DEAR CHINA: YOU’RE MAKING ME NERVOUS……

Behind China's wall, there is much, much more than what meets the eye. Have you taken a look INSIDE those newly built skyscrapers of theirs? There isn't an inside, just an outside. I'm no poet or Hemmingway, but are not China's empty skyscrapers a metaphor for China itself? Did you know that North Korea has one of the largest hotels ever built in the world?! Who is staying there? No one; the building was constructed to simply provide the smoke and mirrors for North Korea's government. And that's exactly it, the government is in control of what is seen or hidden. Ultimately, putting one's faith in China is putting your faith in China's government. I was once told by the former NFL player and coach Herm Edwards; "what you do in the dark, will eventually come to the light."

There are 3 main areas of China that are to be discussed: growth, real estate, and the society.

Let us start with growth. For those who are in investment banking or company valuations, growth is a supreme creature. When valuing a company, one typically looks at growth and margins, among other things. If a company is experiencing high growth, it can be assumed that the growth will eventually lead to a level of sustainability (typically 5 - 8 percent). Otherwise, a company may end up growing into infinity, NOT REALISTIC. But, what is obtainable is preserving the margins that the company had during the high growth years. There may be other instances where margins are reduced by the entrants of competition instead of market saturation. Looking at Procter & Gamble who has the 4th largest market cap as an example, who has annual revenue of roughly $80 billion, still maintains an operating margin (EBIT/Revenue) of 20% while its revenue grows between 5-8 percent annually. Let us return to China, their GDP has grown an average of 10% for the last 30 years, and they now have the third largest nominal GDP in the world (behind the U.S. and Japan). Growth will start to decline in China simply due to the fact they have reached a size where growth will come from the growth of other foreign GDPs and efficiency improvements. When growth rates decline, future earnings estimates decline, and equity prices fall. The Shanghai SE Composite Index, which is composed of 30 Chinese stocks, is down nearly 60% from its highs of October 2007. Since the first trading day of 2010, the Chinese index is down over 26%. Compared to the Dow Jones Industrial Average during the same period, the U.S. has outperformed China by 19%. Once again, China's growth will have to come from foreign GDP growth and efficiency improvements. Both take time to develop and implement.

China's real estate has been a topic of major discussion recently. Values of property have been increasing faster than what was seen during the U.S. housing bubble. In fact, real estate values in Beijing's city center have leaped as much as 6.5% in a single week. The demand for property is truly driving the prices. With a rush to the developed cities from the farmlands by Chinese citizens combined with the entrance of foreign professionals, a siege of demand has swept over the property market. Most notably is the type of new housing projects that are being and have been constructed in China, the "upscale" or "luxury" condos. For anyone who has been following the U.S. housing crises, the amount of deserted high-rise luxury condos has been astronomical. The city of Miami is a perfect example of this. It's not the ultra wealthy who are living in these types of condos, but the newer upper-middle class who depend significantly on their paychecks. When a recession happens, this upper-middle class is the first to downgrade, leaving their condos behind. So what has the Chinese government done? They have implemented some restrictions on individuals buying second and third properties and increased the down payment requirements. But the banks are still exposed like never before. In a press release issued by credit rating agency Ficth, they described how Chinese banks are packaging the loans and selling them to investors at an incredible speed. Hmmm, sound familiar? In fact, it was reported that Chinese banks are now involving themselves in vastly complicated transactions to circumvent the restrictions implemented by the government. It gets worse, the Chinese banks are now realizing the increasing public following of their transactions and large loan balances so they are cutting off more and more access to information on their balance sheets. Scared yet? Going back to the demand side of the Chinese housing, it is still there. However, it is the uncertainty of future government actions and the knowledge of the U.S. housing crises that has frightened some buyers.

Finishing with the society of China, one can really begin to understand the country's future. China has a political system known as Communism, and a business system known as Capitalism. Although it is not true capitalism, it is very strong system. We need to understand the basics of human demands. First there are things like food, water, and shelter. Then love and growth, etc. What is happening in China is that many of the first order needs of society have been met, and now the second level has been fulfilled too. But humans always want more, and the Chinese people want more as well. New desires like the right to vote, travel, own property, and privacy are now being demanded. Many of these, the communist government does not want their people to have. It is through the growth and prosperity of the economy of China that has silenced the cries for more rights. It is in the best interest of the government to do everything in their power to keep the economy vigorous. It's now that one can see that putting faith in China is ultimately putting one's faith in their government.

