China’s transition

Outstanding article on China from Stratfor.  The image that many have of China’s economic growth and political freedom are at odds with the facts.  This article does a great job of showing where things have been, where they are now, and where they may be going.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China’s transition

China is looking increasingly desperate

Paper was first invented in China. So was paper money, and thus runaway inflation. It is interesting to see China return to its historical roots this week with the significant devaluation of its currency, the renminbi.  

China’s actions make it look desperate. The Chinese economy is slowing down, perhaps more rapidly than the communist party in China would like. They have tried spurring stock market growth, and then propping up the stock market to prevent it from falling. Now, they are devaluing the currency to try to get the economy jump-started.

Real economic growth comes from productivity, not from printing currency, redistributing wealth, spurring stock market speculation, or punishing those profiting from stocks falling. All of China’s, or Europe’s, or America’s, or Japan’s attempts to get growth from someplace other than productivity (which isn’t in the government’s wheelhouse) are doomed to failure.

Devaluing the renminbi is an attempt to make Chinese goods cheaper for foreigners to buy. That “works” as long as no other country decides to devalue their currency, too. And, it assumes that market participants are too stupid to adjust prices based on currency manipulation, which history and academic research has been shown not to be the case.

It should come as little surprise that communist dictators misunderstand how a free market works. China is running the risk of not only disrupting the world economy with its actions, but also definitely proving to Chinese people that they don’t know what they are doing. The risks and the results are real, and will be felt worldwide.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China is looking increasingly desperate

China and Greece: sound and fury signifying nothing?

Just a couple of weeks ago, you couldn’t look at the news without seeing dire predictions about Greece leaving the European Union or China’s stock market tanking. Now, it seems like these perils have passed and there’s nothing to worry about. That’s unlikely the case.

I’m an optimist by nature, and I tend to think things will work out in the long run. That does not, however, make me a Pollyanna. I don’t think that problems in Greece or China are the end of the world. But, I also think it’s naive to think that such issues were insubstantial and likely to fade with so little hardship.

Greece still can’t pay back its loans, and they are still demonstrating little desire to reform. European lenders still want their loans repaid, and seem unlikely to grant Greece forgiveness for large amounts of debt. In other words, the situation hasn’t really changed, and therefore still requires careful observation.

China’s stock market did not tank because of some bizarre conspiracy. Like all markets that have been artificially pumped up, it must necessarily deflate. Any attempts to defy that natural process are doomed to fail one way or the other. The underlying issue of China’s economy slowing down has not changed. The political and economic consequences are non-trivial and demand watching.

Markets have a natural ebb and flow, just like nature. And, just like nature, those ebbs and flows are largely unpredictable over the short term. That doesn’t mean you can’t see broader themes evolving. It was easy to see that the tech bubble of the late 1990’s would pop, but impossible to predict when. It was easy to see that the housing market of the mid 2000’s would burst, but impossible to predict precisely when.

Greece and China have real problems that will eventually reverberate throughout the global economy. I don’t know precisely when these issues will loom large, but I do know they haven’t been resolved. This is not a good time to ignore those risks.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China and Greece: sound and fury signifying nothing?

China: more important than Greece

While most of the world was overly focused on Greece, bigger things were afoot in China.

First, the Chinese economy is the 2nd largest in the world. What happens in China matters for the world economy. In contrast, Greece’s economy is but 2% of the European economy. Although Greece’s problems are likely to become broader problems in Portugal, Spain, Italy and France, by itself Greece doesn’t have a big impact on the world economy.

Second, China’s economy is still essentially run by a communist central planning authority. They are giving some free market principles a try, but they have maintained a firm grip on the most important things. How they react to the inevitable ups and downs any economy faces is important for understanding how the world economy will do in coming years and decades.

Over the last year, the Chinese government has been showing they aren’t ready for prime time. First, they have reacted to economic slowing–inevitable in any economic system, whether capitalistic, communistic, socialistic, etc.–with attempts to prop things up. As usual, such attempts look good in the short term but fail over time. Governments just aren’t any good at allocating capital.

