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China - The Mother of All Black Swans (updated)

Vitaliy Katsenelson's picture




 

I presented my thesis on China and Japan at my alma mater University of Colorado at Denver at International Executive Roundtable yesterday.  Here is updated version of my China presentation.  China - The Mother of All Black Swans by Vitaliy Katsenelson - April 2010

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles my email, click here.

 

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Sat, 04/17/2010 - 13:48 | 305802 JeffB
JeffB's picture

Here's an interesting article on Chinese construction:

 

Chinese Construction and U.S. McMansions: When Things Fall Apart

by Charles Hugh Smith  April 14, 2010

http://seekingalpha.com/article/198729-chinese-construction-and-u-s-mcma...

Sat, 04/17/2010 - 13:12 | 305765 mblackman
mblackman's picture

If this argument is fundamentally true, it provides a good reason why the Chinese gov't has remained steadfast in not allowing the yuan to appreciate - it has the potential to increase instability and reveal the government charade as a sham... Good presentation.

Sun, 04/18/2010 - 00:19 | 306368 ZeroPower
ZeroPower's picture

Its all about keeping the countries exports as high as possible. A high renminbi reduces their competitiveness.

Sat, 04/17/2010 - 09:54 | 305490 tom
tom's picture

I think the general thrust of your China bubble argument is right, but you're not going to persuade many people, because you're too simplistic and sensational. You use too much hyperbole, which makes you sound like you've never been to China and don't know much about it, or like you have such a chip on your shoulder about China that you will always say the most negative possible thing about it, even if you know you're exaggerating or misstating the facts.

For example, it's stupid to say that China makes up its GDP numbers out of thin air and actually isn't growing at all. If China isn't growing, your argument that Chinese growth is a dangerous bubble makes no sense. Believe it or not, China really does employ people to aggregate local statistics reports, and most of the manipulation occurs locally, not centrally.

I also think you should ditch the "black swan" title, or at least explain better what you mean. I suppose what you're trying to say is that a lot of investment decisions are being made on the basis of wrong assumptions that a Chinese recession is as unlikely as a black swan. Anyway, it strikes me as cheap piggy-backing on a popular buzz word.

 

 

Sun, 04/18/2010 - 04:56 | 306461 AnAnonymous
AnAnonymous's picture

Too much information to digest. Manipulation made at local levels, mostly on personal initiative (each Chinese province having a best interest in performing this) Are you effing kidding people? Impossible, that is all the works of the Chinese government.

The content having little to do with black swan story? At this point...

Good luck.

Sat, 04/17/2010 - 09:22 | 305461 Brother Revegen...
Brother Revegend Magoun's picture

It has nothing to do with black swans (as an expected event of huge importance)

Sat, 04/17/2010 - 08:35 | 305440 dumpster
dumpster's picture

china and US probably need to be judged by differnt metrics ,

thousands of places for growth in china , US a lot less so, the one area is debt , so much productive output needs to fuel just debt payment

 

china not so. 

their production is fueling some real growth . with millions ready to take the plunge into productive enterprise willing to work for much less,,

the whole nature of the work force is different .

less personal consumption , willing to forge out living standards with some sacrifice,,

the population less dependent on central government to toss a tit of milk and honey.

yadda yadda ,,  

Sat, 04/17/2010 - 08:24 | 305434 dumpster
dumpster's picture

my perception is that much of growth this time around ,, is on the main fueled by many hands working ,, government is less into micromanaging ,,

sure on the government side they poke and creep around making mischief, 

But industry is branching out doing many things independent of government , not like the soviets and their hand in every tractor,

china clamps down and the fraud ,, more so than the civilized USA ,,

boom bust are the result of monetary policys . that distort the business cycles ,

china may find some way around this ,, so much capacity ,, would not be surprised to see adopt the gold standard way before the kicking and screaming fed reserve..

restrant on the issuing of fiat money .

i suspect they have more understanding now of the austrian model.

and they sure as heck are not policing the world now .. with 800 china military camps in places as apart as Henderson Nevada, or grand junction Colorado lol

they are probably more capitalist in parts of the economy than the USA a corruption based model laced with a part dodd, and part doddering politicians .... With eye of toad.. and the front running money changers   

Sat, 04/17/2010 - 07:25 | 305413 Kina
Kina's picture

I think the big issue with China is not its strong growth but that the Government has tried to manually drive and control where growth should be and where the money should go and  so forth, rather than letting the natural market ecosystem choose the paths. We all know that Governmets as a matter of course ruin things when they try to manage the market. So its growing pains are not natural growing pains of a normal expanding and maturing market, but of some unbalanced hybrid.

