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Guest Post: This Is The China You Don't Want To Invest In

Tyler Durden's picture




 

Submitted by Zarathustra of Also Sprach Analyst,

One used to describe how the Chinese economy is like (exactly who started saying that is no longer clear): a bicycle.

Anyone with the experience of riding a bicycle knows that you can’t ride it too slowly, or else you fall over. There was a common belief that China has to grow at least at 8% annual rate (now the number seems to have come down to 7.5%), or there will not be enough jobs being created so that there will be social unrest, that kind of thing.

We are not sure if we have ever had much faith in such theory. To our mind, the society has something seriously wrong if it requires 8% or more economic growth in order to keep it stable. And if this is true for China, the Chinese society is very wrong indeed (or perhaps the Chinese society has been seriously wrong with or without this implicit 8% requirement).

Now, the Chinese government is now worried about growth (we won’t speculate if the government is panicking or not). First, Premier Wen said growth has become a priority. Now, Premier Wen said it is important to “ensure reasonable growth of investment”. Remember that last month, as we noted obvious changes in languages regarding future economic policy, we pointed out that the Chinese government could have very well given up on rebalancing the economy from investment driven to consumption driven in hope to reflate the economy. So with Premier Wen making such comment, perhaps it is now official that the Chinese government has already given up.

If China wants to maintain high growth to eternity, it is possible theoretically even though it is not very realistic, because it requires the government to do things that have been done before, and have been widely regarded as wrong.

Because the government controls the issuance of the currency, there should theoretically be no budgetary constraint. So the government can spend and invest very heavily into eternity either directly or via state-owned enterprises even though there is nothing that China really needs but have not already had. In other words, investment will be done regardless of the expected return. To fund that, the government (including state-owned companies for the purpose of argument) borrow either from state-owned banks (while force banks to lend) or from the bond market (for the purpose of the current discussion, let us just say that both ways of financing are more or less the same). Money supply has to grow at some crazy numbers, and M2 will probably double every 2 or 3 years, and Chinese Yuan will depreciate substantially (there is a running joke among China sceptics that Bernanke is only an amateur when it comes to money printing. After all, Chinese invented paper, printing, and paper money). But because this implies ever more over-capacity in the economy, inflation could be surprisingly low. At the end, GDP will grow by 8% in Chinese Yuan term, and nothing disastrous would seem to have happened to majority of Chinese people (or maybe not).

Brilliant.

If China can indeed create as much output as the government wish (at least in local currency terms), does it mean that China is fine? Does it make the case for investing in China stronger?

No.

FT Alphaville points us to this piece of research from Colonial First State, which is, quite frankly, rubbish. It does not seem to worth the time to refute every false claim that research has written about, simply because there are too many, so we would just pick on one thing.

In here, the author of that research seems to think that high investment with low return or even negative return is fine, partly because:

By not using capital returns as a scorecard for economic progress, China improves the allocation of capital in its economy and raises living standards.

image
China is not Europe, surely…

The first bit about “improves allocation of capital” is something totally absurd (when was the last time you hear anyone said that “the state allocates capital better than the market?”), while the second point about raising living standards is actually correct in some way. To clarify, the process of having government directing money into fixed-asset investments, possibly through state-owned enterprises and/or local governments, no matter how useless they are (i.e. how low returns are), means that those money being spent are included in the GDP calculation. In an economy, expenditure of one sector is the income for another sector, so by channelling money into railroads constructions, for example, the government is raising the income level of construction workers who would otherwise be unemployed, commodities producers who would otherwise have massive unsold inventory, and probably restaurant owners that serve those construction workers, etc. In that sense, it improves people’s lives for that given period.

On the other hand, investing a huge amount of money into something with very low return is destroying wealth. Let us say that a state-owned real estate developer invested a huge amount of money into a large-scale residential development. Despite being sold out, most of these flats were not occupied nor let out. These assets are generating no return, thus they are next to worthless. The real estate developer was lucky to have sold them all, but those buyers would have bought something with huge amount of money which turned out to be worthless. This is by no means the only scenario. The real estate developer in question could very well be unable to sell, and being drowned in debt. To speak more formally, if a country is directing resources into investing something that cannot generate return in excess of the cost of funding, the country as a whole will be destroying economic value even though the country is generating GDP.

