Submitted by Dee Woo
In 1994, Management guru Peter Drucker told Japanese retail tycoon Isao Nakauchi that even though the Chinese market is very attractive, it still has more systemic risks than others and China will eventually face very serious inflation. And “the bubble is both much bigger and more extended than the bubble that burst in Japan a few years ago.”
This prophecy sounded very sensational back then when the Chinese miracle started taking off and the Japanese one went bust, but now its shocking precision has beckoned.“ 'Made in China’ has subsidized many countries’ economical living but not China’s itself. Today from Shanghai to Shenzhen, Many mainland Chinese harbor a passion for bulk shopping trip to Hong Kong to save their gyrating living cost. “buy soy sauce in Hong Kong” becomes a trendy slogan to many informed mainland urbanites. China’s GDP per capita is still 10 times less than Hong Kong’s, but its price level has surpassed Hong Kong’s in many areas. The underlining worry is the high inflation and hot money is always a hotbed of rampant speculative activities. The average Chinese consumer still has relatively low disposable income, which leaves little room to manage under the high inflation. Through China’s history, unbearable living cost is always the blasting fuse of severe social upheaval. That’s something the government fears the most.
For many years, to achieve fast economic growth, China has faithfully followed the loose monetary, fiscal and credit policies.The world’s factory has over-relied on export and investment to create GDP and jobs for way too long. According to Xinhua News agency, over the past ten years, China’s M2 money supply has increased by 450% and arrived at 2.6 times of its GDP in Sep 2010. In emerging markets, M2 usually is 1 to 1.5 times of the GDP and 2.6 times of that is unusual by any standards. China also has a habit of using colossal fiscal spending and overhead investment to push the economic growth when it’s slowing down, a classic example of which is central government’s 4 trillion Yuan stimulus package in 2008. Also to double guarantee the fast economic growth in an economic-crisis-stricken world, the central government uses policy tools to guide the banking system to issue more than 10 trillion Yuan of loans in 2009 and 8 trillion Yuan in 2010. Adding fuel to the fire, China’s ever bulging trade surplus will force M2 to leapfrog through Funds outstanding for foreign exchange(FOFE). According to General Administration of Customs, China’s trade surplus in 2009 is $196.07 billion, which means the central bank will be forced to issue 1.3 trillion Yuan of RMB through FOFE. Chased by too much liquidity, the price starts to skyrocket without much suspense.
Another reason for runaway inflation is that China’s pro-growth economic policy pays little attention to the quality of growth and that creates
serious capacity surplus and liquidity surplus. As a result the rate of return in the manufacturing sector will be severely comprised. To chase better profit, capital and resource will flee from manufacturing sector to speculative activities. Armed with such a pretext, Manufacturing giant Haier, Food giant COFCO, and electrical appliance retail giant Suning among many others have invested heavily on the biggest beneficiary of current economic-bubble---Property Market. According to the "Housing Green Paper" from Chinese Academy of Social Sciences (CASS) on Dec 8th 2010, the Gross margin percentage in property market in 2009 is 55.72% which far outstrips the performance in manufacturing and retail sectors. And these sectors will be even more undercut while cost-push inflation further eats away their already thin profit margin. Chasing the bubble and profiteering from it has become the norm. Right now the government’s rate hike among other tightening policies seems too little to late. Because even though the government is rolling back the credit line, the speculators can still seek finance from overseas channels, shadow banks and other alternative channels. They can employ proxy agents to circumvent government’s policy shackles.
Talking about speculation financing, we can’t avoid mutual funds and hedge funds. To understand the movement of international hot money, we must keep close tabs on them. Lately on many big occasions, Soros has expressed many sentiments of “Short America and Long China”, such as “China wields more power than the US.Today China has not only a more vigorous economy, but actually a better functioning government than the United States .” How come George Soros, the world famous anti-communist speculator, becomes the biggest cheerleader for Beijing Consensus all of sudden? If we decipher his praises heaped on China, we can tell he is very certain that China’s inflation and economic bubbles will grow so big that they will run out of the current policy scope of Beijing and force Beijing to employ the “nuclear weapon” they are so afraid to use so far: drastic RMB revaluation. He can profit from the Chinese asset speculation first and then win a windfall from “foreign exchange casino.” Will Beijing play into Soros’s hands? We won’t know for sure but the sure thing is George Soros opened his fund office in Hong Kong After many years of absence and many other funds followed into around the Great China region. The sharks are circling for the kill. Beijing Consensus says China’s financial market is much less open than Wall Street and hot money will have its work cut out while trying to get into China. Not so! With Shadow banking system and the channels applied by money laundering, hot money can circumvent Beijing’s Macro-regulation and Central bank’s radar. They will become invisible to central bank’s reserve pool. Yes, International money laundering has developed such a sophisticated network that not only the criminal proceeds can come and go as they pleased but also the hot money.
China's economic polices have long been self-indulgent. Beijing Consensus can buck the trend with much fiscal and monetary stimulation but there always gonna be a payback time. In April 2010 State-owned Assets Supervision and Administration Commission of the State Council ordered central enterprises to withdraw from property market. This just reveals how heavily the government and its state enterprises are involved in profiteering from fueling the property frenzy and economic bubble. Since the state is the policy maker and market maker at the same time, we shouldn't be too confident of China economy's soft landing. If China lost its current battle against the high inflation, a serious economic crisis will strike the middle kingdom around 5 years.
These are serious challenges Beijing’s now facing and seems to lack adequate policy tools to tackle. But there are some other profound challenges even more daring than all these:
After so many years of fast growth the bubbles are not only busting on the economic level but also on the Chinese mindset up from the corporation leaders to the average citizens. Recently Liu Chuanzhi, the Chairman of Lenovo and the iconic figure of Chinese manufacturing, faced a serious dilemma while asked why of Lenovo Group’s profit in 2009 60% came from asset investment and only 40% came from manufacturing. He said “when the typhoons come, even a pig can fly in the sky. Everybody is profiteering from this. Why can’t we?” The typhoons refers to the property frenzy and the easy ways to make money. The strategic marriage between Lenovo and China Oceanwide Holdings Group, a private investment firm heavily involved in the property market, can attest to that sentiment. That sentiment manifested in ordinary people’s logic is a common saying by many: “ buying house rather than saving; buying house rather than stock trading.” That sentiment is also manifested on many other levels: from inflated municipal officials' performance to the fate of a young Chinese man’s marriage. These mindset bubbles are impossible to regulate but will have profound implications on National economy, the fate of macro-regulation and the foundation of the government’s rule: what percentage do the vested interest groups account of the overall population? How firmly they will defend the regime against the alienated farmers depleted of lands by urbanization and the desperate marginalized ant tribe in the cities when the bubble bursts and crisis strikes.
Hedge funds and Fed’s QE2 are not all to blame for all these. The Chinese economy already stands close to the edge. What speculators do is to push it over and profiteer handsomely from the chaos. While the US enjoys the luxury provided by the dollar’s world currency status and diplomatic alliance with many major trade partners to export its liquidity and inflation, China enjoys none of that. They should look at the dollars in their hands with fear and doubt. So called Beijing consensus makes little sense, because the world is fast changing, pegging a country’s growth to a certain set of policy tools or a certain reserve currency(the US dollar) is equally dangerous. The battle between Keynes and Friedman has long proven the only consensus is to adapt and change. Right now China needs to adapt and change fast. Or this will be the best time in history to short China.