Is China A Paper Tiger?


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Is China A Paper Tiger?

  1. 1. Is China a Paper Tiger?
  2. 2. What Everyone Thinks They Know• NPR (8/19/2010): This week, China inched ahead of Japan, becoming the worlds second largest economy. It still lags behind the U.S., but probably not for long. Economists estimate that China will be the largest economy on Earth in perhaps as little as 20 years. Today, our Planet Money team asks: What will it be like for the U.S. to be number two?
  3. 3. What Everyone Thinks They Know• Agence France Press (7/8/2010): Chinas economy will overtake that of the United States by 2035 and be twice its size by midcentury, a study released Tuesday by a US research organization concluded. The report by economist Albert Keidel of the Carnegie Endowment for International Peace said Chinas rapid growth is driven by domestic demand more than exports, and will sustain high single-digit growth rates well into the 21st century.• "Chinas economic performance clearly is no flash in the pan," Keidel writes.
  4. 4. What Everyone Thinks They Know• New York Times (01/12/10): And here is the other thing to keep in mind. Think about all the hype, all the words, that have been written about China’s economic development since 1979. It’s a lot, right? What if I told you this: “It may be that we haven’t seen anything yet.”• Why do I say that? All the long-term investments that China has made over the last two decades are just blossoming and could really propel the Chinese economy into the 21st- century knowledge age, starting with its massive investment in infrastructure. Ten years ago, China had a lot bridges and roads to nowhere. Well, many of them are now connected. It is also on a crash program of building subways in major cities and high-speed trains to interconnect them. China also now has 400 million Internet users, and 200 million of them have broadband. Check into a motel in any major city and you’ll have broadband access. America has about 80 million broadband users.• Now take all this infrastructure and mix it together with 27 million students in technical colleges and universities — the most in the world. With just the normal distribution of brains, that’s going to bring a lot of brainpower to the market, or, as Bill Gates once said to me: “In China, when you’re one-in-a-million, there are 1,300 other people just like you.”
  5. 5. What Everyone Thinks They Know• China has destroyed American manufacturing and will continue to enjoy the fruits of cheap labor with permanent trade surpluses• The Chinese citizenry boasts an enormous personal savings rate which can be tapped to transform China into a consumption economy• China has massive foreign currency reserves which will allow them the ability to weather an economic hiccup
  6. 6. What Everyone Thinks They Know• The Chinese GDP growth rate, which has averaged three times that of the US over the past 30 years, will continue at a torrid pace• The Yuan is massively undervalued• China is the cornerstone of the new emerging market world order, dubbed the BRIC by Goldman Sachs’s Jim O’Neill
  7. 7. A Bipartisan Belief• Reuters (11/17/10): The United States should use all available tools, including labeling China a currency manipulator, to put pressure on Beijing to raise the value of its yuan, a U.S. watchdog panel said on Wednesday.• "Chinas deliberately undervalued (yuan) has unfairly conferred substantial economic advantages on China to the detriment of major trading partners, principally the United States and Europe," the U.S.-China Economic and Security Review Commission said in an annual report.
  8. 8. A Bipartisan Belief• Rueters (3/12/10): Senator Charles Schumer said on Friday he plans to move forward soon on legislation aimed at stopping China from "manipulating" its currency.• "Now more than ever, there is a consensus to finally confront Chinas currency manipulation," the New York Democrat said in a statement.• "It is the single biggest step we can take to promote U.S. job creation, particularly in the manufacturing sector. We plan to move forward with revamped legislation on this issue in the coming days," he said.
