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Outlook 2011 & the Next Decade: Is The Smart Money Right About China?
By Dian L. Chu, EconForecast
China has been ranked as the top growing country among the G20 since 2001 and is expected to retain that title for at least another five years (See Growth Chart). However, the news coming out of China for the past three months has not been good. It is looking more and more that it is not a question of if China is a bubble and going to burst, but when.
The country has major infrastructure issues, troubling population dynamics, poorly aligned employment outcomes, inflation problems, a real estate bubble, an opaque and potentially insolvent banking system (had mark-to-market accounting been applied), geo-political problems with North Korea and Taiwan, and an underperforming stock market in 2010 (see stock comparison chart).
Smart Money Rushing Out
While the hot money is flooding into China, the smart local money is doing everything they can to get their money outside of China, which partly explains why Shanghai SE Composite has underperformed other markets for the past year or so (see Comparison Chart).
The many issues of China could conspire to become the biggest train wreck waiting to happen, and potentially dwarf any little budget problems in Europe by a factor of ten.
Big Trouble In Big China
China has a population related societal structural problem. The nation has tried to utilize the vast manpower to its advantage over the last two decades building a powerhouse manufacturing economy through the availability of low cost workers, which supplied the world with lower cost goods.
Nevertheless, the harsh reality is that the nation's infrastructure, quality jobs, food, and overall resources are too scarce to support such mass population, while achieving the government`s goal of a smooth transition to a developed middle class to sustain an internal demand model going forward.
If you think having riots in Greece over the pension retirement age being raised is bad, just wait till riots breaking out in Beijing and other cities over a 90 cent bowl of noodle soup now costing four dollars due to food shortages, and a runaway inflation problem.
Loose Lending = Non-performing Projects
This is only reinforced by some of the news events taking place over the last three months. Let`s start with the raising of banks reserve requirements by the central bank, which is the sixth such increase in 2010.
These measures are meant to curb the excess lending which has fueled much of the overbuilding and real estate speculation occurred over the past two years as China`s central bank initially wanted to avert a recession by artificially creating demand for workers and construction projects to replace lagging demand from the developed economies.
The problem is that too much lending has occurred, and bad lending at that. Because of the cheap available credit, now you have cement companies and manufacturing firms getting bank loans to invest in endeavors such as real estate, which is outside of their core expertise and competency.
Real Estate Misery Loves Company – China & Spain
The result is a bunch of excess inventory and poorly thought-out construction projects which have no means of recouping the initial investment needed to repay the bank loans.
This practice is similar to Spain`s situation now where they have entire uninhabited building complexes that have yet to be marked to market, and will probably ultimately be demolished. But at least in Spain, even though it was a construction boom, it was engineered by developers in Spain, and not by some manufacturing outfits like those in China.
So, multiply the bad business project factor by ten and you get an understanding of the magnitude of bad loans on the books of Chinese banks. The problem is being further exacerbated by the practice similar to Spain`s of banks making additional loans to the businesses just so that they can then turnaround and pay back the interest owed on the original loans.
The only way this would work out is if these projects magically develop revenue streams. Unfortunately, in the case of Spain, a 20% unemployment rate, coupled with a still overvalued housing market in which prices still need to come down significantly, would suggest that by the time the Spanish economy recovers enough to support the excess inventory, the abandoned projects are run down and uninhabitable.
A similar scenario could play out in China as well.
True Smart Money Wary of the Write-off Domino
Furthermore, China`s practice of overbuilding at the height of real estate valuations makes even haircuts on loan write-offs an untenable practice for banks, and by further throwing good money after bad, the ultimate mark- to-market effect could be catastrophic for Chinese Banks.
This is the main reason all the major Chinese banks have gone to the market in 2010 to raise more capital before investors wise up to the underlying deficits these banks face, as these bad loans eventually would need to be written off the books.
Victor Shih, a Northwestern University professor estimates that Chinese local governments borrowed some 11.4 trillion renminbi at the end of 2009, and that local government financing loans to be roughly one-third of China's 2009 GDP.
Shih reckons the most likely scenario over the next few years is that there would be increases of non-performing loans ratio from local governments. This would require a large scale of recapitalization of the Chinese banking system, which would eat up a large share of China's foreign exchange reserves and possibly slow down growth.
I do believe Beijing is quite capable of a few bailouts and surviving a widespread banking crisis, but this most definitely will not bode well for the financial markets. That's most likely why you see insiders removing capital from direct exposure to the inevitable re-pricing that will happen throughout Chinese markets from real estate to the stock market.
