Our Man has long been skeptical of the “China story” and the seemingly commonly held view that China is the panacea, since GDP growth there will never slow down. So in this glance at China, rather than give you a regurgitation of his earlier posts (in case you wanted to know, here’s why Our Man is skeptical), Our Man thought he’d just blithely refer you to various bits in them as he meanders through some observations of the last few months.
A few months ago, Our Man motioned in the direction of the weakening Chinese PMI’s which suggested that the pace of Chinese growth was slowing and this trend continues with the PMI’s preliminary reading for May falling to 51.1 (from 51.8 in April). Our Man also mentioned the various shenanigans that were going on in the copper market (where copper was being used as collateral to help obtain financing, i.e. as a way around credit constraints).
The last few months have seen a whole new spate of shenanigans featuring Chinese companies that are listed in the US. No fewer than a dozen Chinese-based companies currently have seen their shares suspended or halted from trading in US, predominantly as a result of accusations of fraud. There are a lot of companies listed in the US, yet the vast majority of those whose shares are suspended are Chinese. What is more surprising is that many of these companies were ‘supposedly’ blue-chip names like China Media Express, which reached c$1bn market cap, before allegations of fraud led to its CFO and auditor to resign. Or Longtop Financial, a multi-billion dollar darling of the hedge fund crowd, whose auditors resigned saying their previous audits weren’t to be trusted as management and the local banks were complicit in the fraud after the firm was exposed in the impressive Citron Research blog. The most recent example is Sino-Forrest, a $4bn+ market cap company that has lost 80% of its value since a report by research firm Muddy Waters alleging fraud came out. Muddy Waters aren’t the only ones who have been skeptical and now even the mainstream media are cottoning on to the various issues surrounding Sino-Forest. Now, Our Man’s not saying that everything you hear from China and every company there is a lying crock of ****, but hopefully if you’re a believer in the China story you have got your eyes wide-open.
Now, Our Man was pointing this out to a Sinophile friend of his, when the friend very politely suggested that these were private companies and hence while there were shenanigans, the private Chinese companies were merely suckering naive or lazy American investors who bought into their story. Lest that you fall for such clap-trap, Our Man thought it only fair to point you in the direction of some public-sector shenanigans. Remember when everyone was so impressed by China’s high-speed rail? Well, unfortunately, the man-in-charge Liu Zhijun was arrested for embezzlement and that his ministry managed to rack up $271mn of debt (or 5% of Chinese GDP!) and that numerous others are being investigated after safety concerns cropped up (the result of using low quality concrete and other materials). That said, needing to bail out high-speed rail links isn’t unique to China (see Japan’s bullet train, Taiwan’s high speed trains and the lack of profitability of France’s various high-speed lines as examples) though it’s normally takes longer before you need to quietly shutter high-speed lines because no one wants, or perhaps it's can afford, to travel on them.
However, this wasn’t the public issue that caught Our Man’s eye over the last few months. Imagine there were a bail-out of local state debt that represented >10% of GDP (i.e. we’re talking bigger than California or Greece)…that would make major news, right? Well, apparently if it’s a US state or a European country it’s good for 24/7 coverage…but not if it’s China bailing out its local governments. Interestingly, most people thing that the Chinese government tackling this problem head-on is a good thing and certainly acknowledging and quantifying the problem is. However, what matters is who eventually has to pay the bill not who carries the liability. The Chinese have some form with determining who pays from their banking crisis in the 90’s which was a glorified version of extend and pretend. Back then government-backed Asset Management companies bought the impaired bonds from the Banks, issued the Banks new ones and made the interest payments by liquidating the impaired bonds over time. Obviously, when the principal came due the Asset Management cos didn’t have the capital and so rolled the bonds into a new bond backed solely by…a Ministry of Finance letter! Hence the eventual cost was borne by the household sector which through taxation and negative real interest rates helped provide this subsidies to the banks. Don’t be shocked to see a similar thing happen this time. There are of course other ways for the State to pay for this debt that it's taken on; perhaps the state will sell-off some assets to meet these debts, or they will confiscate wealth from the wealthy/SME’s/etc but Our Man suspects that they will continue to rely on the household sector to bear the burden as they’ve done for the last 20years+. The identity of the ultimate payer matters, especially if it's to be the household sector, since one of the primary aims of China’s much lauded latest 5-year plan is the aim of increasing consumption by 2-3% of GDP…and thus starting to reverse the trend of the last 20years.
All very interesting, I’m sure you’ll agree, but the real question is what is Our Man doing with all this information and data that he’s seeing. For that, you shall have to wait till next time.
No comments:
Post a Comment