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Archive for the 'China' Category

If You Believe Chanos on China…

I’ve been listening and reading for the past few months about the possible bubble building up in China. Jim Chanos is one of the more notable persons that has been talking about the enormous overcapacity that is building up in China. He is short companies that are providing the materials to China with which to build. I’ve been trying to determine which companies might be good candidates to short if I were running a short hedge fund. My first instinct was to try to find any company that produces building materials or that mined minerals. Then I read this article on Bloomberg: “Palmer Seeks Biggest Global Mining IPO Since 2007.” If you want to short China, then finding a company like this seems like it would be a good vehicle.

I tend to believe that China is going to experience a downturn like we had in the U.S., but the question is when, and that could be a long time coming.

Alleghany’s Thoughts on the Big Picture and Financial Crisis

Over the weekend I got around to reading some more annual reports. One that stood out was Alleghany Insurance. The reason Alleghany’s report stood out was because of its thoughts on the “big picture,” or rather, the reason for the financial crises of 2008. The general theme for most companies was to blame the availability of easy credit, the Fed, derivatives, and/or American consumers spending more than they were earning.

With this back drop, Alleghany’s thoughts were a real curve-ball. This is how they begin their “thoughts on the big picture” (as contained in their 2008 annual report):

The imbalances that are evident today in the global economy trace their origins to August of 1994, when China embarked upon a course of a managed, nominal currency peg of the renminbi (RMB) against the U.S. dollar. Few remember today that as recently as 1981, the RMB/USD exchange rate was as strong as 1.53 yuan per dollar; by 1994 it had weakened to as low as 8.76 yuan per dollar, and was pegged at 8.28 until 2005. Over the following decade and a half, this currency policy contributed to stagnant U.S. household incomes (real median U.S. household income is lower today than it was in 1998), as U.S. labor could not compete with a massive, artificially priced Chinese labor pool due to the currency devaluation. The mechanism with which China (and other countries with pegged currencies) kept its currency artificially depressed was to recycle dollars into U.S. treasury securities and agency securities, thereby keeping U.S. interest rates artificially low, exporting deflation, and importing inflation. The prime beneficiary of this policy in the United States and other OECD (Organization for Economic Cooperation and Development) countries was the financial services industry, which took advantage of excessively easy money and low interest rates to fund credit expansion to middle class households, who sought to improve their standard of living despite stagnant incomes by borrowing to fund consumption.

So rather than blaming something that was particular to America, Alleghany pinpoints China’s currency peg as a large reason for the worldwide financial crisis. Very interesting.

Durable Goods Orders Decreased

Yesterday I read a long post from Market Ticker detailing some of the recent, distressing economic and business news. Here are some things that stuck out for me.

First, durable goods orders decreased 5.3% on the month and inventories are rising. Market Ticker says this is always a sign a recession is on the way (or at least evidence that people are cutting back on spending), which makes sense to me. People used to be buying lots of crap, manufacturers ramped up production bit by bit to meet demand. Now that the demand is no longer there because people are limiting their spending, inventories will naturally rise and products will not get shipped.

Second, he berates the short-sighted politicians for setting America up for an energy crisis. The fools have prohibited any nuclear energy development for the past 30 years. We’ve turned our food into energy and we have refused to drill for oil off our coasts, oil which we know is there.

Also, and a most interesting and scary prediction that there will be a war between China and Russia in the future:

Let’s talk geopolitical risk – what’s really driving metals prices. Its not talked about, but it should be. China has north of 1.2 billion people. Russia, which shares a border with China, has 140 million, or about 1/10th of China.

Russia has a net surplus of both oil and natural gas, and in addition has a surplus of land per-capita. China has a dearth of all three. So long as China can pay for what they need, this is not a serious problem.

But as we flush, to believe that China can turn to internal consumption and pick up the slack, with a per-capita income of under $2,000, where ours is more than 10 times as high, is pure fantasy.

I wouldn’t take that bet at any odds.

What I expect to happen is that China will eventually run out of ability to subsidize, and will turn to what nations have always historically turned to when faced with severe internal pressures and a resource-rich nation sharing a border with them.

Quite distressing news overall, but good news if you happen to be a bear.

Problem With the Concensus Views About China

I just watched a very interesting presentation (and relatively short at about 27 minutes) by Dr. H. “Woody” Brock, President of Strategic Economic Decisions, about the threat of  China and the 5 general misconceptions of concensus views.

Here are the 5 questions Brock poses regarding the concensus views of China:

  • Is it true that a higher yuan would not improve the US trade deficit?
  • Do those who celebrate the virtues of “cheap Chinese imports now” not understand there is no free lunch?
  • Who says the very low US savings rate is in fact the principal reason for the vast US trade deficit?
  • Is it true that the Chinese will retaliate by “pulling out their money” and/or by reducing their ongoing purchases of US treasuries?
  • On what grounds is the yuan “only” undervalued by 15%-25%?

Brock addresses each of his questions in language that is easy to understand. Non-economists should be able to wrap their minds around the concepts which Brock discusses. 

In conclusion, Brock attempts to answer what should be done about China using the paradigm of game theory. There are three factors that influences the outcome of bargaining between China and the U.S.: (1) the relative risk aversion of the bargaining nation, (2) the relative threat power, and (3) the relative coalitional muscle. Brock essentially says that although the U.S. in theory has the upper hand on two of these three factors, he is worried that the U.S. is incapable of capitalizing on its strengths in order to bargain successfully with China. Brock is worried about the future of the U.S. in relation to China and Asia.

Though I think everyone has heard of “the Chinese threat” or some such variation on that phrase, most don’t really understand the nature of the threat, which is largely economic in nature, though there is a growing military threat. This presentation does a good job providing some simplified concensus views of China and also his arguments that the concensus views are wrong. Watching this will help you understand better the nature of the threat from China.