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What Are the Odds That China Will Follow 1920's US and 1980's Japan?
Today in the news: China
Inflation, Production Accelerate, Adding Pressure for Stimulus Exit
March 11 (Bloomberg) -- China’s inflation
reached a 16- month high, industrial output climbed and new loans
exceeded forecasts, adding to the case for the government to pare back
stimulus measures.Consumer prices rose 2.7 percent in February from a year earlier, the
National Bureau of Statistics said in Beijing today, compared with the
2.5 percent median
estimate of 29 economists surveyed by Bloomberg News. Seasonal
factors stemming from a weeklong holiday may have boosted prices.
Production rose 20.7 percent in the first two months of 2010, the most
in more than five years.
Contrary to many, not only do I believe China is in the throws of a
credit driven asset bubble, but its touted safeguards point the way to
drastic correction.
China huge foreign reserves: Not a savior for the country if
the asset bubble bursts
The concerns highlighted by Michael Pettis (a professor at Peking
University's Guanghua School of Management, "Never
short a country with $2 trillion in reserves?") are telling,
particularly that huge foreign exchange reserves are not a sure shot
solution for preventing China from a future financial crisis. I would
like to amplify the message contained therein, since the news coming out
of China reinforces the fact that it is really not "different this
time" so emphatically.
The Author states:
"...Let us leave aside that the PBoC's reported reserves are a lot
more than $2 trillion, and that if correctly accounted they would be
pretty close to $3 trillion. China's foreign reserves are certainly
huge. They add up to an amount equal to about 5-6 % of global gross
domestic product.
But they are not unprecedented. Twice before in history a country has,
under similar circumstances, run up foreign reserves of the same
magnitude.
The first time occurred in the late 1920s when, after a decade of
record-beating trade and capital account surpluses, the United States
had accumulated what John Maynard Keynes worriedly described as "all the
bullion in the world". At the time, total reserves accumulated by the
US were more than 5-6% of global GDP...
The second time occurred in the late 1980s, when it was Japan's turn to
combine huge trade surpluses, along with more moderate surpluses on the
capital account, to accumulate a stockpile of foreign reserves only a
little less than the equivalent of 5-6% of global GDP. By the late
1980s, Japan's accumulation of reserves drew the sort of same breathless
description - much of it incorrect, of course - that China's does
today.
Needless to say, and in sharp rebuttal to Friedman, both previous cases
turned out badly for long investors and brilliantly for anyone dumb
enough to have gone short. During the early years of the Great
Depression of the 1930s, US stock markets lost more than 80 per cent of
their value, real estate prices collapsed, and the US economy contracted
in real terms by an astonishing 30-40 per cent before recovering in the
1940s.
Japan's subsequent experience was economically less violent in the short
term, but even costlier over the long term. During the period following
its astonishing accumulation of central bank reserves, its stock market
also lost more than 80 per cent of its value, real estate prices
collapsed, and economic growth was virtually non-existent for two
decades.
Reserves of course are not useless as an enhancer of
financial stability, but their use is for very specific forms of
instability. Having large amounts of reserves relative to external
claims protects countries from external debt crises and from currency
crises."
The key term here is "external". China does not face an external debt
concerns, as the country's foreign claim as per BIS (Bank for
International Settlement) stood at only $278.6 billion at the end of
September 2009 (which is only 5.3% of the country's 2010 expected GDP as
per IMF). However, China's domestic debt currently remains
at an uncomforting level (as we will see in our discussion below)
"The risks that China faces today (and the US in the late
1920s and Japan in the late 1980s) is of excessive domestic liquidity
having fueled asset and capacity bubbles, the latter requiring the
uninterrupted ability of foreign countries to absorb via large and
growing trade deficits. These risks include an explosion in domestic
government debt directly and contingently through the banking system... "
This risk is visible in the recent finance ministry announcement to
nullify all guarantees
local governments for loans taken by their financing vehicles, and
its plan to issue rules banning all future guarantees by local
governments.
