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