Second, they are misreading market reactions and have basically lost their cool. After trying to use free markets to boost their economy, they are now trying to prevent markets from clearing by forcing large stockholders to hold instead of selling. There is nothing that spooks markets more than a government’s attempts to force the outcome they want instead of the natural equilibrium that would otherwise exist.

This a classic reversal of cause and effect. Stock markets, like all markets, react to news by adjusting prices to make supply and demand match at market clearing prices. Any attempt to prevent that mechanism from operating in the short term leads to disastrous effects in the long run. Markets are effects, not causes, contrary to how many politicians and historians like to interpret the facts.

The more the Chinese government continues to overreact and try controlling outcomes, the more world markets will overreact as a result. Such impacts will be much worse than letting markets find equilibrium. Just witness commodity price swings in reaction to Chinese intervention and you can get a flavor for how nasty things can get. 

I think what is going on in China should be watched much more closely than what is happening in Greece. The stakes and consequences are much greater.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China: more important than Greece

China: how will its mass urbanization impact the global economy

China’s impact on the global economy is hard to overstate.

Not only is it the world’s second largest economy (by country, not region), but also the source of a huge amount of incremental growth over the last 15 years.

I’ve seen estimates that over 50% of the demand for iron ore and copper comes from China. Almost 50% of worldwide steel is produced in China. I once read that China has used as much concrete in 2011 and 2012 as the U.S. used in the 20th century! I don’t know if such estimates are specifically accurate, but their magnitude gives you a flavor of how China has impacted the global economy. In short, the economic crisis since 2008 would have looked a lot worse without China.

Given that, it’s important to consider the impact of China on future economic growth. 

One of the dynamics going on in China is the move from a more production-based to a consumption-based economy. China is approximately 34% consumer-based versus 70% in the U.S. China has built an economy, predominantly from the top down, that has mostly produced goods for other countries, like the U.S., Europe and Japan. But that source of growth was limited. You can only take market share for so long before you need to become your own source of growth.

China is trying to make that transition, but getting a command and control economy to do that without large disruptions is very difficult. 

One aspect of such a transition is having hundreds of millions of Chinese farmers move from the hinterland to cities. In cities, they can work in factories and produce much more than they can on the farm. That higher productivity leads to higher consumption, thus achieving China’s goals. 

But, how do you move hundreds of millions of people from farm to city. In the west, and Japan, that transition took place over many decades, and mostly organically (by organically, I mean through free market forces, not through government fiat). Those transitions led to disruptions, just as it will in China.

China, however, is trying to do this much more quickly and on a much more massive scale. China wants to move around 235 million people to cities over the next 20 years. For perspective, that’s the size of the 10 largest cities in the world now (from Tokyo at 37 million to Mexico City at 20 million). Can you even imagine trying to regrow 10 of the largest cities in the world, over the next 20 years? (for more information, read Stratfor’s article on the subject)

Achieving such a task is Herculean, and it will impact the global economy.

How? I don’t know. It could all happen smoothly, which I consider unlikely. It could occur with either international or domestic war, as such pressures have created throughout history. It could happen in fits and starts with massive swings in economic growth from boom to bust. No one knows, really, but it bears watching.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China: how will its mass urbanization impact the global economy

China syndrome

Some people think China will grow strongly forevermore.  That would lead to significant changes in both the political and economic landscape going forward.

Others think China will run into a brick wall because governments are terrible capital allocators.  That, too, would lead to significant changes on the political and economic front.

In other words, China will have a large impact on the future of politics and economics no matter what.  You can’t think about the short, intermediate or long term without some attention to China.

With that in mind, I highly recommend a recent piece from GMO (a very good investment firm) regarding China.  

It points out the same problems highlighted in a book called Red Capitalism: that China’s growth is built on a shaky and corrupt financial system.  

I hold the opinion that China is headed for trouble, although I have no idea when that trouble will come about (just like I saw the dot-com bubble and the housing/credit bubble coming, but couldn’t predict when each would pop).  