Because of overcapacity, the private corporate sector will probably not invest and have very low level of profit (if not close to zero as a whole), leaving the state-owned sector and local governments the only agents that will borrow and invest. The process of directing state-owned corporate sector to borrow and invest will generate output or GDP, but they will create even more capacity, leading to ever diminishing return. At the end, corporate profit (state-owned and private sectors combined) will fall to zero, if not negative.

If the author of the research is trying to make the point that China can still grow regardless of diminishing return on capital, what the point exactly is he trying to make for investors in, for example, Chinese equities? If the above scenario that corporate profit will fall to zero is true, why should any one care if GDP growth can hit 8%?  In fact, he seems to acknowledge the fact that Chinese equities have been doing extremely badly compared to the peers.  So why should we care?

To be clear, we are sceptical about whether China can really hit 7-8% growth in the longer run, and we are more comfortable with a long-term growth of 3% per annum.  But even if we are wrong in being too bearish on China’s future GDP growth, and that China successfully reflate its economy to 7-8% growth, we are genuinely not impressed if that is going to mean even lower return on investment and even lower corporate profit.  That means we have come to an uncomfortable conclusion that China is just not the place we would like to be in, regardless of GDP growth.

 

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Mon, 07/16/2012 - 15:17 | 2621253 crawldaddy
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they are buried in debt as well, they just hide it locally.

Mon, 07/16/2012 - 15:39 | 2621339 LMAOLORI
Mon, 07/16/2012 - 18:37 | 2622071 The They
The They's picture

IF the current communist government in China has any continuity with the state founded by Mao it is this: its entire structure has been constructed in such a way as to surpress consumption in favor of production.  Now we are entering a major paradigm shift that requires this trend to REVERSE.  The communist party cannot and will not survive this reversal because they're entire existence is predicated upon continuing the very paradigm that has to change.

Mon, 07/16/2012 - 20:35 | 2622379 potlatch
potlatch's picture

wait till be drop the transexual bomb over Naiking.  That will aslo destabilize the regime.  But that is the point.  No one I know thinks the Chi-com's will be allowed to make it through this decade before being taken out.  It's just a matter of time.

Mon, 07/16/2012 - 15:19 | 2621262 moskov
moskov's picture

The problem is how the hell if US would be able to invest to China while US is borrowing hugely from CHina?

Isn't that even more wrong and ridiculars?

Mon, 07/16/2012 - 15:20 | 2621265 Shizzmoney
Shizzmoney's picture

"These aren't the Communists you are looking for."

Mon, 07/16/2012 - 15:55 | 2621397 tonyw
tonyw's picture

They're certainly not real Communists, oligarchs with their elite taking a fortune yes, so it doesn't matter what they call themselves, communists, fascists, democans, republicrats...

Mon, 07/16/2012 - 16:49 | 2621683 Buckaroo Banzai
Buckaroo Banzai's picture

Of course they are communists. The Chinese State directs ALL economic activity. The genius of the Chinese Communists is they figured out that you can control all economic activity without necessarily having to micromanage it.

In other words, they looked at how our Federal Reserve System works, and used that as a model. The Federal Reserve System is probably the best functional model of how to implement communism (i.e. central planning of economic activity) that there is. The difference is, in the US, the Party Elite are bankers who operate via the Demo-Publican front; in China, the Party Elite are simply members of an actual political party.

Mon, 07/16/2012 - 15:22 | 2621271 zaphod
zaphod's picture

Wait, I thought China was going to become the next reserve currency.

Also, sounds like the chinese government will take over all private industry by funding state backed enterprises to no end, seems to be the exact same situation in the end as they had in the '40s '50s after Mao.

And people invest in China why?

Mon, 07/16/2012 - 15:22 | 2621272 Mr Lennon Hendrix
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You think China cares about social unrest?  America doesn't even care about social unrest.

Mon, 07/16/2012 - 16:54 | 2621697 Buckaroo Banzai
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They certainly care about social unrest. They care tremendously about it. They care so much, they are quite willing to shoot people in the streets.

Here in the US, we don't care about social unrest. 2 million tea partiers can march on Washington and no one will ever know or care because it never gets on TV, and everyone else is too busy watching the NFL, or Dancing with the Stars, or whatever.

Mon, 07/16/2012 - 20:39 | 2622398 potlatch
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2 million?  Try 20 million.  20 million tea partiers march, and these are grassroots people not fake hollywood marchers, and even Fox -- who you usually trust to be at least half-right -- doesn't even cover it!  There are 200 million tea partiers right now, in the US here, I bet.  But are the cameras and celebrities here?  Oh wait!  There's Angelina Jolie!  NOT!