If local government debt that China's local governments have been
raising through off-balance sheet (and similar) investment vehicles to
circumvent direct borrowing regulations - and which is
not counted in official calculations, is included in the total debt -
then the country's debt could rise to 39.838 trillion Yuan or $5.8
trillion. This puts China in similar debt standing with many of the
PIIGS, being that its accounting for 96% of GDP, much higher in
comparison to the IMF's estimate of 22% which excludes local-government
liabilities, in 2010 based upon research by
Northwestern University's Professor Victor Shih, who estimates
China's local- government outstanding debt at the end of 2009 at 11.429
trillion Yuan.
This puts China 4th in line, behind Italy, Belgium and Greece
in terms of gross debt to GDP!
"... And reserves are almost totally useless in protecting
these economies from the risks they face (and, no, no, no, reserves
cannot be used to recapitalize the banks - only domestic government
borrowing or direct or hidden taxes on the household sector can be used
to recapitalize the banks). In fact, it was the very process of
generating massive reserves that created the risks which subsequently
devastated the US and Japan. Both countries had accumulated reserves
over a decade during which they experienced sharply undervalued
currencies, rapid urbanization, and rapid growth in worker productivity
(sound familiar?). These three factors led to large and rising trade
surpluses which, when combined with capital inflows seeking advantage of
the rapid economic growth, forced a too-quick expansion of domestic
money and credit."
The above case is most accurate in regards to China, where the
accumulated reserves have come from preventing Yuan appreciation, rapid
urbanization and rising worker productivity (which remains one of the
key drivers for the country's exports). Thus, if we go by historical
precedence, a huge financial reserve for China does not safeguard the
country against a financial crisis.
These similar concerns are being supported by other analysts and
economists. Trend forecaster Gerald
Celente believes that the depression is global and a contraction
across the entire planet cannot be avoided, and that includes China.
Economist Harry
Dent holds a similar view, recently
saying that, "China will see their bubble collapse strongly when
the U.S.-led stimulus program fails due to rising defaults and
foreclosures later in 2010, at the same time that the world is looking
for China to pull it out of this global downturn."
As suggested above by Michael Pettis, though foreign reserves can be
used for very specific forms of instability, there is one way in which
China can use its reserves to tackle the current problem of rising
domestic debt, that is by converting its foreign currency denominated
assets (which is primarily dollar for China) to Yuan.
However, this would lead to appreciation of Yuan against the USD. With
China being an export-driven economy, this is a measure of very last
resort.
But eventually, China will have to appreciate Yuan as it is
facing considerable international pressure from its trading partners,
more importantly, it looks like the only way to ease strains on the
country's fast growing economy. We feel that this will not be a
voluntary move (China faces new
pressure to let currency rise).
Subscribers should reference the following related topics/documents:
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Wrapping it up for life insurers, it appears they've taken only one quarter of their medicine. Fitch estimates the bulk of losses are for this year and next: $15 billion more. No wonder they went in for TARP qualification.
http://www.businessweek.com/news/2010-01-21/u-s-life-insurers-face-more-real-estate-losses-fitch-says.html
MetLife profit down 70%, bled $5B+ in 2009, another $2B+ expected..
Feb. 2010
"For the latest quarter, MetLife reported a profit of $289 million, or 35 cents a share, compared with a year-earlier profit of $954 million, or $1.20 a share. Operating earnings, which exclude realized capital gains and losses, rose to 96 cents from 17 cents. The company forecast a range of between 90 cents and 95 cents in December.
The company also reported a full-year 2009 net loss of $2.4 billion, or $2.89 per share, reflecting net investment losses of $5.1 billion.
Revenue in the fourth quarter fell 12% to $12.34 billion, below the $12.56 billion analysts polled by Thomson Reuters expected. Operating revenue--which excludes investment impact--rose 13% to $13.3 billion as premiums, fees and other revenue surged 14%, compared with the 6% to 8% MetLife projected.
Net investment losses totaled $898 million, compared with a $2.15 billion gain a year earlier.
