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Posts Tagged ‘china’

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View from the Bottom #23

In Uncategorized on October 20, 2011 at 3:17 am 

(image credit:  labourlist.org)

I am sorry I didn’t write.  I haven’t been able to use my right hand for the last month.  The truth is the worst possible answer, carpal tunnel.  A hunting accident would at least provoke feminine pity and the hope to bridle something untamed.  Instead, it looks like I am fast with my figures, but slow on my feet.

Which brings me to Europe.  The Eurozone has been pushing out press releases at a desperate pace.  Week in, week out, we get rumors of the ECB buying Italian bonds.  The Chinese buying Italian bonds.  Germany and France buying something with 3 trillion dollars.  Hope, perhaps.  But this is like playing defense in your kid soccer league- watch the torso not the feet.  The torso is economic growth; everything else is the feet.  Without economic growth, Europe can’t meet its debt obligations and interest rates will stay high and smother hope.  The arguments for economic growth in an environment with declining wages are stretched.  So I don’t want to spend much time on Europe.  We covered it; we know what is going to happen for the next 6-12 months.  The only hard part is not getting distracted from the truth.

What is really interesting is China, and I wish I could have written more about it earlier.  Yes, the stock market is down over there, but there is more to come.  Let’s look at what has happened in China to understand what will happen.  China’s economy has been rapidly growing, particularly after executing the largest stimulus in the world in 2009 on a not quite so large economy.  In order to pull back the reins, China has tried to curtail loan growth at the banks.  Unlike other economies, China controls how many loans are made by banks.  It is actually the best way to control monetary policy.  Except, that if banks can’t lend, then other entities in the economy will meet demand and start lending.  So what has happened in the last three years is that thousands of large and small enterprises have started to lend money out for projects that official banks could not lend to.  In other words, the least qualified lenders have been lending to the most marginal borrowers.  How much have they lent over the last two years?  One or two trillion dollars.  Between us, that is a lot of money.  For a five trillion dollar economy, that is a lot of money.

But no one knows for sure how much money has been lent out through informal channels, which is what makes it so interesting.  For all the attention that the subprime crisis got, it wasn’t that interesting.  You could go on Bloomberg, see all the securitizations and the underlying collateral mortgage-by-mortgage, know what was going to happen to home prices, then know what the impact of falling home prices would be on consumption and then know the impact of consumption on GDP.  In China, we just have no idea.  Analysts are publishing many numbers about the informal lending sector, but there are no official figures.  We simply do not know how big the problem is and China is also lacking dozens of econometric studies exploring the effects of leverage on real estate prices, real estate prices on consumption, consumption on GDP, and on and on.  They’ve had private property for 10 years, total.

However, there are a few things we can know about China.  First, it is highly likely that informal lending is at least 10% of Chinese GDP, which would make it double subprime at the peak.  Unlike subprime mortgages, the informal loans are working capital or property development loans, which means they are short duration, highly cyclical  and need to be constantly refinanced.  This means that, if we have a problem, we’ll experience it quickly.  Like, over the next 12 months, not 3 years as was the case in the subprime crisis.  We also know that the collateral (inventories and incomplete construction projects) is worse than that of the subprime mortgage market.  We also know that the Chinese government is taking steps to prevent informal lenders from foreclosing on projects, which is good in the short-term, but it means that fewer new informal loans will be made.  This is bad because if a whole portion of the economy exists because informal loans can be refinanced, then a meaningful portion of the economy will be stripped of its oxygen supply, shortly.

So what we can conclude is: that the up-and-to-the-right-line that China’s growth has tracked has had some support from an exponential growth in lending.  The trips to Macau, the handbags and empty condominiums were made possible by artificial growth in leverage.  So the correct growth trajectory for China is not 8%, but some number of degrees lower.  If M2 (money), doesn’t grow at 30% anymore, but instead grows at 10%, does the Chinese economy continue to grow at 7-8%?  Maybe, anything can happen.  But not ever before has a sharp downward change in M2 been accompanied with constant economic growth.  Nevertheless, for the moment, China and its strategists are sticking to the 7-8%, with the caveat that all bets are off if the US and Europe go into recession.  Great, so we know all bets are off.

The implications of a low-growth Chinese economy with a negative interest rate environment over the coming decade will have to wait until next time.  Sorry to hold you in suspense.

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View from the Bottom #13

In Uncategorized on April 12, 2010 at 4:50 am

This View from the Bottom is dedicated to our friend, classmate, colleague and inspiration, Roanak Desai.  He always took great interest in the View from the Bottoms.  I had recently promised him to sit down and to explain my view of how the world fits together.  Now it will be a long time before we get another chance to see each other.  I hope to learn a great deal more between now and then.

