Some Light Shown on My Developing China Thesis

First, in today's news.

Yen Weakens Against Higher-Yielding Currencies After China Growth Quickens

Jan. 21 (Bloomberg) -- The yen declined after a
Chinese report showed economic growth accelerated to the fastest pace
since 2007, damping demand for Japan’s currency as a refuge.

The yen weakened against all of its 16 most-active
counterparts on speculation the nation’s central bank will keep
interest rates low as the economy struggles to gain momentum. The euro
was near a five-month low against the dollar on concern Greece will
default on its national debt as credit-default swaps on the country’s
five-year sovereign bonds climbed to a record.

“The data suggest a bright outlook for China’s economy,” said Yoh Nihei, trading group manager at Tokai Tokyo Securities Co. in Tokyo. “The sentiment is for risk to be on and the yen to be sold.

The yen slipped to 83.66 per Australian dollar as of 2:25 p.m. in Tokyo
from 83.04 in New York yesterday. It fell to 129.06 per euro from
128.68, and lost 0.3 percent to 12.44 South Korean won. The yen was at
91.61 per dollar from 91.24.

The euro traded at $1.4088 versus the dollar from $1.4106 yesterday after dropping to $1.4068, the lowest since Aug. 18.

Japan’s currency declined for the first time in six days against the
euro after China’s statistics bureau said gross domestic product
increased 10.7 percent last quarter, faster than the median forecast of
10.5 percent in a Bloomberg News survey of economists.

China's Growth Accelerates to Fastest Since 2007 as Bubble Risks Increase

Jan. 21 (Bloomberg) -- China’s growth rate
accelerated to the quickest pace since 2007 in the fourth quarter,
adding pressure to rein in surging credit that threatens to destabilize
the world’s fastest-growing major economy.

Gross domestic product rose 10.7 percent from a year
before, more than the median forecast of 10.5 percent in a Bloomberg
News survey, a statistics bureau report showed in Beijing today.
Asset-price gains, particularly in property, are creating problems for
the government to guide the economy, Ma Jiantang, who heads the bureau, told reporters after the release.

The report stokes speculation the central bank will start raising its benchmark interest rate
and tighten restrictions on the nation’s lenders. The one-year swap
rate, an indicator of future changes in borrowing costs, climbed and
the People’s Bank of China guided three-month bill yields higher for
the second time in two weeks.

“Today’s data suggest that tighter policy is just around the corner,” said Brian Jackson,
a Hong Kong-based strategist on emerging markets at Royal Bank of
Canada. “Policy makers will need to move soon to stop the economy from
overheating,” he said, forecasting officials will end an exchange-rate
peg and boost interest rates starting this quarter.

The following is an excerpt from the subscriber document " A Note On Potential Short Opportunity Opinions in China 2010-01-21 01:13:06 475.18 Kb" which is available to retail and pro Subscribers as a 6 page PDF document, Pro subscribers are invited to the discussion/debate between myself and my analysts
on the merits of the China short as it compares to the up and coming
European Sovereign Crisis short opportunities I will be publishing very
soon (a preview is available here: Deflation, Inflation or Stagflation - You Be the Judge! - please excuse the fact that I compressed several European nations into EU charts). Click here to view the debate and add your opinion. I think many will find it very interesting and fact-filled. Click here to subscribe.

---

The apprehensions regarding the Chinese
economy going bust, raised by many analysts appear substantiated to a certain
extent taking into account the current economic scenario in China witnessing inflation,
huge bank lending, rising real estate pricing lending. However, there are some
strong arguments that lead to a contrarian view that China's recent surge is
supported by fundamental growth, and a comparison to the US and Japanese Crisis
is not appropriate.

Concerns over China's unsubstantiated
surge:

1.       Overflowing
liquidity led by large government stimulus packages and bank lending:

·        
Banks in China had extended ¥600 billion ($US88
billion) in loans during the first week of January 2010, compared with a
combined ¥674.6 billion given out in November and December 2009. Moreover, new
loans of ¥ 10 trillion (US$1.5-trillion) flowed into the property sector in
2009.

·        
Beijing's combined stimulus spending and
government-directed bank lending amounted to 40% of gross domestic product in
2009.

·        
Moreover, as noted by economist and author
Richard Duncan to maintain growth of 8% this year, banks will need to crank out
another round of lending equivalent to 30% of GDP.

·        
According to reports by the state-run Xinhua
news agency, the central government has budgeted ¥992.7 billion (US$145
billion) on public investment for 2010. The key concern here is that the
expanded spending and new loans from state-owned banks will bolster production
capacity, fuelling excess, and inevitably compounding deflation.