Fitch Ratings downgraded MetLife's long-term ratings by one notch on Monday partly due to expectations that MetLife's gross investment losses will total between $2.2 billion and $2.6 billion for the fourth quarter 2009 and full year 2010.
Moody's Investors Service reaffirmed a negative outlook for U.S. life insurers this week, as investment losses continue for insurers while the weak economy forces many consumers to hold back on what they see as discretionary purchases, such as life insurance."
"in the throws" = "in the throes"
Note the above is life insurers. Still looking for health insurers.
Reggie, off-topic but.....
I have been asking about health insurance companies' exposure to potential writedowns as I believe this is one factor contributing to the 'no haircuts' (Japan R USA) policy. Obviously there isn't a lot about this in the finance literature to date. However, I did just find this forthcoming article for the Journal of Insurance Issues (great name) with an abstract posted online. Something for your research staff to dig into?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1374023
The Determinants and Potential Effects of Life Insurer Mortgage Backed Securities Exposure
Andre P. Liebenberg
University of Mississippi - School of Business Administration
L. Lee Colquitt
Auburn University - College of Business
Harris Hollans
Auburn University - College of Business
Journal of Insurance Issues, Forthcoming
"We find that, while there is a measurable exposure to RMBS, this exposure and its resulting effects on the asset valuation reserve are unlikely to have a major impact on most insurers’ balance sheets. However, a dramatic downgrade of aggregate (residential plus commercial) mortgage backed securities could result in a decrease in surplus of almost 10% for the largest U.S. life insurers."
Maybe they are underestimating; at any rate, add in international bond exposure and a couple of other sectors and you can see my thesis about the collapse of US health care as part of the 'doomsday scenario' paralyzing the US gov't....it's hidden in plain sight.
I have covered Hartford in detail, and looked at Principal Financial Group - both on the site as a subscription. The life insurers have exposure. I haven't looked into the health insurers though.
Hmmm. It strikes me that the conditions of Chinese choosing to stimulate their economy through fiscal policies and lossening lending standards as well as the most recent rush of foreign investments into their economy were all accelerated, if not created, as after-effects of the US led global financial meltdown we recently experienced.
It also strikes me that now that the Chinese are in this state of inflation with asset bubbles frothing around their economy, it would now actually be advantagous for them to revalue their currency and create other policies to spur domestic consumption, like we wanted all along to help lower our trade deficit and help our unemployment problem.
"or you guys can choose to keep your currency artifically low. You'll keep beeting us on trade for a little while, but guess what will happen if we agressivly raise rates and work to pull all foreign investment out of your economy too quickly - sure we'll get hurt a little too, but once all investment opurtunities in you developing boys are crashed, investors will once again flock to the safety on the US bond" (says Ben)
Over more than 6000 years, China has endured dozens of economic "bubbles". This latest one will be broadcast over the internet and other media, but for a farmer in the Middle Kingdom, the results will be the same. He will continue to do what he has always done, while mandarins and elites in far off cities play games and suffer.
What Are the Odds That China Will Follow 1920s US?
Since first visiting China in 1986 (and going several times a year ever since) I can say that the country has already experienced "The Roaring '20s" several times over.
The more appropriate question is: What are the odds that China will follow 1920s China?
China's Republican Period (1911-1949), in the early years following the fall of the Imperial Throne, was much like the 1920s or even today with free markets all a go-go. Then, too, as now, we had the ill effects of rampant capitalism like class stratification, political corruption and the oppression of the larger populace. This period is also known as The Warlord Era, when the country was in effect controlled by various regional politicians (or criminal syndicates, if you prefer) and the people lived under conditions of endless war and chronic chaos.
So, what are the odds of China having another Warlord Era? My guess: 50/50; and that is why the Chinese central government must now reign in what may already be out of control--local and regional economies.
+10
It's funny that people are only now piling onto the Chinese "bubble" story when the PRC has been in a similar developmental froth for about two decades now. Many local and regional economies are now completely out of control.