China’s trouble could be long term stagnation like Japan experienced over the last 20 years, or economic collapse like Europe and the U.S. experienced in 2008-2009, or outright revolution.  I really don’t know.

But, I do know it’s important to think about ahead of time.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China syndrome

China article

Despite its all-too-common use of the ridiculous term, “state capitalism,” this article outstandingly spells out the case for China to experience an economic crisis in the next 5-10 years: Time Magazine, Why China Will Have an Economic Crisis.  

China can and might change course, but it’s current path is one we’ve seen before and will end in tears.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China article

All eyes on China

Most investors are focused on Europe, but they should be focused on China instead, because what happens in China is likely to have a greater impact than what happens anywhere else.

There are many candidates for focus next year.  The one that makes all the headlines is, of course, Europe. Its economy, as a whole, is still the largest in the world, after all. If that economy collapsed, or the European Union came apart, or the currency union changed dramatically, then it would, without doubt, impact the global economy. But, a lot of what’s happening in Europe is already discounted in market prices. News on the front page is rarely a big mover of markets because markets anticipate change more than react to it. And, although Europe’s economy is large, it doesn’t contribute much to global growth. There’s a small chance that Europe is the big mover of markets next year, but I doubt it will be.

Japan is a dark horse that may have a big impact on the global economy next year. Its economy is still #4 behind Europe, the U.S. and China, but hasn’t grown in 22 years. The issue from Japan isn’t earthquakes or tsunamis, but debt. Japan is the most indebted country in the world if you compare its overall debt to the size of its economy. The amazing thing is that they pay the lowest interest rates in the world on that debt. The reason rates are so low is that the Japanese are so willing (and compelled) to buy Japanese government debt. When retirees start to outnumber savers, though, Japan will have to start raising debt at much higher interest rates. If markets start to anticipate that inevitable transition next year, Japan could be the big mover of markets. I doubt it will be, though, because I don’t think that crisis will come to a head for another couple of years.

The Middle East is, as always, another dark horse that could greatly impact global markets. Although the Arab Spring is making the headlines, the greater concern involves ancient rivalries between Arabs and Persians, and between Iran and Israel. If Iran succeeds in creating unrest between Shia and Sunni on the Arabian Peninsula, or if Israel becomes increasingly worried about and takes action regarding Iran’s nuclear program, then oil prices will rocket and the global economy will tank. Like Japan’s issues, these are unlikely to come to a head next year. But, unlike Japan’s issues, the Middle East is unlikely to face an inevitable conclusion in the short to intermediate term.

The good old U.S. of A. is another place to focus next year. It’s an election year, so many both inside and outside North America will be curious to see how our political field changes and how that could impact the global economy. The U.S. economy is huge, but is growing so slowly that it has less impact on the global economy than it did five or ten years ago. In my opinion, our political transition is unlikely to change things much, so I doubt it’ll have a big impact on markets. Not only is Congress unlikely to tackle our debt issues during an election year, but the Fed is also running low on monetary ammunition.

China, I think, is the most likely candidate to move markets next year. It is both the world’s 3rd largest economy and the fastest growing. It is also the biggest supplier of goods to Europe and the U.S., the 1st and 2nd largest economies. It has a huge impact on emerging market growth, too, because so many emerging economies supply China with the raw materials and other inputs that fuel their manufacturing powerhouse. In 2013, China is going to go through a major political change (every 5 years, there’s a major changing of the guard) that’s likely to be anticipated by markets in 2012. At the same time, China is trying to tamp down high inflation and an overly-exuberant real estate market. Add all these factors together with a bunch of global investors over-focused on Europe, and you have a high probability that China is the one moving markets next year.

I’m not alone in doing this, but I’m watching with great interest what happens to oil and copper prices and on the Shanghai Stock Exchange. Oil futures (which are high, but not outrageously so) seem to be reflecting concerns in the Middle East more than growth in China or emerging markets. Copper has fallen over 20% since last spring, but has not yet declined to global recessionary levels. Shanghai, like copper, has been falling since spring, and is down at levels last seen in the spring of 2009, when U.S. markets were hitting bottom.  