This can be seen at this early stage by the underperformance of the Chinese stock market compared to other global markets. Remember, foreigners cannot invest directly in these markets, so these capital outflows are truly the smart money.
Logistic Gridlock Crimping the Middle Class
Next let`s look at the recent news regarding a severe cutback in automobile registrations in Beijing to 240,000 in 2011 from 700,000 registered in 2010 by the municipal government. Other large cities in China are bound to follow. This is most likely related to the reported 9-day traffic jam on the Beijing-Tibet expressway in August, and other extended traffic jams throughout China in 2010.
China is trying to build infrastructure projects after the fact; whereas with proper central planning these should have been established far ahead of the massive transition from a rural, agricultural based populous to that of a modern, large city based business and manufacturing concentration.
Simply put, it is impossible for all the Chinese citizens who want and can afford automobiles to be able to own and utilize this form of transport without a total breakdown in the transportation system. We are seeing the early stages of complete and counterproductive gridlock in the transportation system of China, and it is only going to get worse over the next decade.
No Jobs for College Grads
For all the talk about how China graduates more engineers each year, and other college educated young people who have strong backgrounds in the hard sciences than most developed nations combined, this is actually another sign of problems to come over the next decade in China.
China`s wealth and emergence into the second largest business economy hasn`t been built around the need for these types of mind and skill set. So literally you have a large mismatch between the types of available jobs in China, that are supported by the heavy manufacturing and construction intensive focus of the past twenty years, to that of the recently educated pool of graduates who have grown in sizable numbers over the past five years.
The Mind Is A Terrible Thing To Waste
This results in a large human asset class that China is currently wasting, as most of the newly educated workforce is working in jobs which require little or no advanced education at the university level. So you have highly educated university graduates in areas like engineering and accounting working low level service and sales jobs that pay less than many manufacturing jobs.
In short, there are too many highly educated Chinese citizens graduating each year for the number of jobs available needing their skill set because China`s economic model isn`t built around these type of jobs. This type of misaligned employment outcomes never ends well; it usually manifests itself in increased civil and social unrest.
8% Inflation in 2011
The next major challenge for China is a skyrocketing inflation, which at its root is the fact that there are too many people chasing too few resources. This fundamental flaw in population dynamics underpins many of the problems that China faces going forward.
Recent CPI data for November illustrates the inflation problem in China with a reading of 5.1% from a year ago comparison, this is up from a 4.4% reading for the previous month. Couple this with the latest 4% hike in fuel prices in China because of rising oil prices, you could expect future CPI and PPI reports to reflect even higher rates of inflation.
For now, most of the year over year spike has revolved around higher food prices as energy has mainly been flat for 2010 thanks mostly to government subsidies. Now that energy prices have entered the picture, China will start to experience even more inflation pressures in 2011.
Furthermore, with the undervalued yuan pegged to the dollar, it is only getting worse for China in 2011 due to Fed's QE2 pressures on the dollar. The real inflation rate for Chinese citizens for 2011 will probably approach 8% next year.
An Asian Contagion by China?
This escalating inflation concern is further compounded by Beijing's lack of decisive action to combat the problem by delaying a much needed currency appreciation, and hiking interest rates in a timely fashion. There is no getting around the fact that these two things need to occur as soon as possible.
By the time the Chinese government is forced to implement these tightening tools, the damage to the economy is most likely already done. The longer China delays the inevitable serious tightening measures, the harder the economic crash that will occur in the aftermath of these policy changes. And it is unlikely to end well. The resultant impact will probably take the rest of the Asian economies down with it – an Asian Contagion scenario.
History Repeats Itself
Eventually central planners and finance ministers around the world might start to understand that policies which lead to bubbles being formed in the first place are counterproductive in the long run. But until that lesson is learned, it seems like we are doomed to repeat the same mistakes over and over again.
Right now, there are more and more signs coming out of China that all is not well with its economy, and the likelihood of a more severe downturn in the future is a distinct possibility, unless its policy makers take decisive and prudent actions to minimize the damage of a hard landing.
Dian L. Chu, Dec. 25, 2010 | Mobile Reader, Website | Google Profile
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Well that explains why the aussie SX was going down the last 2 days while wall st was going up - they knew something was going on...
