Tuesday, February 6, 2024

Keep a very careful eye on China's economy


Things are looking very precarious in China right now.  I'm sure most readers know that Evergrande, one of the country's biggest property speculators, was ordered into bankruptcy by a Hong Kong judge last week.  The company's debt and other obligations amount to a staggering $300 billion - yes, that's "billion" with a B.  Its assets (whose valuation may be debatable) are said to amount to $245 billion;  but most of those assets are buildings it's erected, with apartments that it can't sell - or, if they're sold, the buyers may stop paying their mortgages if Evergrande doesn't deliver all it's supposed to.  To make matters worse, the Hong Kong ruling may be stayed or overturned by a mainland China court, because if Evergrande were to collapse, it might well take a very large chunk of the real estate business in China - a very large part of that country's economy - with it.  That could lead to massive social unrest, something the Chinese Communist Party wants to avoid at all costs.

Now we learn that the Chinese stock market is facing very serious losses.  This is partly related to the Evergrande collapse and related issues, but also to blatant market manipulation by the Chinese Communist Party, which regards firms that grow too big as a threat to its dominance, and tries to control where investors put their money.  Foreign funds are being withdrawn, local investors are running scared, and there are many other factors affecting the situation.  Suffice it to say that everything's in a state of flux, and that's a very undesirable situation for those running China.  They want things to be orderly, controlled, disciplined.  The free market (not that the Chinese market is particularly free, but let's ignore that for now) is none of those things.  Those two perspectives are colliding right now, with unpredictable results.  If the Chinese government cracks down too hard in an attempt to restore stability, it could trigger unpredictable results on top of the existing uncertainty.

Ed d'Agostino shares his insights into the prospects for investors in China right now.

Ever since the pandemic, the US economy has surprised nearly everyone, while China’s economy has stalled. A real estate crisis is unfolding there, which could erase the savings of China’s new middle class, and Chinese stocks recently hit a multiyear low.

From where I sit, the risk-reward ratio for Chinese stocks looks bad.

To start, anytime you invest in a Chinese company, you’re investing alongside the Chinese Communist Party. Since he came to power in 2013, Xi Jinping has amplified the CCP’s influence over “private” Chinese companies. In effect, no business in China is private the way you or I think of a private company, with clear laws and boundaries separating it from the government.

The US-China Economic Security Review Commission summed this up well:

China’s government has developed numerous avenues through which to monitor corporate affairs and direct nonstate firms and resources toward advancing the Chinese Communist Party’s (CCP) priorities. Within this expanded framework of government control, traditional definitions of state control in an entity no longer apply because any entity may be compelled to act on behalf of the Chinese government’s interest, regardless of the state’s formal ownership.

Chinese law explicitly requires people and organizations within the country to “support, assist, and cooperate with national intelligence efforts.” (I’ve mentioned this when sharing my concerns about TikTok and digital privacy.)

Investors also need to consider China’s accounting practices. Chinese companies don’t use GAAP or International Financial Reporting Standards. They generally use Chinese Accounting Standards, sometimes called China GAAP, which makes analyzing them more challenging.

Then you have the transparency issues. Over 250 Chinese companies trade on major US exchanges. Regulators had to threaten to suspend trading under the Holding Foreign Companies Accountable Act to get the Public Company Accounting Oversight Board (PCAOB) access to audits of US-listed Chinese companies. We’ve made some progress here, but the PCAOB reviews late last year led to an unprecedented $7.9 million in sanctions against auditors PwC Hong Kong, PwC China, and Shandong Haoxin.

None of this was too concerning when China’s markets were roaring higher. The CCP was happy to take foreign dollars to build its businesses and infrastructure. Everyone won.

But with China’s financial markets under pressure, and the real estate buoying its middle class at risk, do you really want to invest alongside a government that can change the rules at will and without notice?

There's more at the link.  If you're not already subscribing to Ed's free "Global Macro Update" newsletter, I recommend it.

