March 23,2010

"Short the China Bubble" Trend Is Spreading

By Xu Yisheng, Beijing

A China Bear trend, which got its start when Wall Street hedge fund manager and confirmed short seller James Chanos began dropping bubblish sentiments about the country, is spreading internationally. 

Chanos has been saying since January that China's booming house market has become a bubble supported largely by speculative money. One of his assumptions is that China's urbanization has not come up to expectations. Although Chanos has also said that, "China is the engine of growth that will hopefully pull us out of the morass that we find ourselves in," he has stuck to his point that China's house market has been crazy, calling it a "classic pocket…of overheating and overindulgence."

Chanos, renowned for his correct calling of the Enron debacle and the tons of money he made on it through his Kynikos Associates, has long been regarded as the most astute short seller on Wall Street.

The China-skeptic voice has long been around. Predictions of the "Technical Bankruptcy of Chinese State-Owned Banks" struck up in 2002, when China commenced its banking sector reform. Since then, such voices have been heard over China's over-reliance on exports, the imbalance between investment and saving, its dependence on external energy resources, and a list of other issues.

Now the noise has found China's house market to focus on, along with the government's debt and the yuan exchange rate.

James Richards, once the general advisor for Long Term Capital Management, a massively busted hedge fund, said at a March 15 conference in Hong Kong that China is riding on the "biggest bubble" in history, which is just waiting to burst.  Richards, now the general manager of Omnis Inc., a market intelligence firm, holds that, except for short term speculation, China does not deserve any investment. He said the balance sheet of China's central bank, the People's Bank of China, looks very much like a fund long on the US dollar and shorting renminbi.

Richards has just joined the legion of China-shorters, which includes Harvard University economics professor and former chief economist of the International Monetary Fund Kenneth Rogoff, who warn that China is at the risk of economic catastrophe.

Rogoff said in January that China's growth rate could decline to 2% within the decade due to an "economic bubble caused by excessive lending."

Marc Faber, an independent analyst and one who reportedly predicted the Asian Financial Crisis, has been bullish on China's real estate market but warns of the possible bubble burst.

And the shorting voices extend far beyond the real estate sector. Victor Shih, a professor of Chinese Politics & Political Economy at Northwestern University, says in a report that between 2004 to 2009, the government debt from investment was 11 trillion yuan, (about US$1.6 trillion), double the estimation by official statistics of 5-6 trillion yuan, accounting for one third of China's GDP and about 70% of China's foreign exchange reserves. He estimated that total government debt may be as high as 96% of GDP.  In a worst case scenario, Shih says a financial crisis may break out as soon as 2012.

Although many China analysts doubt the credibility of Shih's estimation, there are open ears on Wall Street. 

On the other side of the hubbub is Jim O'Neill, Goldman Sachs chief economist, with new data on the RMB exchange rate. According to his March 3 report, GS's model, dubbed GSDEER (Goldman Sachs Dynamic Equilibrium Exchange Rate), shows that RMB had been undervalued but is now close to purchasing power parity. GS appears to be an outlier against the international chorus pushing the yuan's appreciation.

O'Neil makes his case in three ways: since 2005, the trade weighted, effective real exchange rate has risen by 20%, largely eliminating RMB's under valuation; China's imports are increasing and its trade surplus is shrinking; and RMB's purchase power at home has been undermined by inflation.

In another report, The Fair Value of BRIC's Currencies, GS says that the real, Brazil's currency, is one of the most over-valued currencies among the emerging economies, while the fair value of RMB has appreciated most since 2000 among the BRIC countries.

Attacking the soundness of China's economic sectors such as real estate is not the end of it. In late 2009, Pivot Capital Management, a hedge fund company registered in Monaco, doubted the fundamental health of the Chinese economy. 

Its report, China's Investment Boom: The Great Leap into the Unknown, based on data from the 12-year investment cycle since 1998, analyzed the production capacity and demand in the infrastructure construction, manufacturing, and real estate sectors. The report concludes that China's investment driven growth is inefficient and unsustainable, and predicted that the government-dominated lending and investment model will collapse in 2010.

The report also compares the ratio of general fixed capital formation (GFCF) to GDP, finding that in China it far overtook those of other Asian countries during the investment boom in mid 1990s. It says a ratio of GFCF to real GDP reveals that the effectiveness of China's lending-driven growth is quickly diminishing. Between 2000 and 2008, for every US$1 of growth, US$1.50 of lending was needed, and the ratio deteriorated to $1 to $7 in 2009. Loans pouring into real estate and stock speculation gave the real economy only a very limited boost. 

It also states that the potential of urbanization to growth may be illusory. In China's Yangzi and Pearl River Deltas, and in the Bohai bay area, villages are virtually eliminated. According to the report, China's rate of urbanization has been underestimated by 20%, indicating that the population in the line of being urbanized is in fact about 100 million, instead of 350 million as long expected. So, it says, China is sliding towards a hard landing and sending as strong a shock wave through the world economy as the US subprime crisis.
 
Pivot Capital Management has earned some little reputation by monitoring possible troubles in Spain, Portugal, Italy, Greece, the Baltic countries, Hungary, and Poland. It had made handsome profits by investing in government bonds and CDSs (credit default swaps) related to Greece, Portugal, and Iceland.

James Chanos says his shorting strategy for China would be to choose a copper mining company that exports 80% to China, digging out the companies liquidity and financial soundness, and "getting involved at the early stage," as most successful investors do.

In a financial market of 10,000 participants, a stock that is collectively believed about to surge soon would be bound to surge since the 10,000 speculators would all buy it. But the sun will never rise from the west even if 6 billion people on earth believe so. Who knows?

 

1611
Name:
Company/Institution:
Country:
Click to Get New TextCan't read this text? Please click the image!
Please verify the text in the image.