Contrarian Investor Sees Economic Crash in China

[ray245]

James S. Chanos built one of the largest fortunes on Wall Street by foreseeing the collapse of Enron and other highflying companies whose stories were too good to be true.

Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China's hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like "Dubai times 1,000 -- or worse," he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

"Bubbles are best identified by credit excesses, not valuation excesses," he said in a recent appearance on CNBC. "And there's no bigger credit excess than in China." He is planning a speech later this month at the University of Oxford to drive home his point.

As America's pre-eminent short-seller -- he bets big money that companies' strategies will fail -- Mr. Chanos's narrative runs counter to the prevailing wisdom on China. Most economists and governments expect Chinese growth momentum to continue this year, buoyed by what remains of a $586 billion government stimulus program that began last year, meant to lift exports and consumption among Chinese consumers.

Still, betting against China will not be easy. Because foreigners are restricted from investing in stocks listed inside China, Mr. Chanos has said he is searching for other ways to make his bets, including focusing on construction- and infrastructure-related companies that sell cement, coal, steel and iron ore.

Mr. Chanos, 51, whose hedge fund, Kynikos Associates, based in New York, has $6 billion under management, is hardly the only skeptic on China. But he is certainly the most prominent and vocal.

For all his record of prescience -- in addition to predicting Enron's demise, he also spotted the looming problems of Tyco International, the Boston Market restaurant chain and, more recently, home builders and some of the world's biggest banks -- his detractors say that he knows little or nothing about China or its economy and that his bearish calls should be ignored.

"I find it interesting that people who couldn't spell China 10 years ago are now experts on China," said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. "China is not in a bubble."

Colleagues acknowledge that Mr. Chanos began studying China's economy in earnest only last summer and sent out e-mail messages seeking expert opinion.

But he is tagging along with the bears, who see mounting evidence that China's stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans.

"In China, he seems to see the excesses, to the third and fourth power, that he's been tilting against all these decades," said Jim Grant, a longtime friend and the editor of Grant's Interest Rate Observer, who is also bearish on China. "He homes in on the excesses of the markets and profits from them. That's been his stock and trade."

Mr. Chanos declined to be interviewed, citing his continuing research on China. But he has already been spreading the view that the China miracle is blinding investors to the risk that the country is producing far too much.

"The Chinese," he warned in an interview in November with Politico.com, "are in danger of producing huge quantities of goods and products that they will be unable to sell."

In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

In recent months, a growing number of analysts, and some Chinese officials, have also warned that asset bubbles might emerge in China.

The nation's huge stimulus program and record bank lending, estimated to have doubled last year from 2008, pumped billions of dollars into the economy, reigniting growth.

But many analysts now say that money, along with huge foreign inflows of "speculative capital," has been funneled into the stock and real estate markets.

A result, they say, has been soaring prices and a resumption of the building boom that was under way in early 2008 -- one that Mr. Chanos and others have called wasteful and overdone.

"It's going to be a bust," said Gordon G. Chang, whose book, "The Coming Collapse of China" (Random House), warned in 2001 of such a crash.

Friends and colleagues say Mr. Chanos is comfortable betting against the crowd -- even if that crowd includes the likes of Warren E. Buffett and Wilbur L. Ross Jr., two other towering figures of the investment world.

A contrarian by nature, Mr. Chanos researches companies, pores over public filings to sift out clues to fraud and deceptive accounting, and then decides whether a stock is overvalued and ready for a fall. He has a staff of 26 in the firm's offices in New York and London, searching for other China-related information.

"His record is impressive," said Byron R. Wien, vice chairman of Blackstone Advisory Services. "He's no fly-by-night charlatan. And I'm bullish on China."

Mr. Chanos grew up in Milwaukee, one of three sons born to the owners of a chain of dry cleaners. At Yale, he was a pre-med student before switching to economics because of what he described as a passionate interest in the way markets operate.

His guiding philosophy was discovered in a book called "The Contrarian Investor," according to an account of his life in "The Smartest Guys in the Room," a book that chronicled Enron's rise and downfall.

