The bubble in China…finds its roots in Western exuberance.
Across the table from us at lunch yesterday sat the prettiest sinologist we had ever met. Long, dark, silky hair…dark eyes….a lively smile…..she is the only sinologist we had ever met, too, but that perspective did not help; she was so lovely and charming we knew we could not disagree with a word she said.
The luncheon had been arranged by our mutual friend, Michel, upon whose face a look of satisfaction was becoming so comfortably fixed, it looked as though it might be there forever. For here was an expert confirming, with authority, what Michel had been saying for years – that The China Story is a fraud.
"I wouldn’t put a nickel in India," says our friend Jim Rogers, "but I think China is the future. I tell people that if they want to do something that will really help their children and grandchildren, they should teach them to speak Chinese."
Jim has made two trips around the world – one on motorcycle and another in a specially-designed Mercedes. His conclusion has become the dominant one – China is booming, China is the future, China is unstoppable. He has even hired a Chinese nanny for his daughter; so she will learn Chinese before she goes to school.
There are two major ways to compete in the business world, price or quality. China has an almost inexhaustible supply of cheap labor. With adequate capital funding…and access to global markets…China seems sure to win a large part of the world’s manufacturing; in fact, it already has.
The China Story line is that it will follow the well-trod path of Asian economies, with export-led growth. Already, it is building so many factories and using so many raw materials, it is disturbing markets on both ends of the production cycle. Chinese buying of raw materials is said to be the cause of a bull market in commodities. Meanwhile, Chinese selling of manufactured goods is depressing prices at the retail level all over the world. Walmart, the biggest retailer on the planet, constantly demands lower prices from its suppliers. Suppliers have little choice but to buy a ticket to Beijing. If a gadget can be made in China…its price is likely to be falling.
Typically, the pattern – pioneered by Japan…followed by South Korea, Taiwan and Malaysia – has been to start with simple products and to gradually take on more complex and demanding production. Little by little, your labor becomes more skilled, your machinery becomes more sophisticated, and your sales team is able to reach deeper into foreign markets. Soon, you have put the American TV makers out of business and you are rivaling General Motors and Ford in auto sales. Sony, Hitachi, Honda, Mitsubishi – all have traveled this route.
The trouble for Japan was that it ran out of cheap labor. In fact, it was running out of labor at any price. Japan’s population is falling…and is among the oldest in the world; it could supply neither workers nor even consumers.
But China, that’s another story!
The country not only has an almost infinite supply of willing, cheap workers, but what China doesn’t know about pent-up consumer demand is not worth knowing. Almost nobody has ever had anything in the Chinese heartland. And there are millions and millions of nobodies.
All up and down the coast, construction cranes are everywhere. In Shanghai, the weight of new construction is so heavy that the entire city is said to be sinking at the rate of 1 centimeter per year.
Among investors, China is attracting standing-room-only crowds. A report from the recent Gold Show in San Francisco tells how investors mobbed Robert Friedland’s speech on Ivanhoe Mines. Friedland had managed to turn the mining story into The China Story…and investors couldn’t get enough of it. Columnist Tom Calandra is sold on it…Friedland and his friends are sure to get rich – again – on the story.
Ivanhoe has a huge property in Mongolia, that will one day – or so the story goes – produce copper and gold. The copper will be sold to China…at ever rising prices. Listeners were invited to imagine what would happen to copper prices if every Chinese family put in an air-conditioner! They are left on their own to imagine how rich they might become after buying Ivanhoe, as China and the mining company boom together.
Across the Japan Sea, the Japanese Central Bank reports that "economic activity still continues to be virtually flat as a whole…private consumption continues to be weak, housing investment remains sluggish, and public investment is declining." But foreign investors in Japan are excited; they see themselves as profiting from The China Story! The fund manager we met in London, for example, saw Japanese companies as the saloons and feed-stores servicing the miners in the Great Chinese Gold Rush.
"Japan has the money, the know-how, the commercial connections, the technology – everything the Chinese need to continue their development," he explained.
