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

As fragile as China.

As I’ve remarked before (here and here), much of the current worldwide economic recovery is due to China. For that reason, the greatest sensitivity to continued recovery is what happens in and with respect to China.

This recovery is as fragile as China (meaning delicate plates as well as the country).

Demand from China has driven up commodity prices and kept production flowing from manufacturing-based economies. For evidence, look no further than companies like Caterpillar and the land-office business they are doing in the far east.

If something were to go wrong in China, the economic impacts would reverberate throughout the global economy.

What could go wrong? If you haven’t noticed, there have been a lot of political issues surfacing between China and the U.S.

This includes the U.S.’s desire for China to allow it’s currency, the yuan/renminbi, to appreciate. This would make U.S. manufacturers more competitive with China. China has no interest in making itself less competitive, so this creates a lot of tension between the U.S. and China.

And then, there’s the spat between Google and China over censorship and hacking. It shows the inherent conflicts that exist between a command and control government like China’s and free market enterprises like Google.

Of course, there’s also the Dalai Lama. He represents the Tibetan government in exile and China doesn’t like his concerns being heard by the most powerful nation in the world. President Obama met with the Dalai Lama this week, infuriating China.

Then, there’s also our insistence on selling high-end weapons to Taiwan, whom China considers to be an errant state. It would be like Russia selling arms to Alaska, with Alaska being quite clear it would like to secede from the union.

So, there are a lot of political issues going on between the U.S. and China, not to mention they hold a ton of U.S. national debt. It’s a touchy situation.

China, too, has its own internal problems. Approximately 700 million people live in poverty in the Chinese interior while another 600 million are growing rapidly nearer the coast. Growth and trade has been great to the 600 million and less so to the 700 million. That is why some 20 million Chinese, a year, are moving from the hinterland to the coast looking for work.

This dynamic means that China simply can’t let growth slow too much. If it does, they will have a revolution in short order. Such is the history of China over the last…oh…2,000 years.

China is an island, geopolitically, and it has repeatedly cycled between external growth/interaction and internal strife/revolution. Until they change their political system from centralized command and control, as it’s been for 2 millennia, this external/internal cycle will continue.

This internal dynamic is the main reason why China won’t let its currency appreciate, and why they are working so hard to stimulate worldwide growth. China needs worldwide growth because they need someone to sell their low cost goods to.

The problem is that political tensions with large economies like the U.S., Europe and Japan are all working against this process. And, of course, the U.S., Europe and Japan all have major internal issues of their own that make them less than conciliatory towards China.

With all that on the table, how long until we see Chinese fragility? I don’t know, and neither does anyone else. But, it’s reasonable to assume the game can go on for several more years.

If China plays their cards right, then perhaps they can keep the game going long enough for the rest of the world to work out its problems and start growing again on its own.

If they slip up, though, which seems highly likely over the next five years, then that fragility could crack the delicate plate and lead to worldwide consequences.

We’d all like to see China succeed. If they do, then the world economy gets bailed out of its experiment with too much leverage. If not, it could lead to another major economic upheaval.

For now, expect China to keep the game in play. It should be good for stronger economic growth than most are forecasting. But, when the end-game arrives, it won’t be pretty.

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.