The global supply chain has remained gently active into mid-April, following a typical seasonal trend.  Automotive activity has stagnated, but construction materials are finally picking up to meet a seasonal trend for the first time in three years.  Overall the activity is muted to a level that is 15% above 2009, but still about 15% below the traditional run-rate.   Vacancy rates in logistics related properties are dropping and employment in logistics-related industries is continuing to improve through April.  Retail activity continues to improve across the board into mid-April, so there is a clear self-fulfilling positive cycle across the supply chain that will make the government economic numbers coming out in May and June look good.  Overall employment in April is continuing to pick-up, which is distorted by census-takers, but nevertheless, the IT sector remains a shining light.

As promised, the Federal Reserve stopped buying hundreds of billions of dollars of mortgage securities last week.  Spreads compressed despite the removal of a large buyer, so there seems to be demand for semi-government insured mortgage securities.  Nevertheless, the mortgage market continues to be nearly 100% dominated by Fannie Mae and Freddie Mac, so Americans are still quite comfortable with the idea of the government as the sole provider of shelter to Americans (but health care remains a no-no).  Indeed, mortgage applications continue to improve into the current week despite interest rates rising slightly overall and home prices muddling along.

I spent most of the last month in China.  There I had the proverbial moment with the cab driver, where he was telling me that real estate is a great investment that can’t go down. It reminded me of 2008, where I got a footrub from a young lady in Shanghai who pitched me on China Mobile stock.  I felt that it was my duty to inform him that real estate could lose its value, but he made a heart-felt appeal that real estate could not possibly drop in value.  I guess you could make a cynical argument that the government cannot afford for the housing stock to lose its value, but what I heard was more along the lines of hopes and dreams attached to real estate values.  I would agree with him if he were right, but the future of the Chinese real estate market remains tricky.  It has less than 10 years of history as anything that resembles a private market.  No one can actually own property, but rather “buyers” engage in long-term leases (~50 years).  This makes buyers more focused on selling than managing a property for yield.  Combine this with the fact that savings interest rates in China are ~0% and inflation is 5%-10% – buyers of real estate are in the market for appreciation – or rather, the market can only support an appreciation-focused mentality.  So Chinese real estate prices have reached a level where multi-generational wealth is used to buy one apartment.  To put it into perspective, apartments I saw at real estate agencies in Beijing were running $500-$1,000 per square foot for, by American standards, B space.  This is starting to approach the levels you see in Manhattan.  The only disconnect here is that Beijingers earn 10 times less.  So it is readily apparent to anyone who will look that there is a structural problem here that will end in tears or in long-term government machinations.  In America, we chose to shed one tear and then opt for long-term government machinations.  China probably doesn’t have the luxury to shed any tears and I’d expect to see long-term government machinations soon.

As always, the View from the Bottom attempts to see what is rather than what we want to be – there is rarely a need to prognosticate to know what the future holds.  PALM has been featured in recent Views from the Bottom to demonstrate that the capital markets are really on a 3-6 months information lag from reality.  True to form, capital markets participants figured out that consumers really don’t want to buy PALM phones about 5 months after consumers did.  Another great example of this phenomenon from the past few days is related to the unrest in Kyrgyzstan.  Kyrgyzstan is a spectacular country that is well worth the visit.  A good portion of its citizens are still nomadic, so there is one publicly traded business in all of beautiful Kyrgyzstan called Centerra Gold Inc. listed on the Toronto Stock Exchange.  The mine is a large portion of Kyrgyzstan’s GDP (~6%) and I happened to drive by it in 2008.  The value of the company was undisturbed by the overthrow of the government for two whole days before plunging.  Amazing.

Again, if there is something that you see in your everyday life that you would like to share and would like to understand the investment implications of – please send me an email or leave a comment in the following format.

I know: That my iPhone internet service is unbearably slow, so I think that AT&T’s 3G service is terrible.

I can reply back with specifics around various companies that can exploit AT&T’s 3G weaknesses or that will profit from AT&T getting its 3G network up to speed.

Or

I know: That I loved Avatar in 3D and everyone I know is going to see it twice, so I think 3D technologies will become a feature in future films and television.

I can tell you the companies that are in the technology supply chain that have the most to gain from greater adoption of 3D and what the inflection points of success will be.

