The Conclusion: Beating a Dead Horse (to Death)

Vitaliy Katsenelson's picture

My “Beating the Dead Horse” article ended with a very insightful conclusion “Need I say more?”.  I received a dozen emails that said – you DO need to say more.  So here I am saying more:

What do we take out of this?  The Chinese ascent over last decade has lowered the degree of separation between China and the global economy.  What happens in China doesn’t stay in China (not anymore); it spills over to the rest of the world. 

Today, Chinese economic growth is the force pushing the global economy. The quality of this growth, however, is low as it is predicated on massive (forced) lending and thus unsustainable.  As Chinese growth slows, China will turn from a wind into sails of global economy to its anchor.  The impact will be felt in many, often unsuspected places. 

It will tank the commodity markets, commodity producers and commodity exporting nations.  Let’s take oil, for instance.  As incremental demand from China collapses, oil prices will follow, taking the Russian economy with it, as Russia is for the most part a one-trick-petrochemical-pony.  According to GavKal Research China accounts for 15% of Brazil’s exports (up from 1.5% a decade ago), significantly impacting the economy of that South American nation..

Demand for industrial goods will fall off the cliff.  China consumed a lot of those goods - $550 billion worth annually (also according to GaveKal Research).  So if Caterpillar expects to sell more of its yellow earthmovers to China, it will have put that thought on hold for awhile.  (Side note: CAT’s CEO expects CAT’s earnings “$8 to $10 per share within five years if the world economy recovers”.  Let me put it into a proper context: in 2007-2008 circa when its margins and sales were at all time high, double their historical average, CAT earned about $5.50 a share.  Good luck!)

Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5% mortgages and 6% car loans.

Identifying bubbles is a lot easier than timing them.  An astute observer could have seen the Japanese bubble developing in 1986, 1987 and 1988, but he would have been “wrong” until 1989.  Now sprinkle on top of this the Chinese government’s willingness to do anything in its power to postpone the bursting of the bubble and the complexity of timing increases exponentially. 

Those of you who are familiar with my writing on this subject may rightfully accuse me of beating a dead horse – or in this case a dead dragon.  But I firmly believe that those who invest in China or ignore the consequence of very likely Chinese economic malaise do so at great peril.

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo., and he teaches a graduate investment class at the University of Colorado at Denver. 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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JR's picture

It is extraordinary that no one ever distinguishes between capitalism and communism, or that it was the offshoring of America to China as she opened her communist doors to Western capitalism that enabled industrial growth in that nation.   Nor is it told of the Globalists’ plans to give away U.S. patents, or the fact that by 2006, the U.S. Patent Office had placed 1,271,000 patent applications on the internet, creating a gold mine for China to steal U.S. innovations and get to market quickly.  Have we grown so blind to freedom that we no longer can price its value?

Globalism closed manufacturing in the USA.  Globalism made a pact with the Red Chinese without insisting on democracy for her people. 

Because of globalism, Chinese pirates sitting at their computers roaming the internet and stealing the details of U.S. inventions that the U.S. Patent Office loads online became China’s R&D program.  Such pseudo capitalism  can never give the spring to invention that our Founding Fathers gave to America when they included  in the United States Constitution  a provision “to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.”

This right of inventors is uniquely American and from it America reaped the spectacular results which are being unloaded from her shores.  In 1997, a study of the inventors honored in the National Inventors Hall of Fame in Akron, Ohio, revealed that 91% of the world’s greatest inventors worked in America and only 9% in other countries.  All this because of America’s superior patent system which gave men the incentive to burn the midnight oil for a chance to own a property right in their own invention.  That is the fountainhead of America’s progress.

As Robert Ringer said in 1979, “The reality is that the communist has been allowed the luxury of keeping his collectivist cake, while eating off the fruits of capitalism.” 

Our country entered into a shameful political partnership with a regime in China that has killed upwards of 65 million people and holds 1.3 billion in bondage.  The price of globalism is high, both for Americans and for the Chinese people who seek a safe place for democracy..

