Is the coming ‘crash’ in China not a real crash?

January 14th, 2010

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By now, you would have known that we have grave reservations on the quality of China’s post-GFC economic rebound. We are not alone in our reservations as there are many experts, both in the mainstream and non-mainstream media who share our view. But there are also many others who seems to hold the opposite view, including Jimmy Rogers.

For those who are looking for answers, all we can say is that China is very difficult to read. It is a country with many mirrors. When we Westerners try to interpret China through a Western lens, culture and context, we may end up misinterpreting, misunderstanding and missing the subtleties of China.

Economic data from China is something that investors should not swallow entirely without question as no one knows how accurate they are or how much of them are made up. As data flow from the bottom to the top layers of the vast Chinese bureaucracy, from the local government to the provincial government and finally to the central government, we wonder how much of the information are lost, misinterpreted, fudged, revised, falsified, misrepresented, hidden and added? Or perhaps we are too cynical?

But if you hold the view that a a big economic correction is coming to China and wants to ‘short’ the country, you have to be aware of what you are betting against. First, you are betting on deflation in China, symptoms of which include falling asset prices, rising unemployment and bankruptcies. Governments, on the other hand, would prefer to err on the side of inflation. When you have an authoritarian government that can make and change the rules, you can be sure that they will draw out the big guns to fight against deflation. For example, what if a trade war threatens to do serious harm to the Chinese economy and social stability? We wouldn’t be surprised if the Chinese government whips out nationalistic sentiments, point the finger at the nations that started the trade war and in the extreme case, start a shooting war. According to Marc Faber, he reckoned that the same would apply to the US too.

But let’s not get too carried away with expecting an almighty economic ‘crash’ in China Let’s play the devil’s advocate for now and examine the reasons why Jim Chanos (the guy who publicly wants to ‘short’ China) may be wrong.

As a whole, China is not too leveraged (unlike countries like Australia, US and UK). The people in major cities (especially Shanghai and Beijing) are highly leveraged and share many similarities with highly indebted Australians and Americans. For example, the housing bubble in Shanghai is much bubblier than the one in Australia. Credit card habits of the city young adults are just as bad as their Western counterparts. Since the financial system in China are still very much primitive compared to countries like Australia, US and UK (the financial sector in those countries are probably too big), the debt disease have yet to reach everyone in China, especially the hundreds of millions of rural peasants.

At the same time, the rich-poor gap in China is much wider than in Australia. For example, there are still hundreds of millions of poor peasants living in under-developed or undeveloped rural areas. Large swathes of China have yet to develop and catch up with the affluence of the coastal cities. A deflationary crash will affect the highly indebted city folks much more than the rural peasants. Since the fruits of China’s economic boom have largely bypassed the latter, they will hardly miss the loss of wealth due to an economic correction because they have not gained much in the first place. Whether boom or bust, these people will still go about their business everyday.

Deflation, in fact, will benefit those on the poor side of the rich-poor divide. The economic boom has a very detrimental effect on them as the price inflationary effects actually made them poorer (we heard stories of migrant workers in Shanghai who are too poor to even buy food). Deflation re-distributes wealth to these people. Currently, the Chinese government is in the process of developing the poorer regions in China. That, plus deflation may re-distribute economic resources and activities to those areas. For example, those same migrants workers who are too poor to buy food in Shanghai may want to return to their home villages because of better opportunities (from government development) and better standards of living (food are probably cheaper and affordable there).

If this theory is correct, it means that a ‘crash’ in China should not be interpreted in the same way as a crash in Australia, Japan or the US. In the Western world (including Japan), an economic crash means that the standard of living for everyone in general will decline. For China, because of its relatively wider rich-poor gap, it may just be a wealth re-distribution exercise in which some will be better off and some will be worse off. On paper, a Chinese ‘crash’ is bad in terms of GDP growth and demand for resources. But socially, it may not be such a bad thing as it may be China back into a more sustainable growth path.

That could be the reason why people like Jimmy Rogers are still optimistic on China. Investors like him are probably not investing their capital on the frothy affluent cities. Instead, he is probably investing in sectors of the Chinese economy that will still be humming along and going about their business even when the ‘crash’ hits the economy. Unfortunately for many investors, the ‘China’ that their investments are in will probably not survive the ‘crash.’

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