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FX Trading – Reader Mailbag: 7 Reasons to BUY China!

Below is a fairly straight forward third-party article, passed on to us by a reader, on why its author thinks you should be bullish on China.

In RED are the reasons – the problems – why I think you should be a little more skeptical before diving into China …

7 Reasons to Buy China
Wednesday, February 3rd, 2010

I’ve been reading a lot of nonsense lately making the case for a China bubble. The reports saying that the 10.7% GDP growth cannot continue, and that the property market is overvalued and set to pop when the government cracks down on lending…

Former Asian Chief of Morgan Stanley Andy Xie says, "China’s property market ‘bubble’ is set to burst as the government curbs credit growth and clamps down on speculation."

Poppycock, I say. I’d like to point out that Xie is best-known for calling 10 of the last three bubbles… meaning he calls a lot of bubbles, and occasionally one actually happens.

(Hey, a .300 batting average gets you into the Hall of Fame; or at least it used to. I’d love to meet a financial advisor/economist who’s made more perfectly-timed forecasts than not. Pete Rose, arguably the greatest hitter of all-time holds the distinction of having made the most career outs of any other Major Leaguer. Maybe we should still take some pointers from Andy Xie’s mechanics, no?)

The truth is that the generals are fighting the last war. Just because the U.S. economic decline was based on a real estate collapse does not mean that China’s economy will do the same. There are very real differences.

Seven Reasons to be Bullish on China

1. China’s cash-fueled bubble trumps a credit or debt-fueled bubble.

Problem: As the author blindly points out below, China has 5% to 6% of global GDP in cash.

For one, China is being driven by cash — not credit. (You may remember this thing called "cash" from back in the day…)

If you count public and private sources, China has 5% to 6% of global GDP in cash; if you count the broadest measures, China has almost three trillion dollars in foreign reserves. And the economy and tax revenues are growing — not shrinking — as they are in other parts of the world.

Yes, “China has almost three trillion dollars in foreign reserves.” But, you see, there’ve only been two other times in history where a single country has amassed the amount of reserves – roughly 5% of global GDP – that China has. Those countries happen to be 1920s United States (pre- Great Depression) and late-1980s Japan (pre- Lost Decade(s)). The similarities between the three should not be ignored.

2. Jim Rogers likes it.

Problem: Jim Rogers likes it … and so does Thomas Friedman.

When asked about the housing bubble (this was back in 2006 or so), he said to short the investment banks. When asked which ones, his reply was, "all of them."
He was absolutely right.

Right now, Rogers is saying that China’s economy is not in a bubble. But he says there are certain areas where real estate is overvalued. Bloomberg quoted him as saying, "property prices should decline in Hong Kong and Singapore. But China’s economy as a whole isn’t in bubble territory."

It seems people get lost in Jim Roger’s bow-tie like they do in Barack Obama’s sparkling eyes and baritone discourse. And then there’s Thomas Friedman, who in a New York Times op-ed recently took on Jim Chanos’s call that China is bubblicious and ripe to be shorted. T. Friedman highlights China’s reserves (as I discussed in Problem #1 above) and the apparent benefits of ridiculous number of students combining with better-developed infrastructure.

But another of the Friedman namesake – George Friedman – offers a different perspective in his book, The Next 100 Years: A Forecast for the 21st Century.

Its economy has been surging dramatically in the past thirty years, and it is certainly a significant power. But thirty years of growth does not mean unending growth. It means that the probability of China continuing to grow at this rate is diminishing. And in the case of China, slower growth means substantial social and political problems. I don’t share the view that China is going to be a major world power. I don’t even believe it will hold together as a unified country. But I do agree that we can’t discuss the future without first discussing China.

3. China will soon have the largest transportation network.

Problem: bridges to nowhere.

When I was a schoolboy in the 1970s, every civic class I took touted the Eisenhower highway system as being one of the greatest growth engines ever produced. The textbooks claimed that because the United States had more highways — of superior condition — than any other country, goods could flow from coast to coast with ease.

I don’t know if they still teach this, but I do know that the U.S.’s lead on its road network is about to end.

China just spent $586 billion (plus additional trillions in loans) on a stimulus package. And a lot of this money is going towards highways, railroads, and airports.

According to the Malaysian Insider, "[China’s] infrastructure spending had been increasing by an average of 20% annually for the past 30 years — a tried and true engine that has helped power the Chinese economy’s explosive growth."