The internationalist bankers at the FedRes financed the sell off of America.  It is time for America to sell off the FedRes.

mannfm11's picture

Good article.  Few understand that China was built on cheap American credit.  The entire game happened in reverse of how it is thought to have occurrred.  It was American credit excesses that created China savings excesses.  The US credit machine has collapsed so the China game will follow.  Plus, China has its own housing bubble and credit bubble as well.  Few understand the necessity of countries like China acquiring dollar assets.  Also, what strategic manufactured items are we getting from China?  What I see is a bunch of crap that is sold in Walmarts.  There will be plenty of labor in the USA once the lending offices close.  Few understand the limits of a manufacturing economy that only sucks money from the rest of the world.  Also, few understand that the USA is still the biggest manufacturing economy in the world, despite its decline.  Once credit inflation ceases in the USA, the economies of scale in China will diminish.  Andy Xie wrote that the Chinese housing boom has 5 years at current pace then it is done.  The Chinese housing industry has 2 billion square meters under construction, the equivalent of 10 million homes of roughly 2200 square feet or close to 6 times the former US housing bubble peak.  5 years from now, demand will be fully sated and there will be no use for a Chinese housing industry.  Think that might create a commodity and heavy equipment bust? 

Anonymous's picture

I would agree with the views except that when China slows down I think would be beneficial to USD as the trade deficit would close (yes we sell them less stuff but all the unemployed americans would buy even less !)

Anonymous's picture

All I can say is, "we can only wish we had it so bad". I haven't any doubt China will have some adjustments to make but these folks have been at it for 2000 years. Meantime we're a-- deep in debt, supporting a massive war machine that chases guerilla fighters on dirt bikes with 50 million dollar airplanes, don't make anything of consequence any more, are re-igniting the problem that almost sank us this time ie bundling up that toxic debt/selling it again and the list goes on endlessly. Meantime we have a government that is so busy blaming each other for problems caused by all that they can't get anything done. It's called "I could care less about the country, I just want mine".

China has massive reserves, builds good products, is busy establishing relationships all over the world, developing their infrastructure, stockpiling resources and that list goes on.

Oh yeah, we'll rise from the ashes to new heights of power and the rest of the world will look on with wonder again. Dream on buddy!!

Anonymous's picture

I will not dilute the conveyance. Conversly the amount of growth available can buffer to give the appearances of more time which we will see, and it may in fact do that as we know we can see the bubble but do not speculate when it breaks. That hinges on malinvestment to direct credit avarice, but do get enough capital off the damn table because that is your responsibity anyway if they linger without true data to why are you there ex ante. Tough as headwinds are they understand this better than the dullards who debase currency by deficits.

Anonymous's picture

It would be great if Vitaliy would address some of the skepticism here. Japan fell off a cliff when it's standard of living rose to that of a first world country. Wages in Japan reached parity with the US. Property prices in Tokyo were higher than anywhere else in the developed world. This was a bubble.

Is China really in the same boat. Wages, standards of living, etc etc are far behind the developed world. Perhaps there will be a bubble in China, but just to reach parity with the US China's economy could easily quintuple. As more and more capital is invested in China is there really any reason to expect that standards of living in China won't mean revert to those in the developed world.

Anonymous's picture

"Let’s take oil, for instance. As incremental demand from China collapses, oil prices will follow"

Yeah, sure. And all the Chinese will stop driving their newly purchased cars.

At some point in the future China will have problems growing, but their problems are tiny compared to the Western world.

Mediocritas's picture

Granted, China is not in as good-a-shape as it makes out, and all individuals, corporations, countries, markets that have calculated for their future based on a super-strong China are in for a downside surprise..I'm 90% sure of it.

But I don't jump on the China bashing band-wagon because...compared to what? If you're gonna bash China then I hope you're murdering the rest.

Much as I don't agree with the Chinese govt system, I have to admit that they're damn good at getting big projects to completion before you can blink. Now the grand plan is to replace the US and European consumer with the Chinese consumer (decoupling through substitution) and I will not be at all surprised if they pull it off.

Look out for China abandoning the flawed Western liquidity-infusion angle and going for a more grass-roots approach (monthly citizen dividend). It'll be obvious when you can no longer find decent marketing and advertising talent in the west as it has all moved east.

A citizen dividend wouldn't be inflationary due to surplus capacity. It's not such a crazy idea, hell, such dividends even used to exist in the USA before the country was lost to central banking (I think Alaska still does).