After college, he went to Wall Street, where he worked at a series of brokerage houses before starting his own firm in 1985, out of what he later said was frustration with the way Wall Street brokers promoted stocks.

At Kynikos Associates, he created a firm focused on betting on falling stock prices. His theories are summed up in testimony he gave to the House Committee on Energy and Commerce in 2002, after the Enron debacle. His firm, he said, looks for companies that appear to have overstated earnings, like Enron; were victims of a flawed business plan, like many Internet firms; or have been engaged in "outright fraud."

That short-sellers are held in low regard by some on Wall Street, as well as Main Street, has long troubled him.

Short-sellers were blamed for intensifying market sell-offs in the fall 2008, before the practice was temporarily banned. Regulators are now trying to decide whether to restrict the practice.

Mr. Chanos often responds to critics of short-selling by pointing to the critical role they played in identifying problems at Enron, Boston Market and other "financial disasters" over the years.

"They are often the ones wearing the white hats when it comes to looking for and identifying the bad guys," he has said.

NYT

[J]

The short version is he's right. China is in deep trouble unless their export markets start consuming their lead tainted toys and other manufactured goods again, and fast. This of course isn't going to happen anytime soon since we have a massive debt overhang problem in the first world and we can't charge up our creditcards anymore to buy their crap. China does not have the internal wealth to soak up their industrial production, nor can they create this wealth in time to save their factories.

In the real estate sector, the housing price to yearly income ratio has blown to well over 10:1 in many cities, this is completely unsustainable on any long term basis, anything over 3.5:1 is a bit sketchy and 5:1 and above is bubble-licious. They can play games and goose the markets for a while, but eventually the money runs out bringing the game to an end.

Oh. And this. Empty buildings everywhere, like Dubai, but many times worse. This is not going to end well, on the bright side there's plenty of square footage for homeless shelters.

[K. A. Pital]

The bottom line is that China has industry, and that industry is effectively the property of China - China's legal system only allows for the lease of industrial property. Industrial economies can have major financial tremors but in the end, China has some mechanisms to deal with it that private systems do not. Namely, it can take whatever industrial plants it needs, arrest funds or goods and overall re-direct capital flows on the order of the government from the export sector to the internal consumption. Now, that's what they have been doing now.

And where is the so-awaited "bust"?

As for the claims that China would suddenly become "bad" for investment, how so? The Chinese have actually taken major steps to ease the legalese associated with opening a body corporate in China or a representative outlet thereof (which I know first hand, I'm looking at Chinese industrial development very closely because I do plan on moving to China eventually, for good).

Comparing an industrial economy to Dubai is fucking preposterous, I wish people weren't that dumb. Dubai is a one-night wonder, an oligarchic super-city which has no industry outside the "financial" industry. Of course the financial collapse threatens a huge place built in the middle of a fucking desert with no other industries to support itself.

China on the other hand is a huge industrial nation of over a billion men. The two are not even remotely comparable, no matter how hard one can spin it.

[Alyrium Denryle]

The bottom line is that China has industry, and that industry is effectively the property of China - China's legal system only allows for the lease of industrial property. Industrial economies can have major financial tremors but in the end, China has some mechanisms to deal with it that private systems do not. Namely, it can take whatever industrial plants it needs, arrest funds or goods and overall re-direct capital flows on the order of the government from the export sector to the internal consumption. Now, that's what they have been doing now.

And where is the so-awaited "bust"?

As for the claims that China would suddenly become "bad" for investment, how so? The Chinese have actually taken major steps to ease the legalese associated with opening a body corporate in China or a representative outlet thereof (which I know first hand, I'm looking at Chinese industrial development very closely because I do plan on moving to China eventually, for good).

Comparing an industrial economy to Dubai is fucking preposterous, I wish people weren't that dumb. Dubai is a one-night wonder, an oligarchic super-city which has no industry outside the "financial" industry. Of course the financial collapse threatens a huge place built in the middle of a fucking desert with no other industries to support itself.