I don’t really know what will happen in markets next year, but I’m watching China with greater interest than Europe. If China tanks, the world economy will follow; if China thrives, markets are likely to do much better than expected. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

All eyes on China

The China Premise

In analyzing financial markets and the economy, almost everyone holds a premise that’s the proverbial elephant in the room: what will happen with China.



For those who believe global growth will have severe problems, their premise is that China is most likely an accident waiting to happen.  Those who believe the opposite, that global growth will take off again, almost certainly hold the view that China is a growth machine that will pull the whole world forward.


If someone holds a view on commodities, currencies, stocks, bonds or gold, I can almost guarantee that behind their view is a premise about what will happen in China.


That premise may be explicit.  Jim Rogers, a noted commodity investor who once worked for George Soros, is a China bull and makes no bones about it.  He moved his family to Singapore and is having his daughter learn Mandarin Chinese because he thinks she won’t be able to succeed without it.


Jim Chanos, the famous and successful short seller, is on record saying China is a bubble that will soon pop.  He’s putting his money where is mouth is, too.


Some hold their premise implicitly.  I’ve heard many agriculture and base metal investors insist that prices can only go up.  They may not lay out the case explicitly, but if you ask them you’ll find they see endless growth and demand from China.


Others are certain that debt deflation (the unwinding of bad loans) will keep the global economy in the tank for a decade or more.  Once again, they may not come right out and say it, but if you ask them, you’ll almost certainly find that they assume China can’t keep growing fast enough to overcome bad debt.


The most intellectually honest will admit they don’t know what will happen.  After all, it’s up to the Chinese.  I agree with the bears that China’s command and control economy will end badly (the history on this subject doesn’t leave much room for doubt)–IF it stays on its current path.  But, that’s a big IF.  


I also agree with the bulls that China has a lot of runway simply playing catch-up with developed markets, and IF they foster free market reforms (rule of law, representative government, property rights, flexible labor markets, private allocation of capital, etc.), then they can be a huge growth story for a VERY long time.  Once again: big IF.


Perhaps the best path is not to guess.  


If you could invest and do well regardless of whether China tanks or soars, wouldn’t that seem the best path?  Granted, if you knew how the story would end, you would make more money betting boldly in that direction.  But, is anyone really certain they know what will happen and–more importantly for investors–when?


What happens in China will impact world markets.  In the short run, this spells opportunity whether boom or bust.  I think making a guess on this over the next few years is a fool’s errand.  It’s better, instead, to prepare for either outcome because getting the timing right is impossible (or lucky).


Making explicit one’s China premise is important to understanding one’s view of world markets and the economy.  More important than one’s premise, however, is whether its based on sound reasoning or gut feel and conjecture.


Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The China Premise

China Rising?

So much ink has been spilled–especially over the last several years–about the rise of China that I wanted to devote a blog to the subject.

I won’t bury the lead: I believe China is more likely another Japan than another United States on the rise.  My goal is not so much to tell the future–I don’t know what will happen–as much as it is to cast doubt on the overwhelming consensus of China’s inevitable rise to supremacy.

What consensus you might ask?  That China’s economy will inevitably surpass the U.S.’s in the next 10, 20, or 30 years; that China will surpass the U.S. in technological superiority; that China will surpass the U.S. militarily; that China will surpass the U.S. in every way possible, it seems.

All of these things very well may come to pass.  But, it is not written in the stars, and the consensus view is almost entirely built on an extrapolation of current trends–a technique of forecasting which is almost never accurate.

As an interesting illustration of forecasting difficulty, I’d like exhibit #1 to be Paul Kennedy’s excellent book, The Rise and Fall of the Great Powers.  Now, granted, this book came out in 1987, when Japan’s ascendancy was widely accepted as given, but it’s a wonderful example of how someone extremely knowledgeable in a specific field can suffer from the biases of extrapolation. 

In his book, he speaks of the 5 centers of power at the time: the U.S., the U.S.S.R., Japan, China and the European Economic Community.  He spells out how clearly Japan is surpassing or going to surpass the U.S. in computers, robotics, telecommunications, automobiles, trucks, ships, biotechnology and aerospace. 