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View from the Bottom #4

In Uncategorized on February 5, 2010 at 7:20 pm

December 23, 2008

There is a sort of kinship between China and the United States.  You land in China and you’re still surrounded by unbridled commercialism and people eating a lot of food really fast.  Both countries also have a yeoman’s work ahead of them in this downturn – however, China has a much heavier load to carry, but doesn’t know it yet.  For the US and European economies, we’ve seen the movie before and it’s a matter of who is playing what part.  On the other hand, what China will do to solve its economic problem is the most interesting game to watch worldwide right now.  Its choices are really hard and really uncertain.

1)                  From the ground, it would be an understatement to say that the Chinese economy is in a pickle in 2009 (to avoid using profanity).  The reason for this is that China has very few monetary and fiscal policy options at its disposal to deal with a downturn that is much nastier than the one in the US.  To make things worse, the Chinese leadership doesn’t seem to know it yet.  China is between a rock and a hard place because it has tremendous currency reserves that it can’t spend, yet it must provide immense fiscal stimulus to keep the economy going (and keep social stability).  China has over a trillion dollars of foreign currency reserves, which the Federal Reserve is working overtime to devalue.  China could try to adopt the Obama build-stuff-everywhere plan, but it can’t because it can’t sell dollars to buy stuff (to build stuff), since it must buy dollars (or sell RMB) in order to support the RMB at an artificially weak level to support exports.  If China starts selling dollars to build stuff, the RMB will appreciate, thereby further crushing exports and job growth.  China could let the RMB depreciate to help the export sector, but that would mean buying dollars, which would mean not spending money to build stuff to boost the economy.   Technically, China could try to finance growth internally, but China effectively is its banking system and the current state of the banking system is that commercial and industrial loans are going sour and the government needs to bailout the banking system, rather than use the banking system to finance internal growth.  What is China to do?  No one has any idea – that is what makes it so interesting.  There is no right path.  What is for sure is that the Chinese economy is contracting far more rapidly than the US (it is growing at a negative rate, not year-over-year, but month-over-month) and will continue to do so because of its composition (heavy emphasis on investment, which for practical and arithmetic reasons can contract more rapidly than consumption).  Nevertheless, the leadership here in China is asleep at the wheel.  There is no clear direction for a solution.  And unfortunately, even if China knew what to do, all of the policy choices at its disposal would take months or years to go into effect, so while they figure it out, it looks dire.

A last word on the macro picture.  China is in a very similar position to the United States before the first Great Depression.  I don’t make predictions; it is a fact.  In the late 1920’s, the United States had tremendous currency (gold) reserves gained from selling goods into post-WWI Europe.  After the Dawes plan, a good portion of the European economy was financed by the US and the US kept the party going in Europe to keep the European markets primed for American goods.  America was the great exporter to the world and owned Europe’s debt obligations.  When things went sour the European debt obligations went bad and the US had few policy options at its disposal – under the gold standard it was hard to devalue the currency to promote exports, so trade restrictions were put in place (as China is pondering at the moment).  Furthermore, the US spent a ton of money on infrastructure and other projects with limited effect (the New Deal worked, sort of and it took a really long time).  The reason for this was that as a net exporter, the productive capacity of the US was far greater than what the US needed for its consumers (i.e. the US was producing for consumers at home and abroad).  So when investments were made and productive capacity was further expanded for consumers that didn’t exist, it wasn’t very effective in driving growth.  Today, China can go with the Obama plan and build productive capacity, but it means something very different in the US than in China.  In China, it would mean expanding infrastructure and production for economic reasons that don’t exist.  The 1930’s were not actually that bad times in Europe.  While recessions were strong enough to lead to the rise of fascism, the economies were well underway in the early 1930’s as government spending increased production to meet consumption levels and bad debts were held abroad anyway.  In retrospect, economists look at the US policymakers in the 1930’s and say “What idiots!”, but in fact the policy choices in a depression that a net exporter has to make are much, much harder than those a net importer has to make (i.e. print money and make the net exporter pay for it).

2)                  The Chinese property market is in disarray.  For comparison purposes, it employs about 70 million people, which is about half of the US workforce.  There are a host of reasons for this.  To cite one example, here in Beijing, many buildings stand empty because ex-pat Chinese bought (long-term leased) apartments as a way to play the RMB appreciation with less restrictions than a bank account would.  When the RMB appreciated a few percent a month, it didn’t matter whether the apartment was occupied or not since its value was growing so rapidly.  Now that the RMB has been flat for 6 months and capital is going to safer places, everyone is selling.