On the thin surface of the Western financial press, it almost seems to be true. China is growing at such a furious pace, the Chinese government is allegedly fiddling the figures in order to understate its growth rate; foreign investors might be alarmed if they knew what was really going on.
They would be appalled if they really knew, was our sinologist’s message.
The woman speaks flawless Chinese, as well as Malay and Cambodian, and has lived for long periods in China. She does not look Chinese, "but that doesn’t matter," she explains, "if you speak the language and understand the customs, they treat you as though you were Chinese. Which is not necessarily a good thing. Life in China is very hard."
"It’s not at all what Westerners think," she continued. "They see the construction on the coast. But they have no way of knowing if these projects are profitable. The numbers…and the basic information…is not available. And if they were to go into the interior of the country, they would see a different world. There are millions and millions of people just trying to stay alive. You see children with bloated bellies; they just aren’t getting enough to eat.
"Westerners see the Chinese system as such a great thing…compared to, say, India, it seems to work so well. But that is just not true. In India, there is more or less a free press. So you learn about all the crazy things that go on. But in China, you never find out. And India, after all, is a free country. That is not at all the case in China. China is still a communist country. Before that, it was still a totalitarian state. It has almost always been a totalitarian state. You still can’t go where you want. You still don’t know what the rules are. You still can’t find out any information. And everyone you talk to – even if he is a successful, powerful entrepreneur – has someone behind him, a shadow, with the real power.
"Right now, everyone seems to want to put money into China," she went on. "But how do they expect to get it out? Even the Taiwanese have not figured that one out. The Taiwanese are Chinese. They have powerful friends, and family, in the Chinese power structure. But even they cannot get money out of the country. They can put it in. They can do very big, profitable enterprises….but when push comes to shove…even they cannot get it out."
Americans and Europeans imagine that the world has undergone a major change. The triumph of Western market-driven consumerism is total, unchallenged and final, they believe. Yes, the Chinese may still call themselves communists, but they follow the same rules – written or unwritten – as everyone else…the rules of civilized, Western commercial transactions. You expect that when you buy something, you can sell it. You think that when you own something, it is yours to do with as you like…and that your money is yours to take home and spend.
But the Chinese have rules of their own, our beautiful new friend reminded us. As a foreigner, you won’t even know what the rules are…until it’s too late.
The China Story is a giant fraud, Michel maintains. It is like the Russia Story before WWI. French investors were the major investors in Russian development projects. Russia was a growth stock back then; it made sense to buy in. Fifty years later, hardly a family in France did not have a few worthless Russian bonds in its attic.
Then, the Russia Story became a Soviet Story. Again, the Western intelligentsia were taken in. George Bernard Shaw, Eleanor Roosevelt and hundreds of other visited Russia and were impressed with the marvels of communist organization. There were construction projects everywhere – canals, dams, railroads, factories. No one seemed to notice that the projects were built with slave labor and would never be profitable, or even useful.
There was also The German Story of the ’30s. The country seemed so dynamic…so well-organized…so full of energy and self-confidence. As WWII developed, many foreign intellectuals who had visited Germany came home agreeing not only that Germany would win the conflict…but that she also deserved to win, because she was the country of the future.
"India is, of course, a mess too," the sinologist concluded. "But each time I left China for India, I breathed a sigh of relief. There was no one following me…no shadow partners…no hidden rules. India is a paradise compared to China."
"Pao mo," we said to our guest on parting.
"Pao mo. Isn’t that Chinese for ‘bubble’?"
"Oh…oh yes, pao mo," she said, saying the words in a way that barely resembled our pronunciation. "Pao mo. Exactly."
November 28, 2003
Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the NY Times and international best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).
Markets in America were closed yesterday. Offices too.
So, there were no cheery headlines to brighten up today’s news. No revisions of GDP or inflation levels…no new figures on housing starts or consumer confidence.
Investors must have fidgeted all day – hoping for some reassurance that the miracle economy was, indeed, still miraculous…and not a fraud.
The miracle is that you can recover from too much spending by spending more…that you can cure a debt problem by borrowing more…that a consumer economy can grow forever without ever having to concern itself about where consumers get the money to spend…and that foreigners will go on lending forever without ever worrying about getting their money back.