My favourite rationalization is the "Migrant Expectations" theory: "Oh, they are just building in expectation of the huge influx of rural migrants over the next few decades".
Because I'm sure those rural migrants are just going to be climbing over each other to snap up garish luxury condos!
Reggie,
The odds are very much in favor of a bust/recession/downturn. That's not the problem, it is in fact the solution. Bust is needed to balance the the imbalance during the boom.
Long recessions/downturn are always courtesy of governments, they create depressions in the name of fighting the recession.
So the question is NOT if china will bust, qustion is what they'll do to fight it.
As we all know, if you don't do absolutely nothing, economy will revive very shortly, same as 1920 with pres Harding.
If they do think of something, well, it'll be 1930s all over again, but I think they're better off, as they have a lot of real money (gold)
Reggie
The only objection that I have with the article... is that you said the accumulation in the United States and Japan of bullion and foreign currency reserves was 5-6% of GDP.
At 2 trillion, isn't China's accumulation much more as a percentage of GDP than either the U.S., or Japan?
Also, if it is a much larger share, is that better or worse for China?
I'm not trying to "stir the pot", only trying to learn something.
Thanks!
I excerpted from the Pettis article, who made a similar point. I don't think it is a matter of being better or worse, but indicative (historically) of the type of internal pressures that build up in order for countries to amass such an accumulation in the first place.
The Chinese won't have an implosion, but an explosion instead.
China real estate speculation is by the (politically) well connected. They are too big (shots) to fail. The government will put yuan in peoples' pockets and order them to spend it. When China's huge savings are turned out, the explosion will take place.
At bottom, China's government and establishment does not care about the welfare of the average citizen; it will be happy to steal their savings by inflation and inflate their own bad debts away at the same time.
China does not index entitlements or transfers from the government to the citizens - it doesn't HAVE entitlements or transfers to citizens. Ordinary Chinese citizens do not have assets available to hedge against inflation, without entitlements, citizens save their money.
China is using its reserves to buy oil and other dollar- denominated commodities.
Right now the dollar is hard as it is pegged to crude oil - dollar prices much above current levels will cause an oil price shock. The dollar/yuan peg is massively deflationary for China. This makes China desperate to break the peg for reasons entirely different from those promoted by 'Brand X' economists.
China is trying to transition from an export economy to one that consumes domestically. @ $1 per day, there isn't enough individual buying power in the country; inflation is necessary to make domestic consumption happen. That is, unless the USA can start exporting its municipal labor unions to China.
The issue is whether hyperinflation in China is contained to the current property bubble or whether it will spread widely. Inflation was so contained in the OECD and Japan leading to their 'Lost Decades'.
There are too many powerful interests which benefit from widespread hyperinflation in China.
Great stuff from Reggie, as usual. You have proven that there is runaway growth and incipient inflation in China.
Now you must prove the harder case: That there is "mal-investment" in China that cannot generate returns to service this growing pile of debt.
Empty buildings generate a negative return by default, unless traded for a capital gain. Cashflow negative assets traded for multiple gains are usually evidence of a pyramid about to collapse.
With due respect, a few anecdotes about empty buildings is not proof. Tell me how many square feet of office space sits empty. Tell me how many sq ft of apartments are empty. Tell me what is the rate of absorption in commercial RE and residential RE. Let's try to calculate how many months/years of absorption we need to fill up this empty space.
All buildings empty until they are filled. Not trying to be a smart-ass, but this is a topic worth treating with your usual and famous rigor...
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a6i2PSZD.Jr4
My favorite line:
"The commercial property space under construction in China at the end of November was the equivalent of 6,800 Burj Khalifas -- the 160-story Dubai skyscraper that's the world's tallest."
and this one is fun, too:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azXVqyY6O8cQ
I am fairly certain at the end of February there was a report on Bloomberg of an America property developer in Peking having his screen saver flip through the empty high rises in that city to remind him of humility. There were 55 in total.
Look up anything lately on Chanos and Hugh Humphrey on Youtube.