  9. 9. A Bipartisan Belief
  10. 10. What If The Consensus Is Wrong?• The 2000s represent fake growth for the Chinese• They funded our misbegotten adventure into subprime mortgages by holding massive amounts of Agency debt, the lifeblood of Fannie Mae and Freddie Mac• This led to a boom in prices and home equity which encouraged consumption of consumer goods, including a lot which came from China, above our means
  11. 11. What If The Consensus Is Wrong?• When Agency debt became worthless and Fannie Mae and Freddie Mac plunged into conservatorship the Chinese rushed from Agency debt, exchanging it for US Treasuries• This is just shuffling paper though. On December 24, 2009, the Treasury uncapped its support for Fannie and Freddie• The taxpayers, and our bondholders, are now on the hook for potentially unlimited losses at the GSEs• Agency debt is treasury debt as long as Congress refuses to act to resolve the problems at the GSEs
  12. 12. What If The Consensus Is Wrong?• It is official Chinese policy to reinflate the US bubble, much like our own Federal Reserve• These policies are failing as home prices continue to fall and real estate activity remain at or near record lows• Unemployment remains near postwar highs• Record numbers of Americans are on food stamps• When you need assistance for necessities, how much spending do you have for discretionary items?• Trade, read Chinese exports, remain well below 2007 levels
  13. 13. What If The Consensus Is Wrong?• Daily Mail (12/23/10): “China has said it is willing to bail out debt-ridden countries in the euro zone using its $2.7trillion overseas investment fund.• In a fresh humiliation for Europe, Foreign Ministry spokesman Jiang Yu said it was one of the most important areas for Chinas foreign exchange investments.• The country has already approached struggling European countries with financial aid, including offering to buy Greeces debt in October and promising to buy $4billion of Portuguese government debt.”• The solution for Europe, drowning in debt is more debt, to give the junkie a greater fix
  14. 14. What If The Consensus Is Wrong?• Chinese GDP growth is drastically overestimated.• From everybody’s favorite, Wikileaks: ▫ 4. (C) GDP figures are “man-made” and therefore unreliable, Li said. When evaluating Liaoning’s economy, he focuses on three figures: 1) electricity consumption, which was up 10 percent in Liaoning last year; 2) volume of rail cargo, which is fairly accurate because fees are charged for each unit of weight; and 3) amount of loans disbursed, which also tends to be accurate given the interest fees charged. By looking at these three figures, Li said he can measure with relative accuracy the speed of economic growth. All other figures, especially GDP statistics, are “for reference only,” he said smiling.
  15. 15. Gross Domestic Parody• Chinese GDP is computed based on recorded production activity ▫ Comparatively US GDP is based on end user consumption ▫ We know the formula as C+I+G+(X-M)• Activity is much easier to manipulate than consumption• This affects data in many ways
  16. 16. Gross Domestic Parody• We have no way of knowing how many goods produced are actually sold• Burgeoning inventories are considered economic expansion using Chinese data methods• China is a centrally planned economy with a central political body deciding on how much funding will be provided in any given year
  17. 17. Gross Domestic Parody• The Central Party forces loans onto the state and local party leaders• In terms of GDP calculations, “growth” is recorded when the funds are disbursed not when new infrastructure projects have actually begun• As I’m sure is becoming obvious, the Central Communist regime can make Chinese growth estimates a certainty through monetary policy
  18. 18. Gross Domestic Parody• In a global economy marred by a steep financial panic and a tepid recovery export driven growth has not been the driver of the Chinese economy in the past 24 months• Chinese growth has come solely through a massive expansion of credit• In 2009 and 2010 new bank lending was approximately 7.5 trillion Renminbi (over $1.1 trillion)• These figures are drastically higher than pre- Lehman numbers (really double anything we had seen previously)
  19. 19. Lots of New Loans• The question is how many of these loans are good loans and the answer is very few• China’s two largest customers are the European Union and the United States ▫ Europe is currently struggling to weather a sovereign debt crisis that could explode within months if Italy and Spain are forced to seek protection from the bond market (with Greece and Ireland already fallen and Portugal on the way this is a distinct possibility
  20. 20. Lots of New Loans• United States economists are actively slashing growth forecasts for 2011 ▫ The Federal Reserve now expects growth next year of 3% to 3.6% ▫ That is down from an initial forecast of 3.5% to 4.2% ▫ Blue Chip Economic Indicators survey expects growth of just 2.5% for 2011• When Chinese stimulus loans were made we were supposed to be in a rapid recovery by now (the much heralded V shaped recovery)
  21. 21. Life Under The Jack Boot• Will these loans be repaid?• First, lets look at how political, rather than market, economies create inefficiencies• In Soviet Russia, padding of official numbers was referred to as tukhta (or tufta depending on who you are talking to) ▫ This concept is explained in depth by Solzhenitsyn in the Gulag Archipelago
