Streetwise Professor

January 10, 2010

The Bear and the Tiger

Filed under: Economics,Financial crisis — The Professor @ 10:25 am

Infamous short-seller and sometime SWP follower Jim Chanos is very bearish on China (H/T MJ).  Sayeth Chanos:

Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point.

I can’t disagree, and have been expressing skepticism about the sustainability of China’s growth for some months.  I referred to China as the Michael Jackson economy: kept performing by outsized doses of artificial stimulants.  That can work for awhile, but as MJ (not the SWP reader:) showed, the ultimate effects are likely catastrophic.

What I find hard to understand is why so many investors and commentators seem to have bought into the China growth story hook, line, and sinker.  I don’t expect everybody to be as skeptical as I am, or as Chanos is.  But one would think that in the aftermath of a major economic contraction which plausibly resulted from an overly expansive monetary policy and various institutional factors that directed most of the ballooning credit to the real estate sector, the China boosters would at least pause to ask whether the same might be occurring in China.  Or to question the reported growth, that always miraculously hits official targets, much in the same way as Enron’s earnings always miraculously came in as expected, with metronomic regularity.

Part of the credulity seems to stem from a confidence that Chinese planners have the ability to manage the economy efficiently and avoid a bubble followed by a crash.  You know, sort of the same attitude that gave people confidence in the genius that was Greenspan.  Well, Greenspan was no maestro, and it would be foolish in the extreme to expect China’s rulers to be any more adept with the baton (or, should I say “wand,” apropos the Sorcerer’s Apprentice?).  At the very least, it is prudent to recognize that there are serious downside risks in China.

The NYT article states that Chinese regulations make it difficult for Chanos and others to trade on that view.  As the old Diamond-Verrechia article demonstrates, such restrictions can delay the market’s reckoning.  But not indefinitely.  China is riding the tiger, and has deliberately taken a huge calculated risk in its massive stimulus program.  The historical track record of these initiatives is spotty at best.  Moreover, the Chinese strategy is implicitly based on a strong recovery in the developed nations generally, and the US particularly, and the prospect for that is shaky.  Add to that the fact that China is massively long the dollar, and hence somewhat a hostage to the highly uncertain effects of the Fed’s unprecedented monetary policies, and the course of those policies going forward.  Putting it all together, the downside risks are pretty sobering.  At least you’d think they’d be.

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  1. “And when it comes to investigating corporate fraud, it’s the short sellers who are the detectives, while all too often our regulators practice archaeology.” – Jim Chanos

    Comment by Surya — January 10, 2010 @ 11:07 pm

  2. “What I find hard to understand is why so many investors and commentators seem to have bought into the China growth story hook, line, and sinker.”

    Desperation to find some source of global growth?

    Comment by rkka — January 11, 2010 @ 5:46 am

  3. Professor, did you see the note on Bloomberg this morning that 3 of the 4 highest valued banks (by price to book ratio) are Chinese Banks? Goldman is somewhere in the 30s. Frankly, it’s ludicrous. US banks are penalized (many trade below book value, which is still likely over stated) whereas Chinese banks (CITIC, etc) are traded at premium, despite the fact that these institutions are propped up by government largesse. The chinese banking system is in for a brutally rude awakening, now if only I could find a way to short some of these banks…..

    Comment by Jack — January 11, 2010 @ 11:14 am

  4. Jack–

    Sure ’nuff. Back when oil was in the $140s, I would often be asked about what would cause its price to fall. I said that the most likely cause would be an implosion in the Chinese banking system, which has long been sitting on a pile of bad debt, mainly from state enterprises. Well, I had the right cause in general (banking collapse), but the wrong banks:) That said, I still think that the Chinese banking system is a major accident waiting to happen. If anything, what happened in 2009 has just added to that potential. With asset prices bubbling based on credit extended by these banks, it will be a minor (or major) miracle for these banks to escape going Japanese a la the 1990s.

    The ProfessorComment by The Professor — January 11, 2010 @ 8:58 pm


    Jim Rogers and George Soros think otherwise. Wrt the housing market in China, home owners need to put 30% down on mortgages. So, Chanos’ call on the real estate markets would be true only if most of the distortion comes from the commercial real estate market – assuming the the rules in that sector are lax.

    Comment by Surya — January 13, 2010 @ 1:27 am

  6. […] Streetwise Professor discusses the unsustainable growth in the Chinese economy. Infamous short-seller and sometime SWP […]

    Pingback by Pickerhead :: Pickings from the Webvine ::January 17, 2010 — December 4, 2011 @ 6:13 am

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