China on the other hand is a huge industrial nation of over a billion men. The two are not even remotely comparable, no matter how hard one can spin it.

The bust wont be economic (not at first). It will be demographic. I have not run the math so I dont know when it will be exactly, but china has a demoghraphic problem. First off it has a huge population... but thanks to the one child policy (which has not been in place long enough for the lag time to catch up) the population is not replacing itself, and the sex ratio is male biased for cultural reasons.

This will lead to an inverted age structure and a population (and economic) collapse as those that are working are supporting an older and older non-working or less productive population. It is a problem when logistic curves are used to project population growth when you DONT have a stable age structure and a biased sex ratio.

[J]

The problem is at this point in time and for the near future they do not have and cannot create the internal consumption to soak up the goods they're producing. China relies on the income from their exports to modernize their economy and build a population which is capable of consuming enough of their goods production to keep their factories open without being overly reliant on the US buying all their stuff. They're working desperately to get there but they're still a fair ways off, it's a process which is measured more in decades than years.

Even without the current global recession it's a tight race for them, can they modernize and build enough of a consumer base before energy resource depletion sends prices through the roof, hampering their efforts. Will they have the water & farming resources to feed their population and meet their industrial needs? I wouldn't say it's impossible, but they had a very difficult challenge ahead of them, now that their export markets are collapsing it becomes even harder for them to make the transition to a modern 1st world economy.

[ray245]

The bottom line is that China has industry, and that industry is effectively the property of China - China's legal system only allows for the lease of industrial property. Industrial economies can have major financial tremors but in the end, China has some mechanisms to deal with it that private systems do not. Namely, it can take whatever industrial plants it needs, arrest funds or goods and overall re-direct capital flows on the order of the government from the export sector to the internal consumption. Now, that's what they have been doing now.

And where is the so-awaited "bust"?

As for the claims that China would suddenly become "bad" for investment, how so? The Chinese have actually taken major steps to ease the legalese associated with opening a body corporate in China or a representative outlet thereof (which I know first hand, I'm looking at Chinese industrial development very closely because I do plan on moving to China eventually, for good).

Comparing an industrial economy to Dubai is fucking preposterous, I wish people weren't that dumb. Dubai is a one-night wonder, an oligarchic super-city which has no industry outside the "financial" industry. Of course the financial collapse threatens a huge place built in the middle of a fucking desert with no other industries to support itself.

China on the other hand is a huge industrial nation of over a billion men. The two are not even remotely comparable, no matter how hard one can spin it.

The bust wont be economic (not at first). It will be demographic. I have not run the math so I dont know when it will be exactly, but china has a demoghraphic problem. First off it has a huge population... but thanks to the one child policy (which has not been in place long enough for the lag time to catch up) the population is not replacing itself, and the sex ratio is male biased for cultural reasons.

This will lead to an inverted age structure and a population (and economic) collapse as those that are working are supporting an older and older non-working or less productive population. It is a problem when logistic curves are used to project population growth when you DONT have a stable age structure and a biased sex ratio.

Just a side note, do anyone knows what's the retirement age for China?

[K. A. Pital]

Predicting demographic implosions, explosions and similar events is extremely hard. The demographic trends can be reversed or changed by rapid industrialization, as so often seen in olden times. Yes, China missed the 1930s as the optimal "second world industrialization" timeframe, but it certainly does it's best in catching up.

Oh, and:

The first surprise was the stable job market. I predicted that labour market conditions would deteriorate sharply, as job creation from the capital-intensive infrastructure projects would not be sufficient to compensate for the job losses in the labour-intensive export sector. But job markets remained stable during the economic downturn. The country even experienced widespread shortage of migrant workers. It turned out that construction of capital-intensive projects is actually very labour intensive.

Five predictions for Chinese economy in 2010
This is rather interesting. It shows that the Chinese government has a large sway over both capital and labour. Moreover, I must agree with the guy that the sway of the government over capitals, and most crucially industrial capitals, has actually increased.