If the Chinese economy goes into a tailspin, it's going to have a massive economic impact all around the world.  China is the manufacturing hub of the entire globe, the center of almost every consumer-oriented product the rest of the world wants.  It also consumes vast quantities of natural resources to produce those manufactured goods.  If it hiccups, the supply of those goods becomes questionable, and those countries that rely on selling their raw materials to China face a sudden and perhaps drastic decline in demand for them - meaning their income, and that of their leading businesses, plummets.  The knock-on effects might be very dangerous for world stability.  Wars have been fought for lesser reasons.

This could be serious.  We don't know for sure yet . . . but I have a bad feeling about it.  Meanwhile, follow the money in China:  who has it, where it's being invested, and (perhaps most important right now) where it's being withdrawn from markets and industries.  Where is it going?  How is it being used?  If it's being pulled out for safekeeping rather than reinvested, the fuel that runs the Chinese (and the world) economy is basically being drained - and therein lie consequences.  Most importantly . . . what happens if the US economy follows China's example?  If China dumps its US dollar reserves in the midst of an economic crisis, much of the rest of the world will follow suit and our currency will tank, taking our economy with it.  Given that China (both its central bank and its citizens) is currently driving the world gold market, the US dollar is probably looking less and less attractive to them.

What's next?  Your guess is as good as mine, but it's unlikely to be healthy for any of us.



Peter B said...

There was once a totalitarian country that financed a massive military expansion by deficit spending, and then used its expaned and up-to-date military to conquer and loot its neighbors at both a microlevel (direct looting) and a macro level (currency manipulation and the like) as well as robbing and murdering a disfavored group of its own citizens.

One difference is that the PRC has a surplus of single youngish males; post WWI Germany didn't

Michael said...

Impact on the USA? Can you say worldwide depression?

ALL banks aside from the AHEM Sanctioned Russian ones are incestuously intertwined in trillion-dollar series of Derivatives and such.

Oddly Russian banks maybe the only ones standing as their money is backed by oil and other resources.

SNIP: As of April 2023, China holds approximately $868.9 billion in U.S. treasury securities1. This substantial amount makes China one of the largest foreign holders of U.S. debt. In fact, it accounts for a significant portion of the total $7.6 trillion held by foreign countries in U.S. treasury bills, notes, and bonds12.

CAN YOU SAY FIRE SALE? I know you can as folks panic to sell before the value od their T-bills drop even more.

Got a deep pantry? EVERYTHING gets more expensive as the "value" of the US Dollar drops to peso or a certain nurse blogger says ruble levels.

Anonymous said...

One thing to consider is that if China even thinks they are about to experience civil unrest on a large scale, for whatever reason, that could be the trigger event to invade Taiwan as a distraction to the people.

Paul M said...

Could get interesting if in order to prop up their tanking economy China demands their support monies back from those in DC they own, especially the Big Guy/Squinty-Eyed Joe. Could be billions.

Old NFO said...

The bigger question is what no longer gets built? Electronics? Steel? Or???

lynn said...

Sounds like China be going down soon. I suspect that they will drag the rest of the First World down with them.

Unknown said...

The ONLY reason the US economy looks like it is superior is the dollar, the world reserve currency, our exorbitant privilege.

As the dollar continues to lose value, Evergrande will seem a raindrop to our Niagara falls

Zaphod said...

Who would you rather have being the ultimate arbiter of corporate survival or failure and thereby the driving force in all corporate strategic decision making? The CPC or Larry Fink / Blackrock?

I'll take the CPC technocrats (O BarcaLounger Boomers and paid up members of the Peter Zeihan Onanism Collective, please, pretty please try to get it into your thick skulls that the CPC has killed far fewer of its own and foreign peoples these past several decades than your USGov, Big Pharma, etc. have) any day and twice on Saturday (heh) over Larry Fink, Soros, and their various co-ethnics who have a deep-seated ancient atavistic drive to destroy me and people like me. The Chinks are not so great and have their issues... but for FFS everybody please Look in the Mirror!