It would be easier to walk on water…or turn water into wine.
But the lumps aren’t worried about it. And neither are we.
Let the miracle continue!
But let’s not be a fool about it, either. There will come a day when investors wake up with a sneaking suspicion that the miracle is a fraud. That would be a good day to own a few anti-miracle investments…such as a Laundromat somewhere…or a goldmine in the middle of nowhere.
John Boland of Remnant Partners in Baltimore recently revealed – at a Grant’s investment conference in New York – the kind of long-shot investment that might turn out to be a lay-up in a less miraculous world. Durban Roodepoort Deep is a South African mining company that was supposed to go out of business 15 years ago, Boland told attendees.
Instead, it bought up reserves of 14.4 million ounces of gold. Trouble is, the gold is deep under the surface, hence the name of the company, and expensive to bring to the surface. At $400 an ounce, it is hardly worth the trouble. But at $1,000 an ounce…Durban Deep is, well, a gold mine.
Further news and thoughts from Addison:
Addison Wiggin, shooting a coup d’oeil over the day’s headlines…
– Black and blue…and beige all over. This day after Thanksgiving is a colorful one. Traditionally known as ‘Black Friday’; consumers satiated on dopamine, turn out en masse, credit cards en main, and push retail balance sheets into the black. Last year, this day saw a 12% jump in retail spending over the year before. But before the season was out, retail spending had retrenched to just a 2% year-over-year increase. Retailers got whacked hard in early January.
– What will this year’s joyous season bring? Well, if the willingness of the almighty American consumer to take on debt through October is any indication, retailers will be quite happy this year. As we noted last week, consumers were expected to tack on $5 billion in consumer credit…instead they tacked on $15 billion.
– What the heck…why not? The Fed’s Beige book came out on Wednesday. And while it doesn’t necessarily reflect a booming economy, it suggests at least one that has absorbed various forms of Federal stimuli in large amounts. As you might expect, consumer spending headlines the Fed’s summary economic reports received by each of its member banks through November 17, 2003. Most regions are experiencing "solid" consumer spending. Only Boston, Cleveland and Chicago reported "mixed" expectations for holiday spending.
– The Beige Book also coos approvingly on every market observer’s favorite subject these days: joblessness. Most regions report that the labor market is "generally improved" or "remaining stable." A host of temporary holiday box schleppers is expected to make the picture even rosier. Real estate and residential construction remain strong in all regions. A headline in the LA times suggests that sales of million-dollar homes has hit an all-time record. At this rate, the government’s well-timed stimulus package could have Americans singing carols well into the New Year.
– "What worries me most at present is that even I, a skeptic, can’t find any good reason why stock markets around the world would decline significantly," writes Dr. Doom himself, Marc Faber.
– "That’s not to say there aren’t a lot of issues that concern me," Faber continues, "but if central bankers around the world are prepared to print money and to flood the system with unlimited liquidity at the first sign of weakness in the asset markets, then it is difficult to make a very bearish case for either U.S. real estate or U.S. equities in dollar terms."
– Faber’s case: "We know Mr. Bush wants to be re-elected à tout prix, and that therefore, over the next 12 months, he and his lackeys at the Fed and the Treasury will only take economic policy measures that are designed to keep the American public happy with ‘circus and pane.’ This economic policy was practiced for centuries by the Roman emperors and was designed to keep the lower classes of society in good spirits and obedient.
– "As was the case in the Roman Empire, ‘circus and pane’ economic policies undermine the value of a currency and, if pursued long enough, eventually lead to a total loss of its purchasing power. However, and this should be noted, such policies can give the majority of investors the illusion of wealth as asset markets appreciate, while the loss of the currency’s purchasing power is hardly noticed.
– "This is particularly true," Faber notes, "of a society that has a very large domestic market, where 90% of the people don’t have a passport and therefore know little about what is going on outside their own continent, and where the import prices of manufactured goods are in continuous decline because of the entry of China, as a huge new supplier of products with an extremely low cost structure, into the global market economy."