  22. 22. Life Under The Jack Boot• Five Year Plans were completed only on paper• Roofs were redone at a fraction of what was expected and material was so scarce that those which were redone had material which was stretched beyond measure• The “roof” had noticeable holes which exposed the rest of the building to the harsh Russian weather
  23. 23. Life Under The Jack Boot• Labor camps and canals always came in ahead of schedule, usually omitting large planning periods that were not officially included in the building schedule• Resources were allocated on political whims rather than by necessity• Theives and those of general dishonor were treated better and their behavior excused while the honorable and productive were forced to the bottom of the social structure
  24. 24. Life Under The Jack Boot• Law became an arbitrary concept• Cases were decided before trial ▫ You were not tried by your peers but by your superiors ▫ Evidence did not matter ▫ Many defendants admitted guilt in court even though they had committed no such offense ▫ They were sentenced to the hells of the Gulag or the firing squad for their loyalty
  25. 25. Life Under The Jack Boot• Since Tianneman, the Chinese government has maintained the traditions of Mao, dressed up elaborately in capitalist garb• Make no mistake, the hidden Gulag Archipelago remains• The “Black Marias” continue, every day and every night, to disappear those inconvenient to the State• The wreckers, “freedom men”
  26. 26. Life Under The Jack Boot• My name is Geng He (耿和) and I am the wife of political prisoner and lawyer Gao Zhisheng (高智晟), who is currently being persecuted in mainland China. On March 11 this year, I arrived in the United States with my son and daughter for political asylum. I write this letter to you in order to, first, express my gratitude towards the American government. At a time when our family was in danger, the American government’s humanitarian aid enabled my children and me to escape from brutal persecution. We are safe now, but my husband’s situation has become more perilous. Therefore, I entreat you to go a step further in helping our family by putting an end to the Chinese government’s persecution of my husband, lawyer Gao Zhisheng.
  27. 27. Life Under The Jack Boot• My husband is an honest lawyer. Due to his professional capabilities our family once had a good income and living standard. When my husband began taking part in rights defense cases in 2003, he clashed frequently with the corrupt and criminalized elements of the Chinese government at all levels. In 2004, he investigated and exposed the government’s actions against Falun Gong followers in the biggest political persecution case in mainland China and wrote letters to Chinese leaders three times requesting them to stop their attacks on Falun Gong. Though his actions did not violate China’s laws, but rather, upheld them, he was still continuously threatened by the government at all levels and his lawyer’s license was revoked. The problems he personally encountered made him realize that, without changing the political system of China, there would be no way to lawfully ensure the safety, interests, and dignity of citizens. Therefore, time and again, within the framework allowed by the Chinese Constitution and the law, he initiated peaceful citizen demonstrations and petitions to expose and protest the problems of corruption in government and tyrannical rule.
  28. 28. Life Under The Jack Boot• My husband’s righteous actions drew continuous and escalating abuse by the Chinese government. On August 15, 2006, they kidnapped my husband and formally arrested him on September 21. During this period, the authorities tormented him in all sorts of ways and even kidnapped, harassed, and tormented our children and me in order to break his will. On December 21, 2006, after having deprived my husband of the right to retain defense counsel, the authorities convicted and sentenced him.
  29. 29. Life Under The Jack Boot• Soon afterwards, my husband revealed these problems to the international community. The authorities were infuriated. They kidnapped and tormented him many times. On the night of September 21, 2007, my husband, with a black hood thrown over his head, was kidnapped and brought to an unknown location. For 59 days, many people tortured and ravaged him in all kinds of ways, including beating him with an electric prod, inserting bamboo sticks into his reproductive organs, holding lit cigarettes close to his eyes and nose, etc., so that his eyes would burn and he would be forced to inhale smoke. My husband told me later that he was in such unbearable pain at the time that his sweat, blood, and other bodily fluids covered the floor. Among the reasons the authorities gave for tormenting my husband was that he had written to the United States Congress.
  30. 30. Life Under The Jack Boot• Because we could no longer endure the Chinese government’s thuggish and barbaric harassment and persecution, on January 9, 2009, I took my children on the treacherous journey of escaping China. On February 4, my husband disappeared again from his hometown in Shaanxi and has not been heard from since. I have no doubt that this kidnapping was the Chinese government’s retaliation for our escape. In view of his horrific experiences in the past, I’m extremely worried about my husband’s safety.