 

 

Sat, 04/17/2010 - 06:33 | 305395 IllusionaryDance
IllusionaryDance's picture

So China is headed for a hard landing... That is going to be one spectacular media event.

I`ll see if I can register ChinaHardLanding.com to start my own cool blog before the media frenzy begins.  

Sat, 04/17/2010 - 06:17 | 305393 Alexandra Hamilton
Alexandra Hamilton's picture

This is just another puff piece claiming that governement is the problem. Get used to it: It was Capitalism who caused this mess.

Sat, 04/17/2010 - 05:13 | 305378 dumpster
dumpster's picture

the wall street journal

business news .. that you can trust.

except for its bit on china and most of the stuff on the usa

why is it for heavens sake this fixation on china's doom..

the USA is skimming on an ocean of debt ,, most states would put Greece to shame ,, an immoral and fraud laced financial section.. all banks up to their kister with junk property .. valued at some model number not reality

the commercial property area now in deep stress,, the second wave of housing to be exposed .

a military policing the world ... sucking the productive value of the nation..

most constitutional safeguards going up in flames..

industry limping along most of it now in china ..

and here on the zero hedge some think china goes down for the count as the usa basks in glory,, and cant even honor the commitments made to the aging seniors

a nation on steroids . trillions of debt laced fiat monthly to keep it alive .

china be the bank .. and some fade china ,

where on earth is this coming from the Keynesian based wonder kids .. that know beans about austrian economics and the source of productive forward looking profit centered enterprize with savings to fuel its expansion .  

Sat, 04/17/2010 - 01:29 | 305319 dabug
dabug's picture

Also the references are somewhat dubious; Chanos? WSJ? Chanos is on tape saying that construction in China accounts for 50% of GDP, its closer to 10%, WSJ? is that an acceptable reference nowadays?.

Sat, 04/17/2010 - 06:15 | 305391 Alexandra Hamilton
Alexandra Hamilton's picture

I guess the answer is yes, when it helps to make your points, regardless of whether or not the information is actually accurate.

Sat, 04/17/2010 - 01:14 | 305309 dabug
dabug's picture

Personally didn't see any meat in the presentation, seemed a bit "showy" with very thin references to Starbucks, Dubai and Speed?? where is the bucket? >:-P. This presentation is another example for me of the difference in work ethic, I could have knocked this together in less than ten minutes. I'm with Dumpster, invest in a hard working culture with a pile of cash and the latest infrastructure or an unemployed obese one with a pile of debt and a crumbling infrastructure? you decide.

Fri, 04/16/2010 - 23:45 | 305242 aaronvelasquez
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Wouldn't higher interest rates in the U.S. bring lots of foreign capital chasing yield?

Fri, 04/16/2010 - 23:26 | 305223 dumpster
dumpster's picture

if california has a 9.  then what .  a dam busting

 

 

Fri, 04/16/2010 - 23:00 | 305202 halvord
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My biggest Black Swan fear about China is the Three Gorges Dam. I assume it was built with enough overage for the inevitable corruption, but what if the corruption cut was bigger than design parameters?

If that dam goes, so goes China. Millions will die.

Fri, 04/16/2010 - 22:31 | 305153 gpsnodgrass@cox.net
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I expect more people from China and Asia to end up in the NBA. 
Kareem Abdul-Jabbar 

Fri, 04/16/2010 - 22:28 | 305149 Pure Evil
Pure Evil's picture

You're facing a lot of skepticism about China because no one likes a party pooper.

Everyone knows the hangovers are coming, but until the meth induced highs come crashing down its party, party, party.

One little question, if you need to shop at a store that is smack in the middle of a 7.1 million sq. ft. mall, how long would it take for a little old lady to walk from the entrance of the mall to the store in question?

I remember going to the Mall of America in Minnesota and was worn down just walking from one end to the other.

