August 5, 2009

>Many worries about China this week. Jeremy Grantham, always a force to be reckoned with, says his analyst worries that China is “dangerously
unbalanced and very likely to come unhinged in the next few quarters.” http://www.gmo.com/websitecontent/JGLetter_ALL_2Q09.pdf
Additionally, investors such as Marc Faber and Jim Rogers are also concerned. There is clearly a liquidity bubble in China. Bank loans this year are up dramatically, despite indications the economy isn’t that hot. As money will do when the real economy can’t absorb it, it seems to be finding its way into stock and real estate markets. The central bank is warning banks not to make speculative loans. There is a great deal of discussion about toxic assets in state-owned enterprises, new buildings with only 20-30% occupancy, etc.

This makes perfect sense in the short term. It isn’t easy running a growth company, or a growth country, in a big recession. Traditionally, you have to build facilities ahead of your need, anticipating the increased worker base you’ll need with business up 10-20% every year. When the music stops, you have a lot of empty offices. You’d better be well financed. From an external standpoint, China is well financed. But I can think of another country, across the Pacific from China, that also has toxic assets in state-owned auto companies and banks, plenty of empty office buildings and warehouses, and tons of debt both internal and external. This country has a political system that can’t say no to any special interest that can round up some voters, and its provincial governments are in a heap of trouble trying to pay for all the pork. Soon the national government will need to rethink its agenda–the central bank is now buying its bonds, not truly as instruments of monetary policy, but seemingly as a buyer of last resort. While the Chinese still have some racial unrest, especially in provinces that are now part of China but whose native tribes don’t really feel like full-fledged members of society, that other nation still arrests minority constitutional law professors on their front porches for dubious reasons.

The point is, nobody’s perfect. Not companies, and certainly not governments. If you can get reasonable execution, and you have competitive advantages, you can do well long-term. When you look at China, you see plenty of cheap labor, and plenty of international credit to buy the capital equipment to make it more productive. You also see the massive investment in infrastructure to facilitate commerce. Meanwhile, the developed world seems to be very interested in raising the cost of labor even more. This has always been a prelude to the export of jobs. And the Chinese have the workers and the capital to take those jobs.

I”m not sure I want to invest heavily right into the teeth of this liquidity bubble. But I think there are too many reasons not to ignore China over the next decade. What do you think?

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