  31. 31. Life Under The Jack Boot• Honorable members of the U.S. Congress, as a wife I am terribly distressed and doubt our decision to leave China. Though I had been mentally prepared to face adversities alongside my husband, our children, ages 16 and five, have already been unable to go to school due to the kidnapping, intimidation, and beatings by the authorities. My daughter even ran away from home. Our relatives and friends are worried that she will become mentally disturbed from her fear. If we had not left that horrific country, their whole lives would have been ruined. However, that my husband was prepared to be tortured for the sake of our escape is like a knife in my heart. My children ask me every day, where’s dad? I’m alone and isolated here and can only appeal to you to pressure the Chinese government to stop persecuting my husband and tell the world his whereabouts and condition.
  32. 32. Fraud• The root evils of the system still remain• With export growth tabled, the credit surge mandated by China’s central party is running into speculation and outright fraud
  33. 33. Fraud• Muddy Waters LLC has initiated coverage on RINO International Corp. (RINO) with a Strong Sell rating and a $2.45 price target.• RINO claims to be the leader in selling desulfurization (“FGD”) and other environmental equipment to Chinese steel mills. It reported 2009 revenue of $193 million. In reality its revenue is under $15 million, and its management has diverted tens of millions of dollars for its own use. We value RINO based on the cash we believe remains in the company after the most recent raise.
  34. 34. Fraud
  35. 35. Fraud• Hedge fund manager John Paulson is most famous for betting against subprime mortgages by being long synthetically engineered CDOs.• He hand picked mortgage pools he thought would go bust and used investment banks to create instruments whose payoffs mirrored those mortgages and marketed those investments to other banks (this made national news in the Goldman Sachs hearings on Abacus and Timberwolf).• The largest loss his fund has ever incurred is happening today.
  36. 36. Fraud• Paulson was the premier investor in Sino-Forest• The company is a Chinese timber producer and has been exposed as nothing but paper• The company claimed to had purchased a sizeable portion of land outside Lincang City in the Yunnan Province.• This purchase never happened, the records verified by the city itself• It’s profits, as reported, and audited, are impossible because those profits are based on timber production that isn’t happening on land it doesn’t own.• Sino-Forest is traded on the Toronto exchange.
  37. 37. Fraud• There are only approximately 3,000 companies which list on the New York Stock Exchange• The NYSE holds itself up as the premier stock exchange in the world with rigorous listing standards• Less than 100 of those companies come from Asia, with just a fraction coming from China
  38. 38. Fraud• A fraction of one percent of the companies listed on the NYSE are Chinese. These companies are supposed to be the best companies in that country.• And several of those companies (RINO, CCME, etc.) have just been nailed as a fraudulent ponzi scheme whose internal financials were so poor that a two man research outfit could issue a report so damning that the stock price has plummeted over 50% in less than a month• No one is even appearing to do due diligence on China anymore• Much like the subprime boom in the US, no one cares until it all blows up
  39. 39. Boom Times• “China’s November car sales hit a one-month record. Total cars and light vehicles shipped to dealers reached 1.34 million, up 29% from the same month last year. Sales for the first eleven months of the year were 12.45 million, up 35%.”• Car sales in China have now outstripped the US for three straight years, despite an economy that is a fourth of the size• Many sales are done with extravagant government incentives• This is similar to mid-decade US auto sales based on 0% financing and “employee pricing”
  40. 40. Hookers In Macau• The latest report from PricewaterhouseCoopers LLP (PwC) on Casino Gaming estimates that revenues in Macau will grow at a compound annual growth rate (CAGR) of 24.7 percent, reaching USD 45.1 billion (MOP 360 billion) in 2014. PwC’s outlook for the global casino market forecasts that Asia’s and Australia’s fast-growing gaming industries will account for nearly as much of the world market as the United States in four-years time.