Fri, 04/16/2010 - 22:33 | 305159 Howard_Beale
Howard_Beale's picture

The meth-smack talk sounds like a speedball. WTF were you thinking going to the MoA? You need your scooter for that, PE. :)

Fri, 04/16/2010 - 21:50 | 305104 dumpster
dumpster's picture

china is not going into oblivion ..

the world is not run on hedge fund money games

it is developed by productive work, producing more than one consumes  education,

china will be the new power house of the next generations the usa will become a third rate debtor nation. 

learn to speak mandarin lol

 

 

Fri, 04/16/2010 - 22:08 | 305123 Bear
Bear's picture

I agree ... the oblivion of which I speak is ours (the developed West).

However, China will not be able to move forward if it does not expand private ownership rights without guanxi... the people with wealth will chose not to invest in China, but rather seek places to squirrel it away (US, Japan, Twain, Korea, Singapore, Aus, NZ)  ... why invest in a place that can take it all away in an instant.

Connected Chinese players are also concerned about the male / female ratios (http://www.msnbc.msn.com/id/5953508) and the unknown course of the next generation.

Watch China!  

Fri, 04/16/2010 - 22:18 | 305138 dumpster
dumpster's picture

that was so last year lol

now hold on to your stuff in the usa as they just took over gm next the pensions ,

china is now becoming more capitalist than the usa.

with an eye to the future ,  

 

Fri, 04/16/2010 - 22:30 | 305152 Howard_Beale
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China is going to go through what all new expanding nations go through--a depression. It's really that simple. Read some history and find me a country that didn't. They don't exist. CB--man of all history knowledge will most likely be able to back me up on this all the way to the bank.

And once again for you newbies--stop junking CB. He has forgotten more than you know.

Fri, 04/16/2010 - 21:42 | 305100 Bear
Bear's picture

Thank you so much for this presentation and http://3.ly/chinaread. I will watch the situation very closely as I watch you very closely ... watching for the tipoff to oblivion.

We don't hear from Jim Rogers much any more ... maybe this is a precursor?

Fri, 04/16/2010 - 21:37 | 305096 Mitchman
Mitchman's picture

If you can call it a Black Swan ahead of time, ten by definition, it is not a Black Swan.  You need to steal another author's thinking.

Fri, 04/16/2010 - 21:24 | 305048 JeffB
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A nice presentation, but there is one sentence (p.19) that doesn't seem quite right:

"But as heaven couldn’t exist without hell, or capitalism without failure, economic expansion can’t exist without recession."

---

I don't think a legitimate economic expansion needs to end in a recession.  Recessions are the result of an artificial goosing of the economy via the central bank - ie. an artificially low interest rate / easy money expansion of the money supply.

 

Fri, 04/16/2010 - 21:53 | 305107 Bear
Bear's picture

Recessions / Depressions come in different flavors and result for different circumstances ... reduction of GDP can come even when central banks do nothing ... we have had business cycles with us since commerce itself began. The next one will not look like the last but I do agree that central banks can really muck the works with intervention of too much liquidity, too little liquidity, or even too much talk.

An open and transparent FED would go a long way in mitigating the risk it poses by its actions. If they knew someone was watching what they were doing ... they would act more in our interests ... or get canned.

Fri, 04/16/2010 - 22:11 | 305128 three chord sloth
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Business cycles will always be with us as they are driven by core human characteristics -- the herd mentality and confirmation bias.

You are right, of course, about central banks mucking things up. Look at the US over the past decade -- the Fed was so determined to "trick" away a moderately deep, but otherwise ordinary business cycle recession that they set us up for the current much deeper, much more problematic balance sheet/debt crisis recession we are enjoying today. Good job, guys! Glad you are so clever!

Fri, 04/16/2010 - 21:29 | 305044 velobabe
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curious you don't include the mass construction to ready beijing for the olympics, in your analysis? i was there prior to this event and felt they were tunnel vision full gear ahead, some modest impact on their economy?

i remember you mentioning this electricity consumption declining a while back. but where do you get your proof? if they lie, how do you get to see the utility bills?

i know someone, lives in their same state, who is heavily embedded with the chinese especially the banking sector. he thinks it is working pretty well. just my 2¢s.