Comments (30)

Jul 13, 2010

great post.... but please, break the larger paragraphs down into smaller ones (its just easier to read online with smaller paragraphs IMO)

    • 1
Jul 13, 2010

Thanks LIBOR! I agree with you, I needed some breaks in there

Yours truly,
The Young Investor

Jul 13, 2010

Not a bad post. Being a follower of China, I would say that the Communist leadership is trying to stimulate economic growth and create jobs in order to stay in power.

When China reaches critical levels of unemployment, the heads of the leadership will be the first to roll. That's why all this growth, attraction of foreign investment and capital is so important.

Another thing: don't trust China's GDP growth numbers. I have a relative in a statistics agency and let's just say that their methods are less than perfect.

Jul 14, 2010

SinoMonkey, I think you are right on. Those GDP numbers can't be as accurate as we hoped. Also, I'd like to know more about China's "ghost economy", that is the part of the economy where the transactions are 'under the table' and not properly recorded.

One thing I find interesting is that I talked to a Chinese business student who is getting their Master's in Banking & Finance, and she said that the best job to have in all of China is to be working for the government! She further went on to say that her wish to work for the government is shared by a large majority of Chinese citizens.

Interesting.

Yours truly,
The Young Investor

Jul 14, 2010
The Young Investor:

SinoMonkey, I think you are right on. Those GDP numbers can't be as accurate as we hoped. Also, I'd like to know more about China's "ghost economy", that is the part of the economy where the transactions are 'under the table' and not properly recorded.

One thing I find interesting is that I talked to a Chinese business student who is getting their Master's in Banking & Finance, and she said that the best job to have in all of China is to be working for the government! She further went on to say that her wish to work for the government is shared by a large majority of Chinese citizens.

Interesting.

Simply because the government has true power in China while in US the corporations have true power.

Jul 14, 2010

It is true, Government officials get paid for jacksh!t but they have power in their hand, guess what.....gray area income is 10x or 20x greater than government's paycheck.

Jul 14, 2010

China has been pissing me off for a long while. Their government tries to have the international power equivalent to the other major nations, while trying to say that they're too young to follow any of the restrictions placed on those nations (think Kyoto Protocol for global warming, etc). It's like watching the younger brother whine about not being able to watch rated R movies when his older brother can, but not wanting to do any of his chores first.

"Despite a voluminous and often fervent literature on 'income distribution', the cold fact is that most income is not distributed: it is earned."
-Thomas Sowell

Jul 14, 2010
moranges:

China has been pissing me off for a long while. Their government tries to have the international power equivalent to the other major nations, while trying to say that they're too young to follow any of the restrictions placed on those nations (think Kyoto Protocol for global warming, etc). It's like watching the younger brother whine about not being able to watch rated R movies when his older brother can, but not wanting to do any of his chores first.

And when the US resorted to using exorbitant tariffs at the turn of the 20th century to complete with industrialized Europe, it was perfected acceptable for emerging nations to gain an edge in order to grow domestic markets. I think the analogy is more akin to an older brother complaining that the younger brother gets special treatment, when he himself had such privileges when he was younger and was the only child.

Jul 15, 2010
accountspayable:
moranges:

China has been pissing me off for a long while. Their government tries to have the international power equivalent to the other major nations, while trying to say that they're too young to follow any of the restrictions placed on those nations (think Kyoto Protocol for global warming, etc). It's like watching the younger brother whine about not being able to watch rated R movies when his older brother can, but not wanting to do any of his chores first.

And when the US resorted to using exorbitant tariffs at the turn of the 20th century to complete with industrialized Europe, it was perfected acceptable for emerging nations to gain an edge in order to grow domestic markets. I think the analogy is more akin to an older brother complaining that the younger brother gets special treatment, when he himself had such privileges when he was younger and was the only child.

accountspayable seems a lot more accurate to me than moranges. besides, whether you like it or not, china is gona be exerting a lot of influence in the world for good.

Jul 14, 2010

Under the table is how most stuff gets done in China. Its all about relationships.

A great book to read is "One Billion Customers." I would especially recommend reading the chapter about the Morgan Stanley - CICC joint venture

Jul 14, 2010

china is a gigantic enigma. it is a huge contradiction in itself. you have to be there long enough to understand all the incredible conflicts that are formed by a combined force of thousands of years of traditions and customs, decades of political turmoil, and rapid westernization (which happened only in the last 20, 30 years or less). Even in China itself, almost no one really trusts the stats such as GDP or CPI. For the chinese this is an era of having faith in nothing, doubting everything they hear or read, yet at the same time having no choice but to find their way to live in a shitty and false reality. i follow china quite often and if u ask me, something is going down sooner or later. that or someone who actually knows what he is doing comes to power.