The problem is at this point in time and for the near future they do not have and cannot create the internal consumption to soak up the goods they're producing ... They're working desperately to get there but they're still a fair ways off, it's a process which is measured more in decades than years.

They are far closer to that now than they were 10 years ago. Ergo, they are in better shape in the current crisis than they would have been before, and their export-dependency is lowering, not rising.

I wouldn't say it's impossible, but they had a very difficult challenge ahead of them, now that their export markets are collapsing it becomes even harder for them to make the transition to a modern 1st world economy.

See, the "First World economy" is not the only possible way to have a decent living. Having a stable Second World income but First World life indicators like healthcare, social services, etc (like the Kerala model) is actually a way to make things decent for China in the coming 30-40 decades (till 2040-2050).

I would actually even say that shall the situation get dire, China can marshall labour armies to labour-intensive projects (they always keep erecting new feats of massive engineering like dams and the like) and keep these labour armies at least well-fed. A Western state with private capitals and enormous amount of various legal norms protecting the occupation of it's citizens and overall the structure of it's economy would not be able to do that.

I must also remind people that India faces the same economic problems as China, also compounded by extreme poverty and diseases - ills that China has curbed with enormous efforts during the six decades of 1950-2010.

An industrialized nation can always stop and conserve capital (the machinery and plants) in the very worst of situations until domestic demand picks up - it can be a fair while and lead to enormous losses of industry, but it is still preferrable to the state some nations find themsleves in after losing foreign investment. A nation that has no industry will fail as soon as foreign trade/tourism/financial bubbles keeping it alive cease to exist.

[Lusankya]

Retirement age for China is 55. So there's a lot of leeway there if they want to increase it.

And the fertility rate in China is 1.7 children/woman. Low, but I don't think it's quite as low as people make it out to be.

China could also increase domestic consumption quite quickly be reforming the healthcare system. At the moment, there are plenty of infrastructural and coverage issues, especially in rural areas, and that is being changed, but the biggest issue from an economic perspective is that while the current system is quite good for minor health issues and regular care, it doesn't provide enough support for major illnesses. As a result, most Chinese families being not American sensible put a lot of money away for use in the case of a medical emergency. If they can find a way to get this money to go into consumption, it will be a massive boost for the economy. The CCP is aware of this, and they are trying out some healthcare reform in order to fix it (though at this stage the focus is mainly on the infrastructural aspect). The biggest problem with implementation, I think, is that they will need to provide a strong incentive to overcome the cultural bias against GPs as well as making treatment for major illnesses readily available, which will be difficult to implement concurrently.

As for the gender imbalance, if it becomes to much of a source of social unrest, China can just start importing women from the Philippines, just like everyone else (sorry Shroomy).

[Alyrium Denryle]

And the fertility rate in China is 1.7 children/woman. Low, but I don't think it's quite as low as people make it out to be.

way the fuck below replacement, and they would need to import a LOT of women. It is not viable.

[Lusankya]

Is having 1.3 billion people there long-term viable either?

[Alyrium Denryle]

Is having 1.3 billion people there long-term viable either?

No. I welcome a demographic collapse for the sake of the world.

[Lusankya]

Is having 1.3 billion people there long-term viable either?

No. I welcome a demographic collapse for the sake of the world.

Well there we go.

In any case, the Chinese lifestyle is less resource-intensive than the western lifestyle, so I don't think that having a demographic collapse will be quite as bad for China as it would be in the west. And with a current retirement age of 55, China has a lot of leeway when it comes to keeping people in the workplace for longer.

[Lord of the Abyss]

As for the gender imbalance, if it becomes to much of a source of social unrest, China can just start importing women from the Philippines, just like everyone else (sorry Shroomy).

The way I've heard it put elsewhere, is that women don't want to go to China, and Chinese men don't want foreign brides anyway.

[Lusankya]

Most Chinese men probably don't want a wife of a higher status than they are, which is an issue with western women moving to China, but would not be one with the Philippines.