2.       Formation
of property and asset bubbles in China

·        
Many analysts say that money, along with huge
foreign inflows of "speculative capital," has been funneled into the
stock and real estate markets which is driving the growth in the both stock
market and real estate market.

o  
China attracted a total of $48.7 billion of "hot
money" in December 2009, the largest amount in eight months, according to China
International Capital Corp.

·        
Y-o-Y growth in home prices during 2009 has
increased continuously (see chart below)

·        
The Shanghai composite index is trading at a P/E
ratio of 34x higher compared to 24x of S&P 500 (US - which is also
witnessing a bull run) and 26x of SENSEX (India - another developing market).

3.       Comparison
being drawn with Japan in 1980s (the bubble era):

·        
Extraordinarily high saving and an undervalued
exchange rate have fuelled rapid export-led growth and the world's biggest
current-account surplus. Chronic overinvestment has resulted in vast excess
capacity and falling returns on capital. A flood of bank lending threatens a
future surge in bad loans, while markets for shares and property look
dangerously set for a bubble.

·        
China's total fixed investment jumped to an
estimated 47% of GDP in 2009, ten points more than in Japan at its peak. Chinese
investment is certainly high compared to most developed countries where it
accounts for around 20% of GDP.

However, a close inspection of the three
main concerns-overvalued asset prices, overinvestment and excessive bank
lending - suggests that China's recent surge could well be supported by
fundamental reasons:

1.       Chinese
share prices are nowhere near as giddy as Japan's were in the late 1980s. In
1989 Tokyo's stock market had a price- to-earnings ratio of almost 70; current
figure for Shanghai A shares is 34, below its long-run average of 37. Though,
prices jumped by 80% in 2009, but markets in other large emerging economies
went up even more: Brazil, India and Russia rose by an average of 120% in
dollar terms. And Chinese profits have rebounded faster than those elsewhere,
for the three months to November 2009, industrial profits increased 70% higher
than compared to a year before.

2.       Moreover,
though the property prices in China have increased (prices of new apartments in
Beijing and Shanghai leapt by 50-60% during 2009; in January 2010, National
Development and Reform Commission reported that average prices in 70 cities had
climbed by 8% in the year to December), average prices have fallen relative to
incomes in the past decade. (See chart below)

3.       Chinese
households' total debt stands at only 35% of their disposable income, compared
with 130% in Japan in 1990. One-quarter of Chinese buyers pay cash and the
average mortgage covers only about half of a property's value. In China, owner-occupiers
must make a minimum deposit of 20%, investors of 40%.

      See  A Note On Potential Short Opportunity Opinions in China 2010-01-21 01:13:06 475.18 Kb for the full article. Visit the Pro discussion forums to view/participate in the debate between BoomBustBlog analysts.

Comments

[Anonymous]

Fact China is basically a global manufacturer they have no arable land to speak of no commodities except for coal and rare earth metals and no adequate source of water
to slake the thirst and food to feed 1.3 bn people. Start there as that is their ongoing biggest concerns. I have a large institutional client go to mainland China five years ago. His takeaway you better hope your kids speak Mandarin. As far as asset liability managers they are very astute.
As pointed out they routinely are enigmatic it is their
very nature making second guessing them a waste of time unless you are one of Zhou's trusted advisor's. Rest assured
they have a tight rein on their economy and obsessively
manage the behavior of their people because in the end they
are communists politically with a quasi capitalistic economy with a big global check book courtesy of the
U.S consumer. As you see them curry favor with Eastern
neigbors and emerging economies they are just looking
for their next rising middle class victim.

[Anonymous]

No arable land, no commodities and no source of water, but a huge military and 24 million more military aged males than females. We could have a very big problem on our hands very soon.

[Daedal]

They just reported 10.7% GDP growth. At this pace, China's GDP will be 50% of USA's current GDP in 5 years, and equal to USA's current GDP in 11 years.

[Reggie Middleton]

No it won't. Bubbles do not = economic growth. Bubbles borrow growth from future periods at hard money rates. The payback is a bitch. As the US, UK, Japan, Dubai, Greece, Iceland, Ireland, Italy, Spain, CEE, etc.

[Daedal]

...that's what I was insinuating. I forgot to close my remarks with a </sarcasm> tag.

[KidHorn]

The problem with evaluating China is the data can't be trusted. Their gov't is well known to publish what they want to be true as opposed to what is actually true.

[duo]

Their GDP is heavily influenced by construction of empty office buildings, apartments, and factories (read: malinvestment).  Not that the US economic statistics are any more relevant.