chanos is right and I think he is we're going to get a lesson on how a more managed economy handles their screw ups.

Report this comment
#29) On March 13, 2011 at 10:45 AM, mhy729 (32.49) wrote:

Jakila, my comments were meant more as furthering of the discussion you were having with checklist re: Asian culture, education, and innovation.  I apologize for the "You really know very little..." comment, as that was rather uncalled for.

Long-run, China's economic distortions are causing significant harm to worldwide economic growth.  A China crash would prove beneficial in that it would destroy the distortions. 

Look at the history surrounding the collapse of the Japanese RE bubble and I think there's a great deal of evidence that Japan's distortions were harming the global economy, as well.  The 90's ended up being a period of dramatic growth, in part, because the Japanese RE crash .

This is very interesting, and I would like to look further into it.  Where might I find such information?

I failed to get this across in my earlier comments, but let me say here that I appreciate your time and effort put into your post and sharing.  Thanks.

Report this comment
#30) On March 16, 2011 at 12:56 AM, JaysRage (88.77) wrote:

I don't think any significant crash could possibly be short-lived.   We came very close to a world-wide depression two years ago, and we are still working on a very fragile recovery.    Quite a bit of the world economic recovery is due to the emergence of China and India as secondary consumer markets that that are taking the place of the bogged down American consumer.   A global crash at a near-term point in the current recovery would be absolutely crushing, and I'm not sure that any companies would get off the mat quickly at all.    U.S. manufacturing is not floundering from commodity costs, it's floundering because of people costs and the economy is lethargic because it has such a large percentage of its economy in service.   People have to "feel" that things are better, which is partially why Bernake is printing money like a crazy man.    Inflation will make people feel wealthy and spend on services until the real infrastructure in housing and banking can heal completely.   I'm not saying that it's the perfect plan, I'm just saying it has a chance, and it's fragile.    

Report this comment
#31) On March 16, 2011 at 1:00 AM, JaysRage (88.77) wrote:

I also think that the emergence of China as a consumer market is happening.   It's not happening at the rate that anyone (including China) wishes it would happen, but it is happening.    I do think there is a bubble in China, but I think we all need that bubble to stay inflated for at least a couple more years. 

Report this comment
#32) On March 16, 2011 at 9:32 AM, sentinelbrit (87.94) wrote:

A command economy always misallocates capital (a capitalist nation also does this, but it often happens because of government induced incentives e.g., U.S. housing bubble). The banks are instruments of the government so are bound to misallocate capital. There will be a day of reckoning. However, I do believe that a consumer society is emerging in China. The problem is that I doubt it will be able to offset the downturn caused by overbuilding. 

Finally, commodities have always gone through bull and bear cycles. Remember it is change at the margin that has the most influence on asset prices. It will not take a lot to cause commodity prices to fall dramatically. But who knows when that will happen! 

Report this comment
#33) On March 16, 2011 at 12:05 PM, mhy729 (32.49) wrote:

The growing consumer society in China has overtaken the Japanese as the major tourist visitors to South Korea.  When once before most signs at establishments catering to foreigners were all in Japanese (along with English), they have all been replaced with Chinese ones (maybe not so much replaced, but Chinese has definitely taken precedence, alongside English).  China also has a trade deficit with South Korea (PRC accounts for 20%+ of ROK exports), and I imagine a lot of that which they are importing are consumer goods, and not just materials for their industries.

Report this comment
#34) On March 16, 2011 at 12:49 PM, fostercdjebsen (< 20) wrote:

My issue with the short China bet is timing. It's not clear how long the Chinese government will keep this bubble going. How do you know when they will allow it to burst?

Report this comment
#35) On March 23, 2011 at 4:38 PM, simplemts (< 20) wrote:

Jakia,

 You redthumbed ONP today... may I ask why?

Report this comment

Featured Broker Partners


Advertisement