[K. A. Pital]

I would also like to add that the current projections have the Chinese economy being around 8,2 trillion (nominal) by 2014, implying a growth of 74% over half-decade. That growth applied to the GDP by PPP, by which account China already is second with a ~7,9 trillion GDP, means that China's GDP by PPP will rise to ~14 trillion.

At the same time, the US economy is 14,2 trillion by PPP now and will be 17,5 trillion by PPP by 2014 (US PPP figures reflect nominals because there is little disparity vs/ income-price disbalance) with modest growth.

China is projected to have a 1,4 trillion population in c.2015, whereas US will be c.320 million, a difference of 4,4 times.

That is not bad at all. China will have a GDP per capita around 5 times lower that that of the USA; considering the horrific overconsumption in America, even a fourth or fifth fraction of that GDP per person is enough to have a very decent Second World life standard.

One shoud also consider that once Chinese economy reaches rough parity in size with the US one (by PPP, of course), it would be huge enough to withstand drastic pressures simply due to the size of it; infrastructure projects could be initiated, so massive that they would employ Chinese labour for quite a while, and unlike the US, China's large engineering projects face fewer obstacles and can be implemented more rapidly thanks to their state's sway over capitals.

China really holds huge sway over industry too, which means that even if the private funding collapses, that would mean a collapse of services industry, but not the underlying heavy industry. Light industry collapse would be an economic disaster for China, but somehow I think cheap goods will always find demand, especially in a crisis.

By my own memories, Chinese light industry had a huge upsurge during the economic crsisis in Russia because people aimed for VERY cheap cloth. And the greater the crisis in the outside world, the more demand will be shifting ot low-cost items.

[Ypoknons]

Most Chinese men probably don't want a wife of a higher status than they are, which is an issue with western women moving to China, but would not be one with the Philippines.

Status would not be an issue, racism is. In Hong Kong, Filipinos, especially maids, are a significant part of the population and Filipino-Chinese marriage is almost unheard of. Caucasian-Filipino marriages are common, but not Filipino-Chinese.

[Lusankya]

I'm not sure if you can separate the status issue from the racial one there, though. My understanding is that most people in China want someone with the same social status as their family (with men willing to look lower down and women looking a bit higher up, but still roughly equal). Is it necessarily because they are Filipino, or is it because they are low-status Filipinos?

[ray245]

I thought that most of the brides are usually vietnamese? There's less of a social stigma in regards to marrying a vietnamese, even in Hong Kong and Taiwan. Additionally, I don't recall mainland China employing filipino as maids.

[mr friendly guy]

Just a few thoughts, maybe someone more knowledgeable can answer me.

1. Doesn't every year (with the exception of the GFC ) Chinese workers from rural areas (ie most of the population) go looking for work in the cities. I believe this trend is starting to reverse back, ie when the GFC occurred workers went back to the rural areas but now that things are picking up, they are desperately trying to get them back into the cities.

In which case isn't there an underutilised population? In which case predicting demographic changes leading to economic collapse would require taking that into account?

2. How industrialise overall is China. For example IIRC a lot of farming is not highly mechanised?

If some facilities aren't mechanised, can't they compensate for the decrease workforce (when it occurs) with increase efficiency by mechanisation?

3. How are other countries who already have aging populations dealing with the fallout, namely Japan and as Rumsfeld dubbed "old Europe"?

If they have some effect at ameliorating the effects, can't China just copy what they have done. If its one good thing they have shown, its that they are very good and copying things.

[K. A. Pital]

If they have some effect at ameliorating the effects, can't China just copy what they have done.

I don't think so, unless China finds a huge Third World region that will become a cheap source of goods for it's internal market, and will make goods cheaper which would allow to inflate the life level in China.

Basically what the First World did to achieve the very peak of it's life level is exploit of the wage/ life level difference between the First, Second and Third World; were all paid at roughly equal rates, the price of goods created by these nations for the First World would have been as high as indigenously made goods, offering no benefit. In that case the life level would start to hit sort of a ceiling because the buying ability of the First World people would stall.