  41. 41. Hookers in Macau• No city in America benefitted more from the subprime debt boom than Las Vegas, Nevada• In fact, the largest annual convention for the subprime industry took place in Las Vegas• Ask Steve Eisman about casino girls who owned 5 homes and stories of tables being three deep• Easy money goes hand in hand with gambling
  42. 42. Hookers in Macau• Las Vegas Sands Macau revenue for Q3 of 2010: ▫ $1,097,750,000• Compared to 2009: ▫ $850,055,000• 30% growth YoY in revenues and a 125% growth in net income• Las Vegas, NV properties accounted for just $290,600,000
  43. 43. Hookers in Macau 3Q Revenue (In Thousands)$1,200,000$1,000,000 $800,000 $600,000 3Q Revenue (In Thousands) $400,000 $200,000 $0 2005 2006 2007 2008 2009 2010
  44. 44. Hookers in Macau• “Throngs swarmed the gaming hall, lining tables two to three deep. Near riots greeted the opening of a series of other new casinos in this gambling- crazed city.”• “Sands doles them out free to high- rollers, mainly new-moneyed Chinese driving Macau’s renaissance.”
  45. 45. Boom Times
  46. 46. Boom Times The empty city of Ordos during morning rush hour. Ordos has the second highest per capita income in the country, behind Shanghai and ahead of Beijing. Hardly anyone lives there…
  47. 47. Boom Times• New development projects in the interior of China are accelerating• The Communist government wants to crack down on migration of youth to the cities of Shanghai, Hong Kong and Beijing• They must create jobs for the youth in the backwards west• Those jobs are in construction. Building cities, apartments, and factories which serve no purpose• China must create 25 million jobs a year or risk civil unrest, the price of totalitarianism
  48. 48. Boom Times• According to Pivot Capital: ▫ Excess cement capacity is greater than the combined consumption of the US, Japan and India! ▫ Idle Chinese steel factories total more than the total steel production of Japan and South Korea
  49. 49. Boom Times• “One clear clue (regarding the rising real estate prices in China) is that the average price-to-income ratio in Beijing has reached 27:1, five times the world average, according to data from the Bureau of Statistics of the Beijing Municipality. In addition, the average price-to-rent ratio neared 500:1 in the city, far above the international alarm threshold of 300:1, which sends out a clear signal that the foundation of the real estate boom is losing stability.”• Shanghai, Shenzen, Beijing, Guazhong (see slide 26)…• Southern California, Florida, Arizona, Las Vegas…
  50. 50. Boom Times• Massive amounts of third mortgages, given with low interest rates and little down payments• Sound familiar?• To keep the bubble blowing, the government has to continue to press hard on the gas
  51. 51. Atlas Shrugged• Imagine standing with your arms outstretched and a weight in each hand• It starts out as being easy but eventually becomes excruciatingly painful• The hand weights now feel like stones• Your arms burn as lactic acid builds up quickly
  52. 52. Atlas Shrugged• Adrenaline pumps through your system• To drop the weights, all that is necessary is for your arms to give ground• Once they begin to drop, only supports can stop the free fall• What looked like calm, stability, strength has disappeared in an instant
  53. 53. Atlas Shrugged• What happens on an economy wide scale?• Assets become liabilities, factories idle, money dries up. The boom goes bust. All that is left is the pain.• Borrowing rates skyrocket• The currency collapses as money flees• In a speculative boom, the catalyst for economic destruction is simply a drop in the growth rate• In statistical terms, reversion to the mean• Romans designed executions around the crucifixition• In short, gravity always wins
  54. 54. Currency Devaluation• China has pegged the Yuan to the Dollar for many years• It attempted to placate critics by instituting a floating rate policy recently but this new policy is more lip service than actual substance• Many believe that this peg has caused the Yuan to be severely undervalued to what it would trade at if there was a free market price allowed
  55. 55. Currency Devaluation• Rarely has this been the case over history though• Pegged currency, stability lull markets into a false sense of security, causes the market to overlook threats• Pegged currencies tend to exhibit sharp devaluations during crises• This has happened recently in Asia
  56. 56. Currency Devaluation• In 1997, the world caught Asian Flu ▫ Thailand ▫ South Korea ▫ Indonesia ▫ Malaysia ▫ Philipines• All pegged to the US Dollar
  57. 57. Causes• Easy money creates inflation• CPI is officially up to 5.1%• Property prices are up around 10% YoY, much higher in certain areas• Food inflation is near 7.5% YoY• Michael Pettis has estimated CPI at over 7%