I think this is also the beginning of inflation being exported from the usa.
its gonna suck - i hate chasing oil and the arabs are the real winners not us with a few thousands worth of crappy shares.
Dian Chu is one of the finest guest writers on ZeroHedge.
I always look forward to her articles, analysis/analyses, and overall 'take' on things.
She writes with clarity, precision and also uses some solid data to arrive at his ultimate opinions and prognoses.
Thanks for the great articles, and keep them coming in the new year!
And ZeroHedge, please do include more of Ms. Chu's thoughts on your OUTSTANDING (the finest 'outing' source of Wall Street & Finance's dirty & naughty secrets) website in 2011.
http://www.businessinsider.com/amazing-facts-about-china-2010-12#
If they just buy more real estate they'll be fine (riiiight!) but maybe that consensus opinion is changing now.
http://www.youtube.com/watch?v=0h7V3Twb-Qk
ghost cities, bitchez!
I think we will collapse Soviet Union style and, when we come out the other side, China will be the new economic Super Power.
Lew Kuan Yew, former president of Singapore, builder of their economic miracle: "It is absurd to think America can rebuild it's economy with 12 million fruit pickers."
Our central planners are making sure we don't have the energy, manufacturing, capital, highly educated work force, and regulatory freedom to rebuild our economic base. Add on top of that, a failed monetary system and failed reserve currency. It is not a pretty picture.
China has many issues but I'd rather be them. The ruling elites would start a war to divert attention before they ever let riots over food shortages consume them.
.
+1
Besides the inequality that makes many educated Chinese feel uncomfortable (don't want to talk about it), they are very scared about their life and their belongings. You ask them how all of this (inflation, inequality, environmental destruction) is going to end and they tell you in confidence that they are really scared. They don't know what is going to happen: is the government going to give them something to eat? Are they sending tanks instead? What is going to happen to their money, their retirement savings, their work?
Do not do business with Chinese whenever it is possible to do otherwise. China is still ruled by ruthless one party and most of the profits go to the corrupted elite. China is no different from Burma or any other similar nation.
Evil always triumps when good men and women are willing to look the other way, just this once, because it could be good for profits. Profits should never be more important than human rights.
A "real estate bubble" in a Communist, command economy.
2011: "May you live in interesting times."
That proverb is quite the curse. That's fine.
Here we are. I know my enemy is the jew.
Oh, no! We're all supposed to put our money in "ultra-safe" "multi-nationals", deriving a "significant part of their revenues" from the "growth" in "international markets" of the "Twenty First Century", doncha know? I mean, really--what could go wrong?
"The country has major infrastructure issues, troubling population dynamics, poorly aligned employment outcomes, inflation problems, a real estate bubble, an opaque and potentially insolvent banking system (had mark-to-market accounting been applied), geo-political problems with North Korea and Taiwan, and an underperforming stock market in 2010 (see stock comparison chart)."
Most of these could be applied to the US as well:
1) Infrastructure in the US is aging and underbuilt rather than overbuilt.
2) The US population is aging rapidly.
3) The best and brightest minds are heading to work on Wall St.
4) Inflation is already above posted numbers, and higher inflation is coming.
5) US real estate still has a way to go before the bubble deflates completely.
6) hmm... "opaque, insolvent banking system"... check, and check!
7) Geo-political problems: hundreds of military bases worldwide, two wars, tension with the DPRK, etc., etc.
8) No "underperforming" stock market, just one that is based in fantasy-land! The Shanghai Composite, while still overvalued, looks like a more reasonable reflection of reality.
I don't think China's the smart money, but it doesn't seem so much worse off than the States or Europe.
In the U.S. you have the (seldom used) right to turf the bastards out.
In China you Kowtow to the party leaders or you die.
Last time when China raised interest rates by 0.25 basis points on Oct 20, Dow went in red by -165 points
China's Christmas present
USA, you do QE and we do QT (Quantitative Tightening) and Fraud Street will do the QV (Quantitative Vaporing).
See comment on similar article here: http://www.zerohedge.com/article/chinas-christmas-present-world-another-...
China is being hoised on two petards: peak oil and China's obsession with building F/X reserves.
China adapted the US- style auto centric 'waste- based' economic model just as that model was -- and is -- crashing. The reason for the crash? Inputs have become too expensive eliminating margins for fuel- using businesses. That is, at some input cost level, almost ALL businesses. China is on the same conveyor belt leading to the incinerator as America. It is a bit farther back on the belt due to cheaper manufacturing labor ... that's the only reason.