That would require a more or less equally industrialized egalitarian world to happen, but it serves to illustrate one point - China can mostly count on itself when it comes to consumption. I.e. China will have to produce most of the shit to feed, supply, and entertain it's citizens, as well as push forward science and the like, on it's own. Now, that is not bad, but it means China will not reach the life level of the First World, bar a miracle happens and throws another China right next to it which the first China would use as a cheap labour pool.

Actually China produces a fair modicum of everything, from low-tech mechanisms to high-tech products (for example, I consistently choose Lenovo over Dell the last few years); it's economy is quite diversified too, as I gather.

The real hidden factor here is of course that the life level of First Worlders will in fact decrease as Chinese life standard rises - Chinese goods would no longer be "cheap" for them and the relative purchasing power of the First World vis-a-vis China will fall. That is unfortunate for the First World, but such are the cards. The Chinese goods will still be cheap - even when China finally outranks all world's economies, which would happen bar major catastrophes, it would still keep the average life standard around your typical second world nation (i.e. Poland - with around Poland's GDP per capita, China's economy would already be double that of the USA, and roughly equal the USA and EU combined, just think of it). Meaning it would still produce for export, just have more leverage versus First World.

This is all quite complex, but judging by the current trends, China is rising to become another superpower in the next decade, Russia and SCO nations will fall in line to become energy-supplying "loose satellites" for the Chinese industrial giant. On the other hand will be the ageing, but still powerful First World, which would have more and more trouble with paying for Chinese goods.

That is what economic trends predict.

[Surlethe]

The problem is at this point in time and for the near future they do not have and cannot create the internal consumption to soak up the goods they're producing

In addition to what Stas said, you also have to remember that China has intentionally been denying existent internal consumption demand by undervaluing the yuan. The government has essentially been depriving its people of wealth in order to export it to the West in return for financial security in the form of T-bills. So demand for consumption beyond current levels certainly exists -- they probably couldn't soak up all the goods they're producing, but they can soak up some fraction.

[Surlethe]

The real hidden factor here is of course that the life level of First Worlders will in fact decrease as Chinese life standard rises - Chinese goods would no longer be "cheap" for them and the relative purchasing power of the First World vis-a-vis China will fall. That is unfortunate for the First World, but such are the cards.

Interestingly, total utility will still rise: the marginal benefit to the China of the rise in income is greater than the marginal utility of the First World fall in income. If my real income falls from $100,000 to $90,000 due to a rise in the cost of cheap imports and a Chinese citizen's real income rises from $5,000 to $30,000, any harm to me is outweighed by the gain to him. It would be interesting to note whether the impact of this slight ceteris paribus decline in living standards will be differentiated according to income: if low-income people in the US are more likely to buy cheap imports (e.g., Wal-Mart customers) then they will be more hurt by increased Chinese bidding ability than higher-income people who are less reliant on imports. Also, it would be interesting to see if higher-income First Worlders are on net benefited by the growth of Chinese consumption demand because of high-growth First World investments in China.

[mr friendly guy]

I don't think so, unless China finds a huge Third World region that will become a cheap source of goods for it's internal market, and will make goods cheaper which would allow to inflate the life level in China.

You raise good points, although I wasn't thinking necessarily in those terms. I was mainly thinking in technological and governmental policy.

An example of the former is robotics. Even as early as the late 80s demographers were pointing out the problems which will occur with Japan's aging population. A suggestion floated was that advancements in robotics will help offset this by making the workforce more efficient. IIRC this has also been suggested what South Korea could do.

An example of the latter would be raising the retirement age. A policy we here in Australia are contemplating. I remember seeing old grannies helping do the work when my tourist bus passed through rural china, so its not an unrealistic policy to raise the retirement age. The trick is how high.

[MKSheppard]

Is having 1.3 billion people there long-term viable either?

Yes. China will not listen to environmentalists and will build shitloads of nuclear plants to support it's burgeoning economic growth.

[Lusankya]

The biggest issue with the population isn't power, Shep. It's water supply and sewerage.