Please understand, he was writing in 1987, when Japan Inc. was thought to be unbeatable, buying up property all over the world, technologically unstoppable.  He didn’t know Japan would fall into an economic funk a mere two years later where Japan’s economy wouldn’t grow for the next 22 years (nor did he see the fall of the U.S.S.R. coming, and even seems to poo-poo the idea).  So much for Japan Inc. and extrapolation of the past.

But, really, how could anyone really think that Japan would surpass the U.S. in computers and software?  Or biotechnology and aerospace?  Yes, Japan has definitely done better in robotics, automobiles and ships, but to provide such a long and overwhelming list as a historian?  A bit naive, I think.

The consensus view on China reminds me in many ways of the view 20 years ago of Japan.  Don’t get me wrong, Japan and China are very different stories, but people’s perception seems to be similar. 

Just as China’s centrally planned economy and “state capitalism” (an oxymoron if there ever was one) is seen as the wave of the future and a better way to govern, so Japan’s Ministry for International Trade and Industry (MITI) and it’s coordination of economic activity was seen as a huge advantage over the U.S.’s capitalism. 

Just as China’s production of engineers and scientists is seen as an unstoppable force, so was Japan’s.  Just as China’s high research and development budget is seen as superior, so was Japan’s.

Just as China’s high national savings rate is seen as an advantage over the U.S.’s consumption, so was Japan’s.  Just as China’s superiority in aptitude tests is seen as intellectually over-powering the U.S.’s poor scores, so was Japan’s.

I believe people make these extrapolations because they don’t really understand the sources of growth.  They simply expect the recent past to keep going, but it almost never does.

Just as Japan’s extraordinary growth came from adopting western technology and industry and having huge western markets to sell to, so does China’s.  If either Japan or China had had to create these industries from scratch, as the U.K. and U.S. had done, the growth would never have materialized.  And, just as Japan’s economy has demonstrated over the last 20 years, if China ever has to rely on it’s own consumers and businessmen for innovation and growth, you’ll see growth fall off a cliff.

Neither Japan nor China invented the Bessemer process, or assembly lines, or transistors, or binary computer logic, or almost any of the other major innovations which allowed them to grow.  They got it all from the west. 

And, this brings me back to my blog of two weeks ago, where I said that return on capital is the most important concept in finance.  You see, neither Japan nor China view return on capital as a primary concept.  Japanese businessmen are frequently on record saying that the U.S.’s focus on shareholder returns is ridiculous.  China is a communist state that sees returns on investment as a mere means to other ends.

The U.S. and U.K., at least during periods of innovation, let returns on capital as determined by individuals allocate resources, instead of some central planning bureaucracy.  The U.S. and U.K., thanks to intellectual greats like Adam Smith (a moral philosopher, not economist), recognized that human potential was unlocked when individuals were able to pursue their self-interest, as long as there was a rule of law and, specifically, protection of property rights.

Good luck finding that intellectual framework in Japan or China. 

In forecasting the future, this return on capital concept is vital to accuracy. 

If the U.S. abandons its focus on return on capital (as the U.K. has in most ways done), good-bye growth and innovation, good-bye technological and military superiority, good-bye world leadership. 

If Japan adopts a focus on return on capital at the individual level, which I believe is possible over time (perhaps in the next decade) welcome back growth and innovation. 

If China adopts a focus on return on capital at the level of the individual–an unlikely route, in my opinion–it can become a leading state.  Without that focus, growth will eventually crash and burn as it did in Japan (China is witnessing a boom in real estate, just as Japan did before its crash–coincidence?).

Forecasting China or U.S. over the next 30 years seems a bit silly without a focus on return on capital, but the consensus opinion is that it’s a done deal–China will be supreme. 

I beg to differ because I don’t believe large population, numbers of engineers, test scores or central planning are the lifeblood of growth, but the innovation of individuals who produce high returns on capital for their own benefit.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China Rising?