Jul 14, 2010
northdakota:

china is a gigantic enigma. it is a huge contradiction in itself. you have to be there long enough to understand all the incredible conflicts that are formed by a combined force of thousands of years of traditions and customs, decades of political turmoil, and rapid westernization (which happened only in the last 20, 30 years or less). Even in China itself, almost no one really trusts the stats such as GDP or CPI. For the chinese this is an era of having faith in nothing, doubting everything they hear or read, yet at the same time having no choice but to find their way to live in a shitty and false reality. i follow china quite often and if u ask me, something is going down sooner or later. that or someone who actually knows what he is doing comes to power.

This "shitty and false reality" is infinitely better than the lives their ancestors led for the past 150 years.

Jul 14, 2010

Anyone buying China long term can have my GlennGary files.

Jul 14, 2010

The Chinese middle-upper class has found wealth through cheap credit, just like the US for the last 30 years.

This will not end well. As an FX Trader, I am watching the AUD, CAD, and other commodity suppliers that have supplied the materials for the Chinese real estate bubble and in return are fueling their own bubbles.

Looking forward to more of your posts.....if you use smaller paragraphs.

Jul 14, 2010
FXTrading:

The Chinese middle-upper class has found wealth through cheap credit, just like the US for the last 30 years.

This will not end well. As an FX Trader, I am watching the AUD, CAD, and other commodity suppliers that have supplied the materials for the Chinese real estate bubble and in return are fueling their own bubbles.

Looking forward to more of your posts.....if you use smaller paragraphs.

China doesn't have the so-called "middle class" as in western countries. This has something to do with history.

  • vanillathunder12
  •  Jul 14, 2010

The group I worked with had a 3 hour meeting on the Chinese real estate market a couple weeks ago (we have a couple positions in Australian mining companies). It is a HUGE bubble. The wealthy just buy houses instead of invest in fixed income/equities. There are tons of unfurnished houses that have never been lived in. The rich just buy more houses because the housing market keeps going up (pretty much the definition of a bubble). They don't live in them, they don't even go there on vacation. These houses just sit, completely unoccupied. What's worse is that these are nice houses, so when they bottom falls out they won't be able to sell them to the middle/lower class. Not sure when it's gonna pop, but when it does it is going to put the US housing bubble to shame.

Jul 14, 2010

yah i dont know why us equity markets haven't followed shanghai or hang seng... i think itll happen sometime soon

Jul 15, 2010

1 "Growth will start to decline in China simply due to the fact they have reached a size where growth will come from the growth of other foreign GDPs and efficiency improvements. "
wrong, It doesn't matter whether China's GDP is #3 or #2 in the world, it's the GDP Per Capita that determines the stage of development. Judging by that, China is still quite poor and can maintain its high growth rate for quite some time.

2 Stock market in China is a giant casino, it does not reflect the real economy in anyway.
Equity index as an economic indicator is almost useless.
Shanghai composite can be up 30% YTD or it can be down, does it really matter?

3 Yes, statistics number is very flawed, but,
A: as long as the measurement is flawed "consistently", the growth number is still valid since it is a year to year comparison.
B: If anything, China's GDP is vastly understated due to its huge cash-based underground economy, a common issue in a developing country.
If you have ever been to China or know any Chinese businessman, you will know that most if not all of them ever pay any taxes.

4 Yes, real estate is a huge bubble.
Yes, it will destroy tons of wealth when it bursts.
But NO, it will not be anything nearly as bad as the one US is facing due to the simple fact that Chinese real estate market has very little leverage and thus a huge equity cushion.
Chinese people tend to over-save. Part of this surplus saving is reflected on China's huge foreign reserve, part of it is reflected on its speculative real estate market. A lot of these people buy properties with full cash.
When the bubble bursts, it will still destroy wealth. But losing half of your saving isn't nearly as bad as being buried under mountains of debt.

5 democracy has very little to do with the economic development. More often than not, it is a drag.

Jul 15, 2010

tsong:

Did you know that there are more people in China who can't read then are people in the United States. The GDP per capita is important when there is a large force of "educated workers". Here's another fact I found on the CIA website, only 1.5% of the population of China has graduated college. Those workers who are earning shit for pay, will continue to earn shit for pay because they are not educated. BUT, China will become more educated but it will take time.

This is why I still like India a lot. They have a very low GDP per capita as well, but they are much more educated.

The statement the democracy is a drag is a joke I hope. The top 10 GDP counries are all democracies except for China. Don't get me wrong, I know what you mean by your statement, but what would you suggest to replace democracy?