Mon, 07/16/2012 - 17:00 | 2621728 BigJim
BigJim's picture

America hasn't had serious internal strife since the 'Civil' War..

China? They have a long history of governments being toppled.

The vast majority of US citizens have too much to lose if they rebel against their 'leaders'. The Chinese, not so much.

Mon, 07/16/2012 - 15:22 | 2621274 Gene Parmesan
Gene Parmesan's picture

Needs more proofreading.

Mon, 07/16/2012 - 15:25 | 2621282 SilverFocker
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I have always thought that China is to my generation what Japans was to my fathers........in the end, they both fade, but China has almost a billion and a half mouths to feed......things will not bode well for those folks as this thing continues to unravel.

Mon, 07/16/2012 - 15:31 | 2621302 moskov
moskov's picture

China can fuck the US, Japan cannot.
That's the difference.

Mon, 07/16/2012 - 15:38 | 2621325 buzzsaw99
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BUG LULZ you just angry little man moskov.

little cinee man couldn't hurt a flea if he fooked it.

where is that penis post? lololololol

Mon, 07/16/2012 - 15:56 | 2621400 Dumb Honkie
Dumb Honkie's picture

@buzzsaw99, Hey stupid HONKIE mother fucker, that's not what your fat ugly smelly mama said about Yao Ming's dick.

Mon, 07/16/2012 - 15:38 | 2621333 SilverFocker
SilverFocker's picture

"China can fuck the US, Japan cannot.
That's the difference"

 

LOL.....how , by demanding what. the only thing China has that we don't is a billion more people. They may have some resources , yet what good will that do if you can't afford to use them, not to mention the shape of their environment that is already bad, long term effects will doom many.

Mon, 07/16/2012 - 16:24 | 2621576 bankruptcylawyer
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Far more importantly, Japan can be fucked easily by both. and it's arguably fucking itself to boot. 

autofellatio for the win.

Mon, 07/16/2012 - 15:30 | 2621297 Manthong
Manthong's picture

Consider this in light of the economic prospects of the contracting EU and American economies.

http://en.wikipedia.org/wiki/List_of_cities_in_the_People's_Republic_of_China_by_population

Mon, 07/16/2012 - 15:31 | 2621301 geno-econ
geno-econ's picture

But, but Mike Holland via CNBC has been saying invest in China for the past year big time.  Oh forgot , he is ex- GS and on Board of China Fund

Mon, 07/16/2012 - 15:40 | 2621340 azzhatter
azzhatter's picture

and a tool of the gangsters on Wall Street

Mon, 07/16/2012 - 15:31 | 2621304 Shizzmoney
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The Chinese people will be fine.  They save in PMs, and that gold/silver will allow them to rebuild in their own small communities once this thing crumbles.

All Americans have is green pieces of paper that are worth nothing, guns, and boobie mags.

Mon, 07/16/2012 - 15:42 | 2621352 Bartanist
Bartanist's picture

And what good are precious metals when you are hungry and there are armed people at your door?

Mon, 07/16/2012 - 15:32 | 2621311 jimmyjames
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(there is a running joke among China sceptics that Bernanke is only an amateur when it comes to money printing.

************

It's actually not a joke-

http://bit.ly/L9EotK

Mon, 07/16/2012 - 15:40 | 2621342 Bartanist
Bartanist's picture

The Chinese are at a great advantage because they killed all of the intellectuals (Obama has not been able to yet, but give him time) .. but the Chinese did not eliminate the practicals and intuitives .. even though they were intelligent.

The Chinese just murdered all of the pompous-ass university professors and the think tank intellectuals.... give Obama time and he will too, JMHO. 

Mon, 07/16/2012 - 16:58 | 2621717 Buckaroo Banzai
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"give Obama time and he will too, JMHO"

Ha! we should be so lucky.

Mon, 07/16/2012 - 15:34 | 2621316 FinalCollapse
FinalCollapse's picture

Each Ponzi scheme requires some growth to keep it going. I guess that in China if the growth is below 8% then their Ponzi will collapse. 

The real numbers indicate that the electricity usage in China is declining. How can the economy grow while the electricity usage declines?

They keep the economy on lies...until the people start rioting.

 

 

Mon, 07/16/2012 - 15:56 | 2621401 tonyw
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Maybe their corruption is so great they need 8% to stand still.

Mon, 07/16/2012 - 15:36 | 2621320 Bartanist
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I just can't get over the fact that there are 30,000,000 Chinese men of marrying age who will never find a wife due to the 1 child policy and the aborting of females.