Anonymous said...

That chart represents a textbook “head and shoulders “ formation also known by technical investors as “ the glide path of the dead duck”. It’s about to go a whole lot lower if the government doesn’t put its thumb on the scale.

Anonymous said...

While Taiwan is a definite possibility, don't forget that China has at least one territorial dispute with every one of it's neighbors.
For example, there is evidence to say that China is more interested in Siberia than Taiwan - Taiwan gets them reunification, at high cost and little profit. Siberia gives them lots of space and resources with much less risk - and doesn't require an ocean crossing.

Additionally, Russia isn't a Western ally and attacking it wouldn't draw the attention Taiwan would.

I'm sure there are other possibilities also - some of which the US is supporting, for example look up US support to India on the LOC with China.

A few thoughts...

Anonymous said...

I don't know whether they'd ask for previous monies back, but I bet there'd be lots of unemployment as future monies are cut off!

Anonymous said...

blatant market manipulation by the Chinese Communist Party, which regards firms that grow too big as a threat to its dominance, and tries to control where investors put their money.
In effect, no business in China is private the way you or I think of a private company, with clear laws and boundaries separating it from the government.

I think private American business is a Norman Rockwell painting myth, and the reality is that in Britain and America the government is just as controlling as it in China. That's why government decides how many flights shall go out of each airport, government decides how many hospitals can be built and where, etc.

LL said...

Most of my business is done around or directly with Chinese whales. The situation in China is far more dire than the rosey, optimistic picture that you paint, BRM. China has never been able to float the RMB on the international currency market and even though the official rate of exchange, set by Beijing is $1 to RMB7, I take it at RMB10 to the dollar and they pay it that way simply because paying in dollars is difficult fort them because of the Bamboo curtain that is up. It will get worse.

Winterborn said...

Yeah, the 1.5 billion to 3 Billion apartment/housing over build (numbers are fuzzy because “China”) might have something to do with that. The apartments that are built from “tofu dregs.” Want an interesting podcast? Look up that term on Youtube or “the history of everything podcast” It’s about 1 hour of holy craaaap they did what!? In “China”

Also, @Jonathan, Xi might like to have Siberia. However. Russian policy has been since the I think the 70's... "you invade, we will nuke you, immediately." Granted Russians nukes may not work. I'd guess that some of them probably do work.

That policy came about after the short war they had before/which triggered the Nixon visit and all that.

The Chinese demographics are a total horror show, with Shanghai university recently publishing an article to the effect of "Urban birth rate of .5" or less, because "China." Russia is on race to the bottom with them. I Remember Peter Zeihan (demographer among other things) saying that with the current data China would be at 645 million or less by 2050. NOT 2100. Fastest aging society in history. With lowest birth rate (worse than during the Holocaust) and worse than during the Black death. And absolute Enron numbers on their economy. And 1 child policy, now 2, now 3, now Please have kids you peasants! The demographics chart for China looks like a lopsided mushroom cloud. CCP admitted to over 100 million people dont exist, mostly women under 40. (The ones who have all the kids) over 30 million more men than women. Which is so much worse than it sounds.

Japan, as bad as it is there, with half of men up to 35 still virgins, is in better shape by far than China.

Get your pallet of popcorn orders in now folks. Hug your wives and kids, this is gonna really get bumpy.

Aesop said...

It gets worse.
Explore China's impending demographic crash.

They're about as likely to take over the world next as Japan was when everyone was Chicken Littling over them in the '80s and '90s.

Aesop said...

And BTW, on a gold standard, the dollar is already at ruble levels, since it's only worth a penny in real (gold) terms, vis-a-vis a gold-backed 1933 US dollar.

The ruble is worth about 1 penny to a current dollar now.

So China (and the US') economic fall would leave them 100 times worse off then than now: the ruble will fall to Zimbabwean levels.

Bummer for Vlad.