Yours truly,
The Young Investor

Jul 15, 2010
The Young Investor:

tsong:

Did you know that there are more people in China who can't read then are people in the United States. The GDP per capita is important when there is a large force of "educated workers". Here's another fact I found on the CIA website, only 1.5% of the population of China has graduated college. Those workers who are earning shit for pay, will continue to earn shit for pay because they are not educated. BUT, China will become more educated but it will take time.

This is why I still like India a lot. They have a very low GDP per capita as well, but they are much more educated.

The statement the democracy is a drag is a joke I hope. The top 10 GDP counries are all democracies except for China. Don't get me wrong, I know what you mean by your statement, but what would you suggest to replace democracy?

As a native chinese, I can assure you the uneducated population will never be educated, but be eliminated or isolated by certain means, 1.5b of people is simply too much for any nations.

Jul 16, 2010
The Young Investor:

tsong:

The statement the democracy is a drag is a joke I hope.

He's serious, and this is a real problem as these guys will mess up in the field of foreign politics.

Jul 15, 2010

You can't deny that a proper democracy is slow to react to any situation. Even in ancient times, during strenuous times or wars there was a "dictator" of some sort that was appointed to make decisions.

He's not saying it's a drag on the entirety of society (although you could argue it is), but economically it is.

I.E. California has been proposing a high speed rail from Northern California to Southern California for years now and has not even started building yet. Look at China and their high speed rail that runs from Mid China to Southern China, it was built in a ridiculously short time.

In general, China conducts policy that is beneficial for their country and are able to execute projects and policies extremely quickly. In contrast, democratic countries, reform and other policies may take months to years. I think it's an exaggeration to say that Democracy is a drag, but it's definitely warranted.

Jul 15, 2010

China's economy is far from being communist. If you believe otherwise then you know very little about the country.
Also, the economy is far from being "mature," so the proctor & gamble analogy is completely off.

Real estate, as someone already mentioned, is nothing like the U.S. There is very little leverage; people actually have the money to pay for these houses.

Politically, China's strong central government is also one of China's greatest strengths. It's what allows them to coordinate and fund something like the Beijing Olympics or the Shanghai expo. The Chinese government gets things done with an efficiency that democratic governments will never achieve.

Jul 15, 2010

"This is why I still like India a lot. They have a very low GDP per capita as well, but they are much more educated."

are you kidding me ??? Adult Literacy India: 66%, China: 94% it's not even on the same level

"The statement the democracy is a drag is a joke I hope. The top 10 GDP counries are all democracies except for China. Don't get me wrong, I know what you mean by your statement, but what would you suggest to replace democracy?"

1 rich countries are generally democracies does not mean democracy brings economic development.

2 Democracy or any other political system is simply a way for people to solve their disputes. It is only a matter of whether that system fits with the country's culture background and stage of development.
A system that works in the developed western countries might not be the best one for a developing Asian country. For a society in rapid development/transformation phase, you need a strong government to keep things in order, quick decision/implementation is absolutely a must.
China started its high speed rail construction about 5 years ago, today there are already 4,300 miles of track that
has operational speed of 120mph (200km/h). In next 10 years, the goal is to expand it to 16,000 miles. Is this even possible in a democratic country?

3 " It is through the growth and prosperity of the economy of China that has silenced the cries for more rights. It is in the best interest of the government to do everything in their power to keep the economy vigorous. "

And what's wrong with that? Don't you just wish that folks in DC can do the same ?

Jul 15, 2010

Personally, I believe that a small government is the best government. I want politicians out of my life and free to make the decisions I want. I never think that a bigger government will solve the problems, especially one that is communist!!!!!!!!

tsong:
China is known for exporting, they produce cheap goods at a cheap price. It is the reason why they have such an intense currency program. They need to keep their currency low to further their competitive advantage. India on the other hand has a niche that is fueled by a growing educated population. I think you are misinterpreting my statements about the 2 countries. I just like India for the fact that their success is transparent and sustainable through good business, while China's is highly subsidized and we don't truly know what is even going on in their, no one really does!

Have you happen to read the latest news on the Ag. bank of China's IPO, it was a disapointing offering. People are hesitant. I'm not saying China is bad, I'm saying are some concerns.

Good chat

Yours truly,
The Young Investor

Jul 16, 2010
The Young Investor:

Personally, I believe that a small government is the best government. I want politicians out of my life and free to make the decisions I want. I never think that a bigger government will solve the problems, especially one that is communist!!!!!!!!

tsong:
China is known for exporting, they produce cheap goods at a cheap price. It is the reason why they have such an intense currency program. They need to keep their currency low to further their competitive advantage. India on the other hand has a niche that is fueled by a growing educated population. I think you are misinterpreting my statements about the 2 countries. I just like India for the fact that their success is transparent and sustainable through good business, while China's is highly subsidized and we don't truly know what is even going on in their, no one really does!