China's Forex reserves are too large, losses in reserve value would bankrupt China while taking steps to gain 'value' in return for them also bankrupts China. Spent for crude, the F/X price increase in yuan is massively inflationary, distributed throughout the length and breadth of the China economy.
At the same time, outside the Forex reserves, China's assets are tens of trillion$ in bad real estate loans secured with uninhabitied and useless buildings along with millions of unemployable over- educated rabble- rousers.
Who goes down first, asks Andy Xie?
Steve
I completely agree that "foreign" reserves are a hot potato. High interest on European debt means squat if the principal is in doubt.
And Bernanke has just shown he can print himself into the largest holder of U.S. debt.
Oil and infastructure, parallelling 1950's America is bad policy indeed.
Now don't be confusing r.a.
Russian central bank raises deposit rates by 25 bps, leaves REFI rate on hold
hey RA chill with "australia should be left out - still part of the british empire" bs OK? .... since when were we ever anything BUT a quarry and or raw materials supplier , anyway?
The Japanese, upon capture of Singapore, in late 1941....had as their MAJOR objective, the removal all previous affinities to the British Empire....and summarily executed about 20,000 ethnic English speaking speaking and aculturated Chinese/Europeans, as was done in Nanking and Shanghai, too...the concept in 1941 was that the centuries old exploitation/suppression of China, India, Indonesia, Vietnam...etc WAS TO BE ENDED TOTALLY, FINALLY COMPLETELY....the Opium war in China, the growing of Opium in India/Pakistan, the Indian Famines....and for the JAPANESE, revenge outright for the 1860's opening of Japan...defeated the Russian Fleet in 1905, Japan realized the beginning concept of the Greater Far East Coprosperity Sphere....in which Japan, would of course be the center/leader....well this Oriental Block Concept is STILL THERE,
http://en.wikipedia.org/wiki/Greater_East_Asia_Co-Prosperity_Sphere
http://www.britannica.com/EBchecked/topic/243983/Greater-East-Asia-Co-pr...
Of course, the Australians, captured by the japanese, know VERY well the Japanese true attitudes towards Europeans....of course history is written by the Victors, so it is not permitted to even THINK negatively regards the Politically Correct Edicts coming from the USA...
and Australia, New Zealand, perhaps India/Pakistan, and the USA...are the natural cultural matches....
RA, while the Asian wars were astonishing in savagery, not that the others were civilized, remember that the victors wrote the history and I don't mean the average American. Yes, the central bankers were at the back of them as usual. The 1905 Russo-Japanese war was bankrolled by the central bankers who upgraded the Japanese navy for the sole purpose of attacking and destroying the Russian fleet, in preparation for WW1 and the Russian Revolution, both of which were in the planning stages at that point. Everything you read about wars, revoutions, rebellions, etc., needs to be reconsidered. Remember what (I think) FDR said, "things don't just happen, things are made to happen."
China's central bank raises interest rates again
China's central bank will raise the one-year lending and deposit interests rate by 25 basis points from December 26, the second time in 2010.
Plunge and big one this time
Here's a link to the Bloomberg article:
http://noir.bloomberg.com/apps/news?pid=20601087&sid=ak7wvVYX9V0c&pos=1
They did it on Christmas Day. I guess they were hoping no one in the West would notice?
I sometimes get this sort of deja vue from the 80s, when Japan was going to take over the world and leave everyone in the dust. Still procrastinating on those Mandarin lessons.
german may be the idiom de jour
China's Wall of Worry
yes, many problems, enumerated...all of which appear to be related to over-application of an ideological/political 'planning process', in an ENVIRONMENT OF CORRUPT NEW RICH,OFFICIALS....and, like/as in America, a Too Big to be held accountable, but in China, these are large Cities and Provinces with considerable Political Pull....
I find it 'interesting' that China has an 'overeducated' unemployable class !! Piss Poor planning for sure...almost the entire rest of what i have to say HERE is a commentary on this strange problem in China of overeducated unemployables...IT IS ENTIRELY FIXABLE, AND NECESSARY TO BE FIXED..
Certainly, it is important, very important that China produce products for both internal use and for external sales at the HIGHEST AND BEST possible level of 'finished product'....EVEN it SOME countries will try to force China to sell its mere 'unskilled production labor', for final assembly 'elsewhere'.