Most damning would be Hugh Humphrey schooling Faber on the "Build it and they will come" insanity during a Russian investment conference (also on youtube)
I believe you mean Hugh Hendry:
http://www.youtube.com/watch?v=ektMQGbW3wk
http://www.businessinsider.com/hugh-hendry-nassim-taleb-and-marc-faber-l...
All buildings empty until they are filled. Not trying to be a smart-ass, but this is a topic worth treating with your usual and famous rigor...
You would need to run Monte Carlo simulations to come up with some basically meaningless data given the parameters for such numbers are too independent of one another.
Understood, but that is obviously beyond the scope of this article (although related data is available both in Chanos's presentation and some on my site behind the firewall, it is all relatively anecodtal due to murky reporting requirements, IMO). In addition, probably besides the point. Let's assume the property can be used to capacity (which I doubt), price appreciation is still considerably above the trend line at over 10% for the month of February y0y. Now, how is that justified is the question.
The returns needed to be generated that you inquired about have to justify this price increase.
Reggie, I want to be as smart as you when I grow up!
Well, the Japanese saw what happened to the US in the 1920's, did that stop them? The US saw what happened to Japan in the 1980's, did that stop us? Please don't tell me that "This time is different", or worse yet the Chinese are smarter than the Americans and the Japanese. Booms and busts are a function of human, and by extension political nature. I don't think it is structurally possible for China to avoid a bubble, because they are already there. Look at the unused capacity in existence (as a net export nation), that is currently being added to as much of the world slides back towards recession.
As you may have been able to tell, I am primarily a data driven sort of guy. I don't make any decisions based on what Chanos, et. al. have to say. I actually came to very similar conclusions, totally independently. My analysts don't get paid per transaction, hence they are totally independent as well. We shall see what comes of it, but practically all of the signs of a credit derived bubble are there. If it looks like a duck, quacks like duck and walks like a duck, is it a Swan?
Check out this quacking swan from the news lines posted on ZH front page:
Reggie,
You're a smart guy but china is not Japan or the US, it's still very much a command economy where the governemnt has a tight grip on the banking sector. My sincere advice is to be very careful shorting China.
The Japanese also had a tight grip on the banking sector, and the Japanese banks were more solvent than China's. Is China willing to let state connected banks fail? If not...
Leo,
My question when it comes to talk of China, command economies and "tight grips" on capital flows is always the following: which government are we talking about?
Beijing has a lot less control over sub-national levels of government than people would think, or in some case hope. The absurd excesses in the Chinese development process, besides the mega-face/national projects like the Three Gorges Dam or Pudong in Shanghai, have by and large been driven by local and regional-level shenanigans. I'm sorry to knock your "knowledgeable" Marxist friends, but it would seem their idea of China either stops at the city limits of Beijing or is firmly stuck in the past.
The national leaders in Beijing talk a great game, but the real question is to what extent these orders flow down through to administrative levels that are actually charged with implementing them. I'd say with great difficulty. If someone argues that China is a tightly controlled command economy, they havne't been paying very much attention over the past 20 years. The local boys have run completely amok. Ironically, this mess is the fault of the central government, as they've been busy offloading fiscal burdens on the local level for years and leaving them to police themselves. And what is the best way for local gov'ts to raise money? Land flipping to developers (since the government still technically "owns" all the land).
To the outside world, Beijing puts on a great face of control, and can keep a tight lid on for projects of national/international importance like the Olympics. But on the ground and in the day-to-day dirt, Chinese development is ill-planned, haphazard, backdoor deal-driven and often bordering on chaotic. Sure the banks are "national" and "state-owned", but who do you think the local branch officer in some podunk hinterland industrial sprawl has to answer to- Hu Jintao? Try the local party officials.
As a comedic aside to prove a point, golf course construction has been banned in China by the national government since 2004 due to concerns over declines in arable land.
Number of golf courses built in China since 2004? Approximately 400.
Thanks for the compliment Leo, but if they have so much control, why have risky asset prices surged so much? Surely they know that this is a bad thing.