WTF do you do with 30,000,000 horny Chinese animal brains (youngsters) who may eventually want children and ceryainly want women. Do you say they are all "gay" or do you put them in the army and have then throw themselves against an undefeatable (or possibly NOT) foe?

Did I ever tell you that in the year 2000, I was told through a non-classified rumor (while I was working at a defense company) that there was a plan for the US to be at war with China in 2012? Well, heck, the timetable may have changed, but if Clinton was giving the Chinese stealth technology in the late 90s (which he was) and we are seemingly doing everything we can to bring the Chinese up to financial and military strength (so that the maximum number or human beings can be eliminated) does it not seem likely that the plan is to engage China militarily?

The real question is then: "who is all involved in this plan?". Is it only the western insiders or are the western insiders conspiring with the Chinese/eastern power ... and who exactly are "the powers"? 

Mon, 07/16/2012 - 16:03 | 2621436 Dumb Honkie
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@Bartanist, Hey dumb HONKIE mother fucker, all those horny Chinese guys will fuck a lot of HONKIE bitches starting with your mama, sisters, wife or girlfriend, LMAO!!!!!!!!

Mon, 07/16/2012 - 17:04 | 2621746 BigJim
BigJim's picture

Spot the Chinaman!

Hey, 'honkie' are you part of the AnAnonymous Bot legion?

Mon, 07/16/2012 - 17:11 | 2621766 Dumb Honkie
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Another stupid HONKIE shitbag with an iq of 69,LMAO!!!!!!

Mon, 07/16/2012 - 17:18 | 2621797 BigJim
BigJim's picture

'LMAO'? What's that, Mandarin for 'yes'?

Mon, 07/16/2012 - 17:29 | 2621811 Dumb Honkie
Dumb Honkie's picture

 Hey douchebag, that stands for the fact you like to suck big black dicks.

Mon, 07/16/2012 - 17:40 | 2621848 BigJim
BigJim's picture

Wow, what an impressively compact language!

You use 'lmao' a lot, so it's pretty obvious to all of us here, that sucking 'big black dicks' is something that clearly dominates your thinking.

Why is that? Are you a Chinese woman who dislikes the famously small penises of your countrymen?

Mon, 07/16/2012 - 17:50 | 2621910 Dumb Honkie
Dumb Honkie's picture

Hey shitbag, your ugly mama says she likes the humongous Yao Ming's dick over your 2 inch pea-sized cock.  You really are a motherfucker.LMAO!!!!!!

Mon, 07/16/2012 - 15:36 | 2621324 Bazinga
Bazinga's picture

China has been carefully divesting itself of US treasuries/dollars. Also, they have been buying hard assets (gold/mining companies/rare earths/real estate). They have displaced the dollar in international trade with a number of countries. China lives by a 10, 50, or even 100 year plan that they execute on unlike the 10, 50, 100 second plans of the US. Their plan is not to be dependent on any other country for their own economic survival.

They know they need to insulate themselves from the USD. When Uncle Sam sneezes, they are not going to catch the cold. They will be the last man standing during this crisis. Then they get to be the king for 100 years until the new king rises.

Mon, 07/16/2012 - 16:05 | 2621456 onebir
onebir's picture

"China lives by a 10, 50, or even 100 year plan that they execute on  "

That the people who are responsible are *seen* to execute on even if that involves faking statistics.

China is just as messed up and unsustainable as developed countries - it just got there faster & in different ways. (I wish it wasn't: for the most part I like the place, and the people.) And with so much existing poverty and lawlessness it's going to be much harder to control when TSHTF. 

Mon, 07/16/2012 - 17:11 | 2621767 BigJim
BigJim's picture

 China lives by a 10, 50, or even 100 year plan that they execute on

Frankly, I'd rather live in a country with a free market (not that we do, of course) where people could decide what investment horizons suited their needs, than a central-planning quagmire.

Remember Mao? Stalin? Hitler? Those guys had "10, 50, even 100(0)" year plans, too.

It's not the length of the plan that counts. It's the planners. And central planning fails, chiefly for the reasons Mises detailed - that when you destroy price discovery, you make rational economic calculation impossible.

Mon, 07/16/2012 - 15:37 | 2621330 Gringo Viejo
Gringo Viejo's picture

Bummer. Just bought a piece of the 3 gorges dam amusement park. Had high hopes for the "won ton barrel boat" rides through the spillways. Now...it's all turned to shit..........

