One Story to Sum Up Investing in China
We overheard one story while in Beijing, that captures in a nutshell the challenge in getting a handle on investing in China:
”I was in an antique store, negotiating for this antique knife,” our China contact told us. “I was about to make the deal when the guy looked at my Rolex watch and offered to exchange. I was ready to do it, but I knew my Rolex watch was a fake, and I didn’t want to take advantage of this guy. So I told him I didn’t want to trick him and that the watch was a fake. He said to me, “That’s OK, this knife is fake too.”
That’s one thing about China that is tough to untangle: figuring out what’s real economic growth and what’s fake. Walking around in Beijing – seeing all the new buildings, the traffic and the bustling stores – makes you wonder how much is due to natural demand and how much is artificial stimulus. If it’s more of the latter, then much of what we’ve seen is unsustainable.
There are two important parts of the macro backdrop that are important to understand about China. First, there has been a tremendous increase in bank lending since the end of 2008 – it’s up something like fourfold. And we know from experience that when banks grow that fast, bad things tend to happen later. What happens when banks grow that fast is that they slide down the credit quality spectrum. In short, they make tomorrow’s bad loans.
Secondly, we know that the Chinese government has put in place a huge stimulus plan. And again, we know from experience that when governments invest money, you inevitably wind up with ‘bridges to nowhere’ and all kinds of boondoggles. The money doesn’t flow to its best economic uses, but to political ends.