Posts Tagged ‘Jim Chanos’

What if China crashes?

Sunday, May 9th, 2010

Regarding the current drama in Europe, if the European authorities does nothing (or stoically refuse any thought on moral hazards), the world will get a GFC II, in which Australia may not be so lucky this time round. Our guess is that when push comes to shove, the Europeans will eventually print money and kick the can further down the road. After all, with the nightmare of the Panic of 2008 still fresh in their minds, they will not repeat the ‘mistake’ of acting too slowly. The outcome will be more moral hazards and monetary inflation, which is something we and our children will pay down the road.

Meanwhile, as the global financial markets are fixated over the current sovereign debt crisis in Europe, contrarian investors (especially Australian investors) should look at another part of the world for any potential mishaps- China. Starting from January this year, the Chinese government had been tightening the supply of credit. Measures include turning off the credit tap to increasing bank reserves requirements. Recently, unlike 2008, the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst (see Is China’s Stock Market Crashing?).

As we wrote in Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle), with all these tightening measures, China will slow down this year. The question is, will the Chinese government accidentally over-tighten cause a crash instead? Remember, its objective is a soft-landing (which they managed to pull off in the 1990s under ex-premier Zhu Rongji). But will they end up going too far, resulting in a hard-landing?

Only time will tell.

But if it happened, you can sure that Australia will have a very ride. As we warned our readers a few months ago in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

The first effect of an economic slow-down in China will be a fall in base metal prices. Already, there are some signs that base metal prices are cooling off. For example, copper prices are approaching the lows made in January this year. If China crashes, we can expect base metal prices to crash too.

Next, given that the Australian dollar (AUD) is seen as a commodity currency, it will fall. This is to be expected as Australia’s terms of trade and business cycle is closely tied to Chinese demand for commodities, which in turn is tied to the business cycle in the Chinese economy. A crashing Chinese economy will be likely to test the AUD as it was tested in 2008. Mining companies in general will not do well in such an environment. In fact, speculators like Jim Chanos will be shorting the Australian mining stocks (see How is Jim Chanos going to short China? (Australia: take note)).

Then, with the deteriorating terms of trade (due to falling Chinese demand), the Australian economy will slow down. With that, there will be speculations (and hope) that the Reserve Bank of Australia (RBA) will be cutting interest rates.

If China’s coming slowdown is just a soft-landing, then the story may end here. But if it’s a hard-landing, then there will be more complications. In that case, Australia is very likely to have a hard landing too. This is where we are getting nervous. The critical thing to watch out for is Australia’s unemployment rate. As we wrote in RBA committing logical errors regarding Australian household finance,

Given Australia?s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises, it will eventually reach a critical mass of prime debts turning sub-prime.

Given that Australia’s highly leveraged banking system is heavily concentrated on mortgages (Black Swans lurking around Australia?s banking system), there will be a tipping point in the unemployment rate that will trigger a banking crisis. That in turn may trigger a currency crisis (see Will there be an AUD currency crisis?).

How to buy and invest in physical gold and silver bullion
If there is an AUD currency crisis, the RBA will be in a quandary. Should it cut interest rates further to support the domestic economy (and condemns the AUD)? Or should it raise interest rates to defend the AUD (and condemn the domestic economy)? This was what Iceland faced in 2008- high inflation, collapsing currency and rising unemployment. The Icelandic central bank had to raise interest rates to defend its currency. Remember, a collapsing AUD implies that the price of oil imports in AUD will sky-rocket (limited to the extent that oil prices are falling due to reduced Chinese demand). As you can read in Five potential emergencies- energy crisis, this will be extremely disruptive to the Australian economy.

Of course, the scenario that we painted is extreme. But after having read and understood Nassim Nicholas Taleb’s The Black Swan, we learnt not to say “never.” Hopefully, the outcome will not be that bad. But for those who want to be prepared, we highly recommend How to buy and invest in physical gold and silver bullion.

How is Jim Chanos going to short China? (Australia: take note)

Thursday, February 18th, 2010

As we all know, the infamous short-seller (who made the famous short call on Enron), Jim Chanos, has declared publicly that he is shorting China. The question is, how is it possible for him to do so in a practical sense?

For one, there is no market mechanism to short Chinese A-shares in mainland China. Currently, the ability to short-sell shares in China is on a trial basis, with no exact time-table announced for a transition to a full basis. As this Financial Times article reported,

The regulator said it would follow the principle of ?test first, then expand?, and would select some companies to launch products on a trial basis.

But the statement left many questions unanswered, including which companies will participate, whether foreign groups will be included, and the exact timetable.

The only practical way to short China is to short-sell Chinese A-shares on the Hong Kong stock exchange.

But there’s another alternative. And that is…

No, we wouldn’t give the spoiler in this article. Watch this YouTube video clip below:

Please note this is not a recommendation to short-sell Australian miners tomorrow. This is for you to understand that the short-seller sharks like Jim Chanos are probably on the alert to pounce on Australian miners.

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

Thursday, January 14th, 2010

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.’