Mon, 07/16/2012 - 16:48 | 2621672 Dumb Honkie
Dumb Honkie's picture

Hey stupid fucker,    only in your wet dreams.LMAO!!!!!

Mon, 07/16/2012 - 15:43 | 2621354 orangegeek
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Search "china's empty cities" on youtube.

 

http://www.youtube.com/watch?v=E9msCpYbyPs

 

This one is dated, but it's a good spin on what's happening there.

Mon, 07/16/2012 - 15:46 | 2621368 Sean7k
Sean7k's picture

Let me see, if I remember right, the OPEC nations were going to take over the world from all those oil profits. Then, Japan Inc was going to take over the whole enchilada. Now, it appears China will fade as well- I'm shocked I tell you, just shocked!

Fool me once, blame on you. Fool me twice...

Mon, 07/16/2012 - 16:32 | 2621377 Dr. Engali
Dr. Engali's picture

The Economist's cover story is about the" Comeback Kid Rebuilding America's Economy" last time they ran a cover story about it's time to invest in America was right before the collapse.

Mon, 07/16/2012 - 17:12 | 2621781 BigJim
BigJim's picture

Yeah, I saw that.

I didn't read it, But I'm assuming they see the eventual collapse of the dollar as being good for exports *snigger*

Mon, 07/16/2012 - 15:56 | 2621392 Bokkenrijder
Bokkenrijder's picture

The Chinese as a people love to copy everything, and they will also copy the fiat currency system.

The Chinese leadership also want to be able to control everything, so again, they will tend towards a fiat currency system.

And last but not least, the Chinese love to gamble, leading to all sorts of bubbles.

So forget about all this hype of China becoming the next super power and creating a gold standard!

When it comes to economics the Chinese are just as American as apple pie.

Mon, 07/16/2012 - 16:06 | 2621466 Dumb Honkie
Dumb Honkie's picture

I know one thing the U.S. will not be a superpower by the middle of this century because more than half the population will be hispanic and black.

Mon, 07/16/2012 - 16:03 | 2621444 Rockfish
Rockfish's picture

As always conclusions are arrived through personal bias and perspective. Based on western culture view point - capitalist system and individualistic ethos it is easy to bet on collapse of China.  

China with its culture and billion and half people resembles more like a aunt or bee colony.

The longer China is able to keep out the western religion of mindless consumption the better chance it has to be successful at the expense of the west.

Mon, 07/16/2012 - 16:08 | 2621469 lsbumblebee
lsbumblebee's picture

You see, from a pagoda, the world is so tidy.

http://www.youtube.com/watch?v=Uz_TI80pSfw

Mon, 07/16/2012 - 16:21 | 2621550 Rockfish
Rockfish's picture

No like the rest on ZH  I demand, vehemently demand the changes to a broken system but maintains my status quo.

Mon, 07/16/2012 - 16:09 | 2621477 Toolshed
Toolshed's picture

Stuff of nonsense.

Mon, 07/16/2012 - 16:08 | 2621473 onebir
onebir's picture

Overlong relabouring of an obvious point.

Mon, 07/16/2012 - 17:11 | 2621769 bankonzhongguo
bankonzhongguo's picture

People forget China "discovered" America before Columbus and said; "So what?"

The Chinese elite are mainly worried about the perception of chaos and hyperinflation on their watch.  Lord knows the Milner Group types have some grand scheme to break China into the wudai shigou. 

With 2 you get egg-roll.

Chinese political culture always destroys itself from the inside.  I would worry when i see the Mongols riding horseback into Poland, or at least a robot amphibious landing onto Japan.

 

 

Mon, 07/16/2012 - 17:47 | 2621898 negative rates
negative rates's picture

Come on now, the US grew at @8% for all decades execpt the 30's. Now we crow about not having a 4% growth but the recession is over. Don't trust todays stastics, thats the only thing from China we count on.

Mon, 07/16/2012 - 17:52 | 2621917 q99x2
q99x2's picture

For Cries sake they have a mass murderer on their currency. If that doesn't tell you something I don't know what will.

Mon, 07/16/2012 - 18:37 | 2622072 silverserfer
silverserfer's picture

only a ponzi scheme requires perpetual growth.

Tue, 07/17/2012 - 00:01 | 2623117 silverdragon
silverdragon's picture

Zarathustra,

 Bicycles and quoting Chinese govt statistics. Get a f*cking job, flip some burgers. What a steaming pile of nonesense.

 

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