  58. 58. Causes• Copper, cotton, silver prices are skyrocketing• Oil is at $93 a barrel• Costs are exploding• This is disastrous for the Chinese people, many still live in poverty (per capita GDP is 102nd in the world)• It also hurts Chinese factories; textiles, toys, many of the factories which we associate with China have margins of 5% or less
  59. 59. Causes• China so far has taken only half measures to corral these price shocks• The required reserve ratio has been raised three times• This policy doesn’t even combat the effects of the Federal Reserve’s quantitative easing policy let alone counteract the effects of China’s stimulus policies
  60. 60. Causes• The true answer to China’s inflation woes would be to curtail new bank lending• This cannot happen though because it would deprive the asset bubble fire the oxygen it needs to keep burning• In a country that rules over its citizens, severe inflation would be enough to change government policy• Nothing scares Beijing more than an unhappy populous
  61. 61. Causes• Many talk about an exploding Chinese middle class and a new consumer culture on the rise• We hear about China carrying the world economy going forward• Missing from this analysis is any mention of demographics and the effects of government policy on the aging of the Chinese population
  62. 62. Causes• The One Child Policy has been in force since 1978• It is estimated that a woman is forced to have an abortion under the law every 2.4 seconds• That amounts to 35,000 a day• New York City is aborted in nine months• Overall, it is estimated that 400 million children have been killed since the policy’s inception
  63. 63. Causes• There are other effects besides the staggering loss of life• Boys are preferred over girls. Many first children are killed if they are daughters• This has led to a gender inbalance within Chinese society further deteriorating the birth rate within the country• What does this mean for the domestic marketplace?
  64. 64. Causes• It will shrink drastically• The working age population will begin to decrease within the next few years• China has no social security program• The burden of caring for the elderly falls to the children• We are seeing a classic pyramid trap occurring
  65. 65. Causes• Two parents care for four parents• At any one time we can expect only two Chinese workers to be responsible for one retired pensioner• That is worse than the ratio in the United States• The fiscal responsibilities for carrying on our entitlement programs has caused the release of the Simpson-Bowles recommendations
  66. 66. Causes• We are also seeing the fiscal effects that result from demographic changes in Europe and Japan• These countries are rightfully identified as slow growth nations• Big government is crashing, retirement ages are being raised and benefits cut• Yet the largest government is viewed as immune to this trend?• Why?
  67. 67. The False Comfort of Foreign CurrencyReserves• Many cite the huge foreign currency reserves that China possesses• At $2.7 trillion it is approximately 100% of their economy• The last time countries boasted similar trade surpluses was Japan in 1989 and the United States in 1929, immediately preceding massive crashes
  68. 68. The False Comfort of Foreign CurrencyReserves• From 1929 to 1933 the Dow Jones would lose 90% of its value• The Nikkei average today is currently around 10,500• It was at 38,000 in 1989, a 75% decline in value over two decades• In real terms it is approximately 12% of its 1989 value• Creditor nations are hurt excessively during global slowdowns
  69. 69. In Conclusion• Adam Smith wrote about China:• “China has been long one of the richest, that is, one of the most fertile, best cultivated, most industrious, and most populous countries in the world. It seems, however, to have been long stationary. Marco Polo, who visited it more than five hundred years ago, describes its cultivation, industry and populousness, almost in the same terms in which they are described by travellers in the present times.
  70. 70. In Conclusion• All travellers agree with the low wages of labour, and in the difficulty which a labourer finds in bringing up a family in China. If by digging the ground a whole day he can get what will purchase a small quantity of rice in the evening, he is contented.• The poverty of the lower ranks of people in China far surpasses that of the most beggarly nations in Europe.
  71. 71. In Conclusion• Any carrion, the carcass of a dead dog or cat, for example, though half putrid and stinking, is as welcome to them as the most wholesome food to the people of other countries• Marriage is encouraged in China, not by the profitableness of children, but by the liberty of destroying them. In all great towns several are every night exposed in the street, or drowned like puppies in the water”• This was written in 1776. It could easily be written today…