Fri, 04/16/2010 - 22:26 | 305147 Howard_Beale
Howard_Beale's picture

Velo,

The whole world thought the Nasdaq was working well in March 2000, the Dow in Oct 2007. The Euro was a great idea. Not.

China has a banking system that is not even 15 years old. There were no demand deposit accounts in China in 1996. It's all a delusional illusion from the inside looking out. Vitaly makes strong points and time will prove him correct.

They are not a self sustaining population and globalization will be their downfall, just like all the rest of us.

Fri, 04/16/2010 - 20:46 | 305021 mcarthur
mcarthur's picture

Good stuff.  People lose sight of the fact that investment is supposed to result in a return greater than the costs required to service the debt on the investment.  This came through in spades to me on a dinner boat off the coast of Maui a few years ago when all the total strangers on the boat wanted to talk about was how much their house was worth.  I thought pphhhhhh at the time.  Their (your) house is worth not one cent more than your kids can afford to pay for it and this is a function of your kids income. China is following down this path in spades.  Lots of investment but no return on investment.

I'm in the resource industry and I watch what the Chinese are willing to pay for assets and get a chuckle.  It is plain to me that they will never get a return on this investment either.   If you take this bubble and combine it with todays GS blowup I can only see deflation washing over many shores as a number of theses are dispelled.  For instance, do you want to be long Rio Tinto, Freeport or BHP once demand collapses?  A friend will be over in China shortly and I've asked him to see how many cranes are idle in comparison to the ones moving.  It is a command economy afterall.  You can't command profits however.

Sat, 04/17/2010 - 09:42 | 305474 kaiserhoff
kaiserhoff's picture

+1  Yogi Berra said you can see a lot by just looking.

Prices were so absurd in Marin County (and many others) that when children inherited a house mortgage free, they still had to sell.  The tax burden would ruin them. 

China has no middle class, no checks or balances, and no place to hide from the beast.  Their most reliable export is cash to Swiss bank accounts.  (proceeds of bribes)  When no one cares about costs, there can be no profits.  Look at any government run enterprise. 

Fri, 04/16/2010 - 20:14 | 304996 harshudeshpande
harshudeshpande's picture

with all the due respects..is this not something that you posted a month back? I did like the article back then though.

Fri, 04/16/2010 - 19:37 | 304948 greg merrill
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WHEN is coming soon....

 

http://merrillovermatter.blogspot.com/2010/04/china-lending-continues-to-slow.html

 

China lending has already slowed dramatically.  Copper, Zinc, and Aluminum inventories are building up there as well.

Fri, 04/16/2010 - 19:34 | 304941 boeing747
boeing747's picture

9% GDP isn't a miracle, US had 18% GDP prior 1929 crash. Every housing bubble bursted and followed by a decade or two of recession. Look at Japan, HongKong and US, is China an exemption?

Fri, 04/16/2010 - 22:21 | 305145 Howard_Beale
Howard_Beale's picture

Not on my tax return. :)

This time is different never happens.

Fri, 04/16/2010 - 19:26 | 304934 Fritz
Fritz's picture

Now, if we just knew when...

Fri, 04/16/2010 - 22:12 | 305131 Bear
Bear's picture

+100

When is the only unanswered question.

Fri, 04/16/2010 - 19:24 | 304932 Orly
Orly's picture

Vitaly, thanks for the analysis.  I think you are right on the mark.

In my humble opinion, the USD will be the prime beneficiary of this entire mess.  A global flight to safety (and the higher interest rates don't hurt...) will expand the strength of the greenback.

The next ten years is going to be a great time to travel abroad if your'e American.  Think they're sick of us now, wait 'til 2025.  The world will have had enough with these unruly, fat and unsophisticated heathens.

(But funny how everyone speaks wonderful English?)

:D

Fri, 04/16/2010 - 22:55 | 305191 Oh regional Indian
Oh regional Indian's picture

Very interesting to see/read views such as the one above on a Gold understanding site.

The USD will rally while being fundamentally debased.

Kind of like a rocket, as it gets higher, it burns fuel and gets lighter.

And it (said rocket) is never good for a second go.

It finally crashes and burns. 

Easy enough to see, yes?