– Trouble is, as your editors have been laboriously pointing out day after day, if pursued long enough, "circus and pane" economic policies undermine the value of a currency and eventually lead to a total loss of its purchasing power. Indeed, yesterday was one of those days…despite the holiday in America.
– While traders, brokers and market makers relaxed on the couch with their hands neatly tucked into their pants watching football in New York yesterday, the dollar got sacked and dragged down to a new all-time low against the euro; 1.197. Ouch again, groan your Parisian correspondents. As part of the 10% of Americans with passports (and the even smaller contingent that actually use them), we feel the dollar’s pain keenly.
– The greenback also lost big yardage against pound sterling, then later spiked by the wily South African rand. If you are planning at trip to London anytime soon, be prepared to pay $1.71 to buy a £. Way down in Jo-burg, the rand rushed its way to a fresh 43-month high against the dollar.
– The yen, on the other hand, put up an effective defense. But we are beginning to wonder how much stamina the diminutive currency has left. Since August, in an attempt to keep its exports cheap in the eyes of the needy in American, the Bank of Japan has swapped yen for dollars at the rate of $1 billion per day. We were flabbergasted one day last week, when the BoJ bought $9 billion in the currency markets, pushing the greenback up from 3-year lows against the Yen; that same day, it was rumored to have just Y8,500 billion left in reserve.
– Today, our back-of-the-envelope calculations reveal that Japan has just 72 days left, thanks to the U.S. wanton attempts to destroy its own currency. What’s more, the Financial Times tells us that the "Bank of Japan reports first loss in decades." The central bank has announced that it can’t pump any cash into the Japanese government’s 2003 coffers. It made a profit of 288 billion yen in the first half of 2002; between January and June this year, it lost 110 million yen. The BoJ accounted for more than 1% of Japan’s overall tax revenues last year.
– That would be a first, huh? Picture the headlines that would arise out of this scenario: The world’s largest economy hell-bent on destroying itself inadvertently bankrupts the world’s second-largest economy…what a hoot! We almost can’t wait!
Bill Bonner, back in Paris…
*** Never before have we seen such a thing in the popular press. For the first time, in a TIME magazine article entitled "The Dollar Drag," the idea of hedging against the dollar has been presented to lumpen Americans. Since January of 2002, the dollar has lost 25% of its value against the euro.
*** "An Electoral Raid at Baghdad" is the headline story in today’s left-leaning Liberation. There on the cover is a photo of G.W. Bush, Commander in Chief, serving turkey to the troops.
We recently received a signed photo of the president, thanking us for our support. "Working together," said he, "we will build a better future for every American." We cannot recall giving the man any support or working together with him, but it may have been at a time when we were both drinking.
In fact, all we recall is our criticism of his reckless wars – shooting wars and trade wars…not to mention his war on the next generation’s solvency. Most critics don’t like the guy because he is considered an "ultra-conservative cowboy." We wish he really were.
We have to hand it to the guy….he may not be a military genius, but he seems to have a real talent for attacking the media at vulnerable points. Just when Hillary Clinton was set to grab headlines with her appallingly opportunistic Thanksgiving Day visit to Afghanistan…George goes on the offensive and upstages her completely. Mission accomplished.
But the admirable part, dare we be naïve in saying so, is that the president may be entirely genuine; he probably liked the idea of having turkey with the troops in Iraq…whether it brought him good press or not. He just let the TV crews in to cheer them up too.
*** Oh là là…the life of a moral philosopher pretending to be a stock market commentator is not always easy. No easier than a Maryland Episcopalian pretending to be a French catholic. Yesterday, we received a surprise phone call. It was from Henry’s priest…who had found our commentary in the French version of the Daily Reckoning and was not happy.
"Oui, mon père…" we replied. "Yes, we admitted, we did use your name. And yes we did make a joke. But no, we did not intend to cause you any embarrassment."
"But you must realize, here in France this is no laughing matter," he continued. "We have a long history of religious persecution. This is a sensitive subject. It is not something you should treat so lightly."
"We did not really think that anyone would take our comment about burning Henry at the stake in St. Peter’s Square seriously…" we protested.
"Oui mon père…mes excuses…"