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China’s Economy… Where All is Not As It Seems

[Dan Denning is in Europe sorting out the financial crisis, armed with nothing but a paperclip and a very old pink hat. Along with Nick Hubble, we're manning the Daily Reckoning fort while he's gone].

We left you last week with the thought that the market looked very sick indeed. A crash, we said, wouldn’t come as a surprise. Well Friday’s action in the US wasn’t quite a crash, but it wasn’t far off either. And gold’s reverse crash – up nearly US$80 in the US session – added to the fear.

Europe is the primary fear driver at the moment. But weak manufacturing and employment data in the US on Friday cast doubts over its so-called US recovery. And last week China’s own state-doctored statistics showed the growth of the big players in the manufacturing sector ground to a halt in May.

We’re heading into a global recession. That’s what the bond market is saying. It’s why some government bond yields are at all-time lows. It’s why the Swiss and German government can borrow at a negative interest rate. And it looks like equity market’s finally got the picture on Friday. They now realise, for the first time, that this is serious.

For the past few months we have tried to relay the seriousness of the situation to you. But sometimes it is taken as fear-mongering. Following on from our semi-regular criticisms of China’s phony economic growth and impending slowdown, we received this curt email:

Dear Sir,

Your editorial articles are becoming close to ridiculous and you are seriously threatening the credibility of your whole publishing business.

How can you talk about China’s “tottering economy” when GDP growth is 8.5 to 9% p.a. even if it is revised down slightly. We would be happy to have 3-3.5% growth if our economy was going well, but they have a growth rate of nearly 3 times of ours.

So what if it is revised down slightly? It isn’t a big deal, it is still a tremendous growth rate!

Comparing their situation to America’s Great Depression is bloody ridiculous!!! Obviously you have no idea what’s going on. Have you ever been to China, spent time there, spoke to people, businesses, banks etc? I have. Do you realise that the Chinese economy is predominantly driven by internal consumption, not exports and that is greatly influenced the urbanisation process that will continue for at least 10-15 years?

What is frightening is that your ill-formed publication affects the thinking of thousands of people who otherwise would think nothing of such a news. You create panic amongst investors and you are responsible (at least partially) for the panic-driven volatility that characterises today’s markets. This is very sad indeed.

We wouldn’t be surprised if this is a pretty standard viewpoint amongst Aussies who have grown to believe in China’s economy. So we should address some of the points raised.

Firstly, you can’t compare China’s economic growth rate with that of a developed Western nation. If China’s growth were 3% per annum it would be a disaster. Most China watchers consider anything below 7% will constitute a hard landing. China is approaching that level now.

Comparing China to America in the 1920s is not ridiculous. Both countries had massive credit bubbles. Both accumulated huge foreign exchange reserves. Both experienced an investment boom. America’s bust was a deflationary depression. Who knows what the aftermath of China’s boom will be?

We’ve never been to China. We don’t subscribe to the notion that you must be ‘on the ground’ to give credibility to your opinions. In the midst of a credit bubble, actually going to China would give you the wrong opinion. Speaking to people infected with the bullish views that credit booms inevitably bring about provides the wrong signals.

Although we did visit Dubai in 2006, and thought it was a debacle waiting to happen.

The Chinese economy is not driven by internal consumption. It’s driven by fixed asset investment (empty roads, trains, houses etc.), itself driven by government decree, not the market. Consumption as a percentage of GDP is at the lowest point in years. That’s because investment as a percentage of GDP is so high…and completely unsustainable.

China’s whole economic structure is built around maintaining employment and social stability. Profitability – the essence of capitalism – takes a back seat. Corruption delivers the profits to the chosen few.

So in many ways China is in worse shape than the US was when it was the emerging power at the beginning of the 20th century. It’s just that Australia blindly sees itself as hitched to China’s industrialisation and urbanisation…a process that will apparently go on uninhibited for another ’10-15 years’.

We’d like to think that our ‘ill-informed publication’, which comes to you for free, does influence the thinking of thousands of people. Hopefully it has made you think about how screwed up the world’s financial system is. More importantly, we hope it has struck enough fear into you to take some action and control of your wealth.

After all, someone has to do it. The mainstream press certainly aren’t up to the task. The Financial Review, which, as the name suggests, should review financial stuff, leads today with the headline Rudd Still Preferred PM

So a bloke who has no chance of leading the country – because his party hates him – is the people’s choice to lead the country because they hate the only other two leaders – Gillard and Abbott.

The Financial Review does take a look at the market turbulence further in. One headline states ‘The big worry is depending on policymakers’ while a few pages later a bolder headline says, ‘Policymakers take centre stage’.

From this we can infer that because policymakers are centre stage the market continues to deteriorate. As we mentioned last week, the size of the financial markets are now so huge that policymakers are impotent when attempting to control them.

The market is only now beginning to realise this. Perhaps that is why gold jumped so sharply on Friday. The common explanation is that gold jumped on hopes of more money printing by the Fed. But hasn’t that ‘hope’ buoyed stocks for months now? Why does the prospect of QE3 now only boost gold but not stocks?

Nothing is as it seems in a broken financial market. We would guess gold’s surge had to do with the fact the market has less faith in the Fed and European Central bank, not more. This makes sense, as gold is an anti-government trade.