Higher numerical value against a basket of other junk does not make it strong.

Only relatively stronger.

I thought such was clear to most en-lightened folks here.

Think intrinsic value, not a silly number.

I think intrinsic value glitters.

 

;-)

 

 

 

 

 

 

 

Fri, 04/16/2010 - 22:20 | 305143 Howard_Beale
Howard_Beale's picture

I absolutely agree with you Orly. The buck is going to rally as the markets crash globally, just as it did into March 2009. The Euro will be no longer in 4 years max. I'm being generous on that time frame. All markets are going to crash and there will be no safe havens in equities. Cash will be king. PM's will decline but I will not sell mine as it will be another safe haven.

This is perhaps the best presentation on China I have seen to date. Hats off to Vitaly.

I smell a big change coming. We are on the precipace of the final leg down of extremely interesting times that no printing press will help. Get ready gang, times are going to be great for the bears.

Fri, 04/16/2010 - 21:21 | 305074 JeffB
JeffB's picture

Oops.  Double post.  Please delete.  Thanks.

Fri, 04/16/2010 - 21:14 | 305067 JeffB
JeffB's picture

I'm not so sure we're such a great "safe haven".

 

Our total federal liabilities (adding in the "unfunded", "off-the-books" liabilities) such as Social Security, Medicare, Prescription Drugs, but not federal guarantees for Fannie, Freddie etc.) comes to more than $1 million per taxpayer - $2 million if both spouses work.  It's also growing by more than $20,000 per year per taxpayer.

Our government spent 86% more than it took in last year, and the preliminary budget for this year projected a deficit of 49% more than total revenues.  But that was at $1.1 trillion deficit.  That has been bumped up a bit since then.

I'm not so sure higher interest rates will expand the strength of the greenback.

 

Fri, 04/16/2010 - 22:00 | 305114 dumpster
dumpster's picture

higher interest rates will bury the productive power , it will ramp up the cost of internal borrowing , it will put stress on the debt level

higher interest costs . will bring the operation of the usa to its knees.. where will these moneys come from , how many trillions a month in interest cost can we bear as a nation;

if we foresee a 14 trillion debt ,, just a point difference is 140 billion or 25 billion a month in added costs with no payment to the principle , a compounding of debt that will be infinity ,  

Fri, 04/16/2010 - 19:22 | 304921 dumpster
dumpster's picture

black swan event

 

China will do what china wants ,

they will set the rules ,, they have the trillions of foreign debt holding,,, a blank check to purchase productive and valuable foundations .

they are a billion strong looking for the better life

they are leaders in asset and mineral development world wide,

they are coming of age ,, with a strong fifty year plan.

China may have a hick up or two. along the way.\

but the black swans reside in the USA..

in the fraud and gaming . with the non-rule of law, a unfunded liability stretching from here to the end of time

Me thinks that china with its autos, high speed rails , infrastructurebuild up .. work ethic .

the investments are like a big glove that will be filled by an enormous rising standard of living

Fri, 04/16/2010 - 23:09 | 305209 Miyagi_san
Miyagi_san's picture

Sweet spot...without being dragged into a war or two or three

Fri, 04/16/2010 - 19:42 | 304954 Seer
Seer's picture

And they're going to stole the fires of manufacturing with what/how?  Raw materials, raw materials... w/o surplus cash to buy (at smoe point their reserves are going to dry up) they're sitting ducks.

Fri, 04/16/2010 - 21:34 | 305091 dumpster
dumpster's picture

my friend how did the USA do it in the 1860 1900's 

they can create their own gold backed money , the Bank of china ,

the people will develop higher standards of wages,, it is a circular thing,,China will chop the wood , carry the water , develop the means necessary to be come independent ,

they have the raw materials , the labor , the skill set the education.. now watch the strength of the division of labor. steel for the backbone , metals for industry , power, they now use more oil than the usa , produce more cars . so this brings jobs , service industry, a thousand opportunitys for roads , construction, yadda

they have a huge internal mass of hungry , looking for a better life population,

 

and surplus cash ,, comes from the productive savings of the capital base, they consume less than they produce . the difference goes into the progress of a nation.

not the fictious and debt based fiat of the western world

 

to think other wise is hubris ,

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