...no way...China HAS a couple Trillion dollars equivalent from Europe/USA, this MONEY should definitely be LENT to the European countries now offering VERY HIGH risk-premium interest rates...the VERY PURCHASE OF WHICH will result in an immediate capital gain, from the LOWERING OF SOVEREIGN RISK in such countries as Ireland, Greece, Lithuania, and some OTHER former 'East Block' countries, including RUSSIA itself (in the form of direct commodity swap-trades, etc)...
So China should/could use "Dollar Diplomacy" and buy the high yields of Europe, WITH CONDITIONALITIES, of course
....that Europe accept top quality FINISHED PRODUCTS from China, in direct competition with Germany, France, Great Britain
....NOW is the time for those countries in Europe getting the less than enthusiastic monetary help THEY NEED, to see WHO, really is willing and able to be 'good neighbors from the East'.
...Translated FYI that the former Cold War USSR/China countries, JOIN UP into an ECONOMIC POWER BLOCK ....
Needless, to say, almost...therefore, ALL THOSE unemployed just graduated Chinese Engineers should be SENT OUT to the new friends in Europe, perhaps Cuba (NEW concept, eh??)
.... Australia, however, SHOULD BE KEPT OUT...KEPT ONLY AS RAW MATERIAL SUPPLIER....you see thats part of the British Empire STILL, the 'great game' / spying sabotage+Aussie Unionism...all no good..
China FOOD PROBLEM....ARE YOU KIDDING, with 2 trillion American/European dollars you can buy a lot of bread to distribute....as a temporary measure...
Now, the Problem with China, is a TOO ideological application of Planning....China needs a kind of School of Thinking, fostered AS IT WAS IN POSTWAR JAPAN 1945-1955, about actual Engineering Economics, WHICH IS THE TRUE 'SCIENTIFIC INDUSTRIAL SOCIALISM', otherwise known as 'planned economies' in the Fascist manner...
....and EXECUTION OF ECONOMIC CRIMINALS....in show trials, of course, but under pre-exisiting laws based mostly on a concept of 'economic violence' (something the USA has yet to grasp)
the 'failure of planning' = failure of communism, we USA love that Reagans conquest of the Evil Empires of Planned Economies....(= they were doomed to failure....eh?)
simply because of human greed, not tempered by fear of failure
...a 'politico' cannot fail, but rather 'removes his competition'...so the failure is China being run by Political Officers, rather than City/ecological-system-Engineers and such.
...it is FIXABLE...there is a 'mindset' that comes with 'technical education' 'higher schooling' THAT IS A SENSE OF TRUTH AND RIGHTNESS, OF OBJECTIVELY....i would guess ALL of the 'educated, unemployed college graduates' would have an ANTI- Politically-correct attitude, already...THAT MUST BE FOSTERED,
...AND THE OLD PARTY HACKS 'retired'....and this process is more likely to be possible in the New China, than in the Old Europe, and the Old USA...both fossilized, needing to 'hit bottom' like an incurable alcoholic needs a defining moment, before 'healing/change' is possible...
....And the 'peoples money' should NOT be open to World Currency exchange/manipulation, YET...let the Bank of China, do as the USA Federal Reserve, and print its own money, as much as needed, till the necessary 'societal upgrades' have occurred...
More, China SHOULD NOT automatically adopt the USA/European transportation model...THEIR MODEL has been market/profit driven....the cars that use oil/gas, the roadways that use the residual bunker/tar oil, the very construction of cities, such as LA....where nobody walks, nor in practice uses SO CALLED PUBLIC TRANSPORT...... and the use of TRUCKS for main line long distance transport....RIDICULOUS, YOU USE BOXED land/sea/rail/truck multimode transport....you MINIMIZE the fuel per ton/mile, you ENGINEER THAT, while it still can be done...
And Electric POWER should be a major means of industrialization, WITHOUT POLLUTION...NUCLEAR POWER, OBVIOUSLY!!!!! No anti-nuclear, non-proliferation dispute THERE, in the New China, why has this not gone further....and 'forget major solar/wind....and other BULLSHIT' projects, SELL that shit to the WEST...use the electric for trains, buses, trolleys...all sorts of genuine public transport, as it was BEFORE OIL and Capitalistic implementation of a totally oil-based market profit based society...
hopefully, european nations won't be as stupid as the US to fill their store shelves with crap or even well made products made in china. This neo liberal trade ideology must die and be buried with Milton Friedman, I thought someone might noticed by now it doesn't work ... guess not.