I am sort of a perpetual student. I don't know much, but I learn a lot. One thing I have learned is that whenever things start to move out of equilibrium, there are always participants saying "this time is different" from all of the others. Just as you are saying that China is different from Japan and the US despite the exact same reserve buildup, foreign investment, surplus, heated economy, etc.
Russia allegedly had things under control as well. History repeats itself - all of the time.
Alas, time will tell and we shall see. The current banking scenario and the sovereign debt issue is one of the biggest bubbles of our time, possibly bigger than the subprime/real estate one. Again, we shall see.
Reggie,
Last night, I had my quarterly dinner with the Men's Club, a group of left-leaning individuals, mostly Marxist professors. They provide me insight that I simply can't find on mainstream media. Anyways, the now retired professor Sam Noumoff and I discussed the topic of a Chinese bubble. Sam told me flat out that "even if there is a bubble, they will deal with it quickly. China saw what happened to Japan, and they don't want to end up like them."
Sam Noumoff taught political science here at Montreal's McGill University. He personally placed a few senior Chinese officials in their positions and is well connected with what is really going on in China. I take his insight seriously as he has nothing to gain by peddling China.
I will repeat what I've said before: short Chanos on China. He and others warning us of an impending Chinese implosion have no clue of what they're talking about.
Short people who believe whatever other people say, even if the "other people" have Phds.
"Sam told me flat out that "even if there is a bubble, they will deal with it quickly. China saw what happened to Japan, and they don't want to end up like them.""
Nice. Like a typical Marxist the prevailing idea is central planning works. After continually raising reserve requirements, credit still expanded in January 2010 faster than all of Q4 2009. The credit crack is here and all of the junkie industrial commodity exporters and emerging markets are addicts.
You beat me to it:-)
if for no other reason, China will have severe economic problems simply due to its very young status as a reformed and changing economy. history is clear on this....doesn't matter if it is deflation, inflation, whatever....its infancy in and of itself will cause major problems.
if this does not come to pass, then this version of China will be the exception to the rule that has governed all civilizations since the dawn of mankind.
You both beat me. I'm dead last. Poor central planning is a massive waste of resources. Take a look at this video, courtesy of Mish. China's Empty City. I wouldn't be so quick to praise China and their communist party.
http://globaleconomicanalysis.blogspot.com/2009/12/china-faces-crash-sce...
Centrally planned city in Mongolia, built to house 1 million people. Current population, almost 0.
Short Pettis when you are at it. At the end of the day it will, as always before, turn out it was a prudent way to short all political junk peddlers like Sam Noumoff et al.
Begging one simple question: how on earth the great marxist china magician of Oz will tread water, defying economics. I'm sure they can - and will - play political smoke and mirrors. I know their tricks by heart. Pray tell me, how exactly will China masters of the universe deal with unavoidable collapse of their ponzi credit bubble with ensuing deflation of epic proportions? What concrete steps will be taken to "deal with it quickly"? I know some obscure canadian marxist says so. Short Pettis and Chanos. Political mambo-jumbo peddlers tell me so. OK. Now tell me how? Economic 101. And then I can light Noumoff a candle each of my remaining days.
Anyways you do not need to reply, I knwo the answer. The Chinas will apply turbo-mega-hyper... bazooka! Yes. Paulson-grade, China-made commie financial superduper weapon.
BTW I remember courses of marxist "social economy", I do know the difference between commie theory and praxis from experience, how about you?
Right on. And who is China going to sell all this production to when trade barriers are erected and demand flatlines?
They will "deal with it quickly" in the same way all political asshats do: by pretending it does not exist and jiggering the numbers so as to socialize the losses.
This is the same way Soviet America and its MBA apparatchiks are dealing with our innumerable problems. Peak oil? Structurally high unemployment? Trade deficits? Decrepit infrastructure? Moral hazard? Zombie banks? Nah! Doesn't exist! ... and if our stubborn refusal to acknowledge reality doesn't work sufficiently well, we'll just print more money.
Same deal in China. "Political elite" is a great job for the delusional.