Plans call for China’s highway system to stretch 85,000 kilometers by 2020, surpassing the roughly 75,000 kilometers of interstate roads currently in the U.S.
There was a time when Americans could build an airport on a volcanic island in three days. Now we spend 10 years bickering over the rebuilding of the World Trade Center. I’ve yet to hear a date on the grand opening…

In a sort of vicious cycle, local Chinese governments allocate funds and resources to ridiculous projects (malinvestment.) Because without this investment demand they would be left with excess supply, but this investment demand really continue to create excess supply. From John Garnaut in The Syndney Morning Herald

So there are now airports without towns, highways and high-speed railways running parallel, and towns where peasants are building houses for no reason other than to tear them down again because they know that will earn them more compensation when the local government inevitably appropriates their land.

And this fiscal malinvestment is not reserved only to infrastructure spending.

4. China is now the number one auto market.

Problem: no comment.

Naturally, if you build roads… people want to drive on them.

In 2009, a total of 10.3 million passenger cars were sold in China — up 52.9 percent from just a year earlier. Domestically-branded cars accounted for 30 percent of this total.

Nick Hodge of Alternative Energy Speculator says, "The Chinese auto industry is growing in an exponential fashion. And it’s not all old fashion gas engines. There are 50,000 taxi cabs in Shanghai that run on natural gas. But the fastest growing company makes a battery-powered car. The stock is up 400% already, and it’s going to quadruple again."

5. China boasts public sector savings and low debt.

Problem: getting Chinese citizens to spend more. (Note: I assume the author meant to say “private sector savings.”)

The average Chinese citizen saves 36% of his income. He can do this because the cost of living is far lower than in the United States. There is almost no credit card debt, and all mortgages require a 30% down payment.

Despite the drop in Chinese exports due to the credit crunch-induced collapse in global trade, China’s domestic consumption has held up alright. But that may be in part to the stimulus money China pumped into its economy. Currently, consumption is not strong enough to make up for the slower pace of exports that will likely not return to its pre-crisis rate anytime soon, if ever. There may be another stimulus effort in the works for China, but what can the Chinese consumer manage without the handouts?

6. Chinese manufacturing is still rockin’.

Problem: it’s feeding the overcapacity.

According to the Wall Street Journal, the HSBC China Manufacturing Purchasing Managers Index rose to a record high of 57.4 in January from 56.1 in December. A PMI above 50 represents growth — and this is the fourth month in which the PMI has grown.

Purchasing Managers Index

Hmmm, recent industrial production numbers seem to bode well for Chinese growth. But therein lies much of the worry surrounding China – bubbles and overcapacity.

The chart at the right shows the amount of finished industrial goods and that total overtaking the peak total at the end of 2008 when the crisis hit hardest.

It’s all part of that vicious self-reinforcing cycle that’s dominating Chinese policy. I’ll defer to John Garnaut in The Syndney Morning Herald again and his conversation with Professor Yu Yongding:

[Yu] believes China is trapped in a cycle where constantly rising growth in investment is constantly increasing China’s supply, but consumption has conspicuously failed to grow fast enough to absorb it. And so China is forced to increase investment in order to provide enough demand to absorb the previous round of increased supply, thus creating ever-widening cycles of oversupply.

In this manner, the investment share of gross domestic product has increased from a quarter of GDP in 2001 to at least half.

“There is sort of a chase – demand chasing supply and then more demand is needed to chase more supply,” he says.

7. Oil production is increasing in the Middle Kingdom.

Problem: only if I’m right about the other problems, I guess!

The Chinese oil major CNOOC jumped 10% on news that it was increasing production by 28% for 2010. Bloomberg reports: "The forecast says a great deal about the likely trajectory of China’s manufacturing and transportation industries for the balance of the year. But it is also a reasonable guide to oil demand, which so far analysts have expected will be modest this year."

Oil companies don’t increase production unless they believe that it will be met by
an increase in demand. CNOOC has 2.8 billion barrels of proven reserves and a
market cap of $7.1 billion. They obviously think that the moderate global growth picture — which the future market equates to $75 oil — is wrong.

The only conclusion to be made is that China’s growth track for 2010 is much
better than most experts think.

China’s growth is heavily dependent on exports and investment. Have a look, with 2009 full-year estimates included, as to how China’s current investment trend as a percentage of GDP stacks up to similar periods of major growth in other countries:

GFCF/GDP of various countries

Source: Pivot Capital Management

Keep in mind that with the collapse in global trade, 2009 investment figures should show another big increase as to its contribution to GDP; this trend, both in intensity and
duration, is unprecedented:

Intensity and duration of capex booms

The concern is that it’s becoming an unhealthy and unsustainable balance. If that proves
true, then the results of slower-than-trend growth could prove ugly. In which case, who
cares about oil production numbers then?