Anonymous's picture

I've been to China quite a few times in the past 3 years (Hong Kong, Shenzhen, Guangzhou, Liuzhou, Nanning, Zhuhai, Zianjiang, Chengdu, Shanghai & Beijing) and have seen first hand all the (high quality) development projects recently built and currently underway... the old sections of cities are being replaced with modern apartments/office buildings/shopping plazas/parks... roads & highways being built... ultra high-tech and efficient subways/metro rail... some of my business associates have friends within the Chinese government and they have big plans. No major slowdown coming there, I can assure you that.

Anonymous's picture

Well ... the Chinese beat the Packistanis (who beat us) in manufacturing. ... Example (local hardware store):
Packi: 1pr cheap garden gloves: $0.99 (3 for $2.97)
Chinese: 3pr " " " : $2.49 (3-pk only)

American versions are $1.49 & up, best price.

So, while we may want to decouple from China, we are most definitely intertwined, and cannot. Our (hidden)inflationary cycle was covered up by the export of manufacturing for everything that had a cost increase. I am having a *very* hard time finding anything ***not*** made in China. ... So, the Chinese are holding the FNM, FDY, & T notes and have kept true interest rates artificially low. ... Now all they have to do is to STOP SUCKING UP THE DEBT & the interest rates will go BOINGO! Then the REAL DEPRESSION will hit & The GREAT RECESSION will look like a Garden Party. (Now, if I could only beam back to 2000 & buy a few thousand ounces of GOLD at $330/oz. and short a few thousand shares of Freddie & Fannie.)

drwed's picture
drwed (not verified) Aug 25, 2009 1:16 PM

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AnonymousMonetarist's picture

China Anstalt?

Aug -Sept 1929 :But news of the great increases in broker's loans each week brought periodic sharp drops to the market and general apprehension.

rhymes with

credit indices widened  today following another sharp drop in Chinese equities.

Anonymous's picture

Pls stop printing this diatribe. The author makes no effort to differentiate between a plausible cyclical downturn (which is the case for China currently) and a secular bear market (US currently). There is neither an understanding of how an malinvestment cycle may be contained while not taking the whole economy down with it (remember resolution trust days in US) nor any sense of scale vis-a-vis debt binge recently promoted in China vs one seen in US for almost a decade.


Anonymous's picture

Well put.

Anonymous's picture

Again, more arrogant China bashing, what is it with ZH conributors? Yankee patriotism, clinging onto American empire fantasies? Lets take a paragraph from this nonsense and tweek it:

"Today, American liquidity growth is the force pushing the global economy. The quality of this growth, however, is low as it is predicated on massive (forced) lending and thus unsustainable. As American growth slows, America will turn from a wind into sails of global economy to its anchor. The impact will be felt in many, often unsuspected places."

Anonymous's picture

What's the matter numbnutts? Don't like the truth or something? Get a grip already. Its over pal. Deal with it. Frankly who really gives one good hoot about the chinks? They got most favored nation status in 1994 and during the meantime, slick willie gave them our nuclear secrets so they could build up their armed forces into a modern force. Loral, run by a zionist pig named Eric J. Zahler, and also a FOB, (friend of bill) gave the sorry chink commi's our satelite technology. So now these assholes are playing right into the game that has been set up for them, to be our new enemy for us to fight in the near future. Instead of whining about someone picking on your precious chinks, maybe you can pull your head out of the dark places and smell the coffee. Its over for the chinks. We don't want their poison toys and bad pet food. We don't want their stinky sheetrock and their crappy tools. Can you dig that sucka??? :)

Anonymous's picture

Excellent, World War 3 then. Why are you on a financial information site, should'nt you be stockpiling weapons? :)

Anonymous's picture

The Bloomberg lawsuit for Fed to reveal its $ 2 Trillion " donations has paid off - judge rules in Bloom's favor..Cheers to alan grayson as well..

Jim B's picture

Well, if China is such bad shape,  I contend that we must be in really bad shape.  China is actually producing goods that the rest of the world wants and the transfer of production and technology to China continues.  I am starting to feel like we are unfortunately becoming the world's anchor.  Sucking up resources and goods in exchange for a currency that is being debased by quantitative easing and deficit spending.  I worry the FED is creating a bubble that will only burst when the world rejects the dollar.  Time will tell.....

peoplesdemocraticsocialistrepublicofmaryland's picture


China is in bad shape.

And America is in abysmal shape.

Sorry about the repeatly beaten "dead horse" (watch out for PETA :) but this information needs to continue to come out.

Great acticle.