China: Playing the Devil’s Advocate

Jim Chanos gets it right more than 70% of the time (unlike Alan Greenspan)

 

jim_chanos--300x300.jpgSource of picture: New York Post

 

Somebody has to play the devil’s advocate, but having just finished reading Gillian Tett’s excellent Fool’s Gold about the financial crisis, this is about more than just trying to provoke a response; it’s about challenging the dangerous assumption that the future will always be the same as the past.

Here’s an article about the dangerous assumptions surrounding China which are accompanied with a dangerous amount of complacency.

 

 

By John Richardson

“WE are often derisive towards the ability of governments to do what markets do better,” said Jim Chanos, the famous investor, in a recent lecture.

“When it comes to China, though, everybody is willing to bet that nine guys in a room [the country's top leadership] will get it right all the time. I am willing to bet this is not the case.”

You hear the same level of confidence from chemicals company executives that Beijing will skilfully engineer persistently high levels of economic growth, both in the short and long term.

“Because of good government control – and because one party dictates all – the economic prospects remain very good,” said one Singapore-based senior executive with a global commodity and speciality chemicals giant.

And a source with an oil-to-chemicals major, who we considered naming but decided it was unfair to single him out as this view is so commonly expressed, added: “Nobody doubts that China’s long-term economic prospects are good.”

He clearly hasn’t listened to the likes of Chanos, who made a fortune from short selling ahead of the global economic crisis and sees similar opportunities presenting themselves in and around China.

He was widely quoted in the financial press in February as saying that China is going to crash.

But if you watch the video of his lecture, he says he was misquoted and instead argues that he meant that there are pockets of overheating and overcapacity in the Chinese economy.

He recommends shorting companies that have heavy exposure to China’s property sector – including western building-material suppliers and property developers. You could put many chemicals and polymers companies into this category.

His longer-term view is that China’s growth model – rapid urbanisation accompanied by heavy fixed-asset investments – needs to change.

Urbanisation is reaching a demographic peak, as are the economic benefits being delivered by providing basic education, he argues.

State-directed lending is inefficient by nature as the inputs into the economy (the costs) are greater than the outputs, as was proven by what happened in the former Soviet Union, adds Chanos.

He accepts that as innovation improves and as the focus moves away from state-directed and therefore inefficient lending – and as latent domestic consumption is further unlocked – China’s potential is enormous.

But he makes the valid point that getting from A to B won’t always be a smooth process. This will mean frequent periods of uncertain growth and a great deal of volatility.

There also has to be a chance that China doesn’t make the transition.

This makes the claim we quoted earlier – about the country’s undoubted strong long-term prospects – a little like the view expressed before the economic crisis: that there would never be a US nationwide house-price collapse.

A period of uncertain growth in China appears to be taking place right now.

Earlier this week, for example, Guo Shuqing, the chairman of China Construction Bank, reportedly warned about the danger of GDP expanding by more than 9.5% in 2010.

“It [too-rapid growth] will mean more duplication of construction, more excess capacity and higher waste of capital,” he was quoted as saying.

Many analysts believe growth will exceed 9.5% this year, and estimate that in the first quarter the economy expanded by 11-12%.

Oversupply of money and increased liquidity leading to inflation and asset-price bubbles were further problems, the bank chairman was also reported to have said.

This latest official warning about overheating – one of many over the past few weeks – might indicate further economic-tightening measures are being considered.

His comments also support some of the inefficiencies in China’s growth model highlighted by Chanos – most notably, money being poured into new industrial capacity that has added to further overcapacity in many industries.

Urban fixed-asset investment rose by more than 40% last year and by 28.6% in January-February 2010, according to official data.

“The strong import volumes we saw for a wide range of chemicals and polymers in 2009 were partly the result of this rise in investment in new industrial capacity,” said a UK-based chemicals consultant.

“As big amounts of new capacity came on stream, inventories had to be filled with raw materials, including chemicals and polymers.”

Western chemicals companies benefited from this inventory building.

US linear low density polyethylene (LLDPE) exports to China rose to 318,369 tonnes in 2009 from 183,293 tonnes in the previous year, according to data from China Customs.

US polypropylene (PP) exports increased to 493,381 tonnes from 117,673 tonnes.

Overall LLDPE imports jumped by 49% to 2.2m tonnes and PP imports by 57% to 4.2m tonnes, according to the New York-based trade data and analysis service, International Trader.

Just one of the many complications exporters to China are contending with is how all these new plants will run now that inventories have been filled.

One factor is the shortage of labour in Guangdong province, an unintended consequence of government efforts to boost economic conditions in western and northern China. This has reduced migrant-labour supply in Guangdong, the export-processing heartland.

Returning to the Chanos theme, inefficient investments in too much industrial capacity could mean greater exports of finished goods from China at a time when trade tensions over the value of the dollar versus the yuan are already very high.

If trade barriers are erected in response to a rise in low-priced exports of finished goods, this will add yet another degree of uncertainty to chemicals and polymer import volumes.

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