Central banks don’t need to print for gold to soar. As investors lose confidence in policymakers, capital will continue to flee into safe havens. That’s why bond prices are at record highs. Big capital knows that the system is broken…it’s positioning for safety and preservation. Gold, with no counterparty – it’s no one’s liability – is the ultimate safe haven.

Our ill-informed suggestion? Buy some, before the opportunity disappears for a long, long time.

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

When Capital Comes A Knocking
2012-06-01 – Greg Canavan

When the Pain From Spain Moves Across the Plain
2012-05-31 – Greg Canavan

Greek Game Theory: Default, Devaluation, Austerity, Deliverance?
2012-05-30 – Nick Hubble

Desperate Stock Market Traders Waiting To Be Made Whole
2012-05-29 – Murray Dawes

Greek Elections: The Fear of Uncertainty
2012-04-28 – Dan Denning

Greg Canavan
Greg Canavan is a feature editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Sound Money. Sound Investments, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
Greg Canavan

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7 Comments

  1. Cheng Xe says:

    You are wrong. China will grow with awesome power. As always, you GL underestimate the will & skill of the Chinese. Never mind. It will be displayed yet again.

  2. Alex says:

    If China would be in a recession if growth rate dip below 7%, does it mean India is now in a depression since its growth rate is only 5.3% this quarter?

  3. Luke says:

    I think this is very ‘sound’ advice, you have hit the nail on the head.
    Soon there will be no denying the global economic recession/collapse, the way I think about it is the GFC didn’t go away, it was a minor blip on the radar that was caused by corporate debt. That corporate debt spread and gained momentum to countries, like a spreading cancer that grew in strength – first infecting the weak (ie Greece), and then the stronger (ie France, Germany) as they try to help the weak. Everything is connected.
    The way I see it is there will be a period after a global economic collapse (unfortunately I think there will be one) where people need to reevaluate our economic system. I think a big part of this will need to include a different value based system that factors in the well being of the planet and people. Although I think this will be excellent in the long run it will take a world of pain to get there.
    To most people it may sound like mumbo jumbo but as far as I am concerned, the writing is on the wall. It’s cause and effect.

  4. Ross says:

    On one side. You need to go to China. You need to listen to people that went to China in the 70′s and 80′s, those that actually got outside the Peace Hotel and the special zones. You also need to understand how household savings and savings culture actually plays in an economy, Governments might be able to abuse it like the Japanese but it provides resilience. You pretend to be well read but quickly forget the fundamental place of agricultural reform in the historical rise and fall of empires (including the American empire).

    On the other side. There is an issue with state-corporate enterprise debt, but there have been issues of equal gravity that the Chinese have managed before. One example was the basket case inefficient state owned enterprises and the cadre entitlement syndrome. After the state acted to cancel automatic guaranteed jobs for graduates (that where prior no matter the ability to gainfully employ them or their individual abilities they got slots in loss making enterprises or gridlocked ministries) the so-called democracy movement harnessed the retrograde leftist students leading up to Tiennamin. The state won and demonstrably the people’s lot improved.

    As far as the dependence on mercantile exports go and dependence on deficit country consumerism, that too is an issue. Moreso than for Germany which is more biased towards capital goods and its production and small shops more adaptive. The end of dollar recycling will hurt unless the Asian co-prosperity and Eurasian SCO led economic enterprise can work.

    Putin is in China at the same time as the underperforming Smith and his case is the more compelling even if more captive to state corporatist planning styled thinking.

    http://rt.com/politics/official-word/putin-russia-china-article-997/

  5. Lachlan says:

    China has approved an estimated $23 billion of steel projects that will use material produced by companies such as Rio Tinto Group (RIO) and BHP Billiton (BHP) Ltd.

    Steel production in China will possibly amount to more than 700 million tons this year. The 2011 output was 683 million tons.

    I believe if China eases there will be a response in the economy because rates there are around 9% and there are restrictions on speculating in fixed asset so therefore it is likely that demand is far from saturated. I understand that DR is averse to central planning and I understand perfectly well the degenerate nature of the same and yet there are wealth cycles in the world throughout history and the background is almost always one of meddling by the powers. Did post war US do well because they had a free market. Partly, but do we discount the presence of capital by entities that had no interest in such a philosophy.

  6. Dave says:

    So China’s boom must be bullshit because it doesn’t conform to you pre-existing ideology about what capitalism is? Pity that the state has always been involved in the organisation and facilitation of capital accumulation in the real world if not in fairy-tale pictures of ‘free markets’ – which don’t look anything like really existing capitalism.

  7. Chris Giles says:

    Dear Greg
    It is a very brave person who passes judgment on a country without having even visited it! One thing you would notice on a visit is the incredible resourcefulness and diligence of the Chinese people, and their well placed patriotism and pride in their country. I submit that China’s exports are not likely to collapse – for example I see no sign people are slowing their buying of such well known Chinese products as Apple laptop computers, Iphones and Caterpillar tractors. Also China has no sovereign debt to speak of and a genuine huge internal demand, with a populace largely able to pay. China is a country with a strong sense of history, and their recent history has confounded the distant armchair economic experts and will continue to do so. None of this looks like a country in serious trouble to me. Go and have a look and see for yourself !!

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