Have you happen to read the latest news on the Ag. bank of China's IPO, it was a disapointing offering. People are hesitant. I'm not saying China is bad, I'm saying are some concerns.

Good chat

I hate it when people like to deal in absolutes. Good vs. Evil, Democracy vs. Communism. I think some of you guys need to get out of the Cold War mindset and see the world in the shades of gray that it truly is. I agree that China's government has been hindering the progression of a strong financial sector in China's economy, but at the same time it is not necessarily wrong in its reserve. And you can't deny the benefits the strong central government has at the macro scale, despite many failures to support the common man at the micro level.

On the other hand, I hate how people see India as a "democracy" and automatically assume that it will be the next big power in the world. India is much more polarized in terms of wealth than any of the top economies in the world. It has among the world's largest population of billionaires as well as a huge population in destitute slums. The caste system has yet to be broken down, and social mobility is all but impossible. The country has a billion people but a size of only a third of the US. And that doesn't include many uninhabitable mountainous regions. Finally, you may hear success stories in Mumbai and New Delhi, but how many other areas of the country have you heard of breakthroughs in culture, economy, or education? That's because most of India is in worse poverty than many peasant communities of China. Finally, China has its borders buffered mainly by either friends or allies. Meanwhile, India's influence is heavily checked by neighboring Pakistan (thank God for British foresight) and will not likely become a superpower anytime soon.

Jul 16, 2010

small government is good, only in a highly developed/matured society where most of the rules/orders have already been established, where most of the functions can be carried out by private institutions.

For a developing country, you need a strong government led by capable technocrats, to make quick decision, to provide basic services, to establish a national development strategy, to mobilize its limited resource to provide stability and order in an otherwise rapid changing economy.

You put a small government in a place where there is no road/running water/electricity, where most people are undereducated, you will never develop !

China is more about manufacturing, which I think is absolutely the correct way to go. It is the only way to generate hundreds of millions of jobs and to move massive amount of rural labor into the cities.
India? give me a break. As large and as successful as its IT industry is, it only employs about 1-2 million people. Do you honestly think a country of 1 billion can be developed by a strategy that is tailored towards its top 0.1% well educated ? what about the remaining 99.9% who is not well educated enough to participate in IT outsourcing? you call this sustainable?

PS: Ag. bank of China's IPO is never about money. It is about the IPO process itself, to bring a modern corporate structure and a market oriented way to measure its performance. So the fact that its IPO has been completed, it in itself is the biggest success.

Jul 16, 2010
tsong:

small government is good, only in a highly developed/matured society where most of the rules/orders have already been established, where most of the functions can be carried out by private institutions.

For a developing country, you need a strong government led by capable technocrats, to make quick decision, to provide basic services, to establish a national development strategy, to mobilize its limited resource to provide stability and order in an otherwise rapid changing economy.

You put a small government in a place where there is no road/running water/electricity, where most people are undereducated, you will never develop !

Wow man, I read through your comments on this thread and you sound someone who is working for the Chinese government promoting their policies!
Although there might be some Chinese people on this board, you're futile attempts to justify your beliefs toward a communist government will prove to be unsuccessful, especially in a board where 95% (assuming rest of the 5% of the people are Chinese) of the people reside in democratic countries.
Some of your rebuttals on the original post seem to be valid, only the economic arguments, and maybe there might be some exaggerations about risks of bubbles.
But, every rapidly growing country has had debacles at some point in time. One thing for sure is that, there definitely will be something that will cause your economy to sink for a while. It might be the real estate or it might be something else. But these days, the thing that concerning me the most is this extreme polarization occurring at your nation, in terms of wealth distribution. Furthermore, there seems to be more hostile attitudes developing from the "dormant" groups of your country: the destitute, non-government officials, minorities, etc. Are you guys gonna bring a tank and shoot them all once they confront against you guys? That might sound facetious, but I don't see that much of a difference from that to how you guys have treated the "problem you guys have made" against Tibet. Before disseminating your government-oriented faiths, first support humanity. Study some western developments of democracy; French revolution might be a good start. What, some people are naturally born to be subservient to officials' dick, and it is all justifiable under economic development slogan when that real person in question does not even share a single portion of the growing pie?
I won't go any further, but don't back up your arguments with relative efficiency, unique history, or any other stuff that don't make any sense in front of human rights. There are no conditions that can be made in front of human rights, nothing.

Jul 16, 2010
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Jul 18, 2010

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