3)                  On to the US.  I found a great graph, which is attached.  I didn’t come up with this, but it represents a turkey’s daily estimate of the probability of its own survival into the next day – starting on the left with its birth, every day that passes and it is fed, it becomes more confident that it will survive to see tomorrow.  That lasts all the way up until Thanksgiving, ironically, the day that it thinks it is most likely to survive.  The day after Thanksgiving, its probability of survival is 0.  Of course, this is a parable, the graph is a common representation of a group of people taking risk.  In this case, the data is the extension of mortgages in the US.  A similar graph can be constructed for commercial and industrial loans in the US.  These loans make up about 25% of the US banking balance sheet, have very low recovery rates when things go bad, usually cause banking crises and have yet to go bad in this economic cycle…until December.  December saw a substantial contraction of C&I lending.  This is a problem because these are loans to businesses, so they support employment and the making of stuff.  Plus, the reason that a bank would contract its lending is that its existing book of loans is starting to perform very poorly…Meanwhile, back at the ranch, in the public markets, the VIX (often called the “fear index” (a higher number means more fear)) has been dropping rapidly.  Since late November, investors have been becoming more sanguine about their prospects for survival for another day.  Every day that has passed has brought good news of bailouts and Obamarama to fill the Christmas news-void.  Odd isn’t it?

View from the Bottom #3

View from the Bottom #2

View from the Bottom #1

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View from the Bottom #3

In Uncategorized on February 5, 2010 at 5:34 pm

December 6, 2008

The real time data on the US supply chain continues to contract in early December at an accelerating pace from November, so the January data on December that the US Census, Fed, etc…put out will be more bad turning to worse.  Most Wall Street economists still predict high single digits unemployment, while the real time data still makes double-digit unemployment a done deal.  The data on C&I lending also indicates that this collapse is well on its way.

I only got around to finish reading the CPI and PPI releases from November this weekend.  While the headline numbers were negative, more than 2/3rds of the line-items were actually up!  So a few big movers (commodities and some industrial goods) brought these numbers down, but the environment is not completely deflationary yet.  That being said growth in growth of nearly every line item was negative, except of course for banks – which have tremendous pricing power at the moment.  Ah, to be a bank in a credit crunch with no legacy assets, every commercial bankers dream.  Right now SCHW and WABC are the only banks I know of that are living the dream.  There’s about 8,000 other banks out there, so if you know of any, I’d love to hear about them.

I am a diligent student of the Federal Reserve balance sheet, which has seen a lot of action recently (why not, some boys dream of being a fireman, I can dream of owning a bank that prints money).  If you look through the most recent Federal Reserve balance sheet this week you will notice a curious thing.  There are about $500bn in reserves.  The Fed usually doesn’t carry any meaningful reserves.  If the Fed is keeping Ben at the printing presses overnight to bail out this or that bank and finance this or that Congressionally mandated hand-out scheme, what is the money doing back on the Fed’s balance sheet?  Odd.  There are many explanations for this, including some from the Fed that don’t make a lot of sense.  The immediate explanation is that the Fed started offering an interest rate on deposits in early October, so the money stayed on balance sheet (rather than being multiplied by 10x by being lent out into the economy by normal banks).

This leads me to another strange 2008 occurance, which is that lending to our spendthrift government for three months will get you a .01% interest rate, 6 months a .19% rate and 30 years a 3.12% rate.  The spread on TIPS is effectively zero (although there are some artificial calculation-related issues driving this).  This is all to say that the capital markets have decided that a steep deflationary period is at hand with little prospect of inflation.  Deleveraging is and will continue to crush asset prices, so I can’t disagree with this view in the near-term, but beyond the near-term, it seems like a strange interpretation of events that have already occurred.  One might consider it odd that inflation expectations are at record lows given that Ben’s efforts at the printing press haven’t fully hit the money multiplier in the banking system yet, or that Obama’s announcements to spend money wherever (as long as it is lots of money) haven’t hit the money supply yet, or that the Fed plans to make another $800bn to buy bad assets from financial institutions, or that Ben made his career writing about inflating currencies to avoid Depressions, or that China is currently trying to buy gold as fast as it can without disturbing the market, or that the US government would like its currency to be worth less against the Yuan, or that the Chinese government last month made it a policy target to flush US dollars back to America in order to have another year of 8% GDP growth, or that the largest owner of US debt remarked this month that – “after a short while, the dollar may be going down again.  I’d like to bet on that!”.  In the face of reality, I have seen stranger things happen – like an IPO based on a powerpoint deck or a no-money down loan to someone unemployed.  The consistent periodicity of these phenomena are striking – a year of momentum, a year of irrationality and then a year where things crack.

View from the Bottom #2

View from the Bottom #1

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