That China’s One Child Policy will eventually wreak havoc on China’s economy will come as no surprise to HS Dent readers.  We have written for years that China will find it impossible to sustain a viable domestic consumer economy when the younger generation is, due to the simple math of one child per every two parents, half the size of the preceding generation.  Others have commented on the effects on the country’s tax base and pension system.  The result will be an unmitigated disaster for China as the country grows old before it grows rich.  The “China Century” that many sinophiles love to speak of will be aborted–like so many anonymous Chinese babies due to the One Child Policy.
Read the rest of this entry »

If you want to extinguish a fire, you don’t douse it in gasoline. But that is exactly what China is proposing to do in its housing market (see “China poised to add REITs to cool down simmering property market“.

In order to reduce demand for Chinese real estate, the government is proposing the launch of several American-style real estate investment trusts (”REITS”). Now, I should be clear on this — I am a big fan of REITS as an asset class, even if I wouldn’t necessarily recommend them today. If bought at decent valuations, REITS can provide a solid cash yield and can offer equity-like levels of total return. But China’s move makes absolutely no sense.

REITS bring liquidity and new capital to the real estate markets by making real estate accessible to smaller investors. Naturally, this has a way of bringing more money into real estate, not less. Investors who would never consider buying an ownership interest in a real estate partnership would jump at a chance to own liquid REIT shares.  As REITS attract more investors, they buy more property.  Hence, speculation in the REIT market quickly translates to speculation in the physical real estate market.

So how exactly will the launch of REIT shares reduce speculation in real estate?  Because a huge influx of new investment capital will lead to new construction, thus reducing the demand pressure on existing structures and helping to cool the rising prices.  Right.  That makes sense.  Add massive new supply to a market that is already suffering from a supply glut (see Pivot Capital report).

This is the kind of twisted logic you expect to see near the top of an investment mania.  Investors would be wise to sit this one out.
Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The Times of India ran an interesting headline this morning:  “India to be fastest growing economy by 2018”

According to the article, India will overtake China, currently the fastest growing economy. This wouldn’t surprise me one bit.

China is an economic miracle, to be sure.  It is commendable how the Chinese have managed to pull so many people out of poverty in so short a time.  But as we’ve discussed in other posts, many of the factors that drove China’s growth are already slowing or will begin to slow soon:

1. Export growth to the United States and Europe is not likely to recover to its pre-crisis levels anytime soon.   This means that China will have to send a larger share of its exports to other developing countries — countries that, like China, are all trying to grow their economies via export growth.
2. China’s growth rate of urbanization  should significantly slow down in the coming years.  Migration is done by the young and economically “hungry.”  Once you turn 30 and presumably are married and /or have a family, it gets significantly harder to put all of your belongings in a suitcase and catch a bus to the big city.
3. There are limits to the sustainability of stimulus / infrastructure spending.  Virtually all of China’s growth in recent years has been due to infrastructure investments; so China had better find some new avenues for growth fast.
4. Finally, and perhaps most importantly, China’s Spending Wave peaks in 2015.  This implies that China has virtually no time to develop a strong consumer economy.  Even if Chinese consumption were to rise to American levels as a percentage of GDP tomorrow, within five years consumption growth would hit a wall, and HARD.

India has none of these problems, though it does have some others that we’ve highlighted in the past: horrid urban congestion, poor education for the bulk of the population, poor infrastructure in general, lack of basic sanitation in most of the country, and a truly rotten combination of mass democracy and a powerful, entrenched, and corrupt state bureaucracy that sucks the vibrancy out of the economy.

Still, all things considered, India’s problems can be fixed.  I’m not convinced that China’s can be.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The American West used to be littered with “ghost towns.”  Sometimes, a settlement outlives its usefulness.  Perhaps a town used to be an important rail head, but new railways made it obsolete.  Or perhaps soil erosion made the area unsuitable for agriculture.  There are really an infinite number of reasons why small towns could be found empty.  But a major metropolis?

In China, things are done on a massive scale.  Even ghost towns.

Check out the following video. (If you can’t view it, follow this link.) Normally, Al-Jazeera would not be our network of choice. But in this case, Al-Jazeera did an excellent job of illustrating how truly ridiculous China’s infrastructure bubble has become:

In America, ghost towns were once prosperous settlements that simply outlived their usefulness.  But in the case of the Chinese city of Ordos, this was a major urban center that was built from scratch that never had practical value.

It’s hard to draw firm conclusions over an anecdote like this.  But it does add to our belief that the China infrastructure boom is  a bona fide bubble with all the excesses that come with that distinction.  And we all know how bubbles end…

Charles Sizemore, CFA

Stratfor reported some statistics for China that should be disturbing.

China’s National Bureau of Statistics released on Feb. 2 details about economic growth for 2009, including the components of the year’s 8.7 percent growth rate. Growth is broken down into investment, consumption and net exports. Of these categories, investment contributed 8 percentage points, or 92 percent, of overall growth.

Meanwhile, consumption contributed a comparatively measly 4.6%, while net actually exports subtracted 3.9%. So,virtually all of China’s growth is based on stimulus / investment.  Without this capital spending splurge, China’s growth rate would have been a paltry 0.7%.

Given this, it would hardly seem that China would be the engine to pull the world economy out of the doldrums.   This is a development we intend to keep an eye on in the months ahead.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Five hundred years ago, China was the most powerful country in the world, hands down.

“The Ming Empire ruled a people more numerous than the ancient roman empire at its height, larger in territory than modern Russia, vastly more powerful and richer than all the petty fiefdoms of contemporary Christian Europe put together,” writes Wayne Hale, NASA’s Deputy Associate Administrator for Strategic Partnership, in his NASA blog.

The Chinese also had the largest navy in the world — with ships that rivaled the size of WWII aircraft carriers — and used that navy to explore much of the globe (British writer Gavin Menzies contends in his controversial book 1421 that these Chinese explorers actually circumnavigated the world, discovered Antarctica, and even colonized parts of the Caribbean.)

So…what happened?  Why aren’t we all speaking Chinese today?

The outward-looking emperor who funded China’s age of exploration died, and a new emperor came to the throne–an emperor with a very different set of priorities and a different set of advisors.  As Hale continues,

These voices counseled the young emperor to turn inward. Surely China had enough problems to solve in China, why waste time and energy exploring?…  They advised that China should protect what they had from the foreigners.  Foreigners who wanted what the Chinese had.  The emperor followed this advice. He completed the great wall to keep foreigners out. He built a new capital, a forbidden city to keep the citizens of his own country out.

The emperor ordered that the fleet be burned.  The sailors were disbanded. It became a capital offense to build a sailing ship with more than two masts.  The emperor even ordered that all the records of all the voyages be burned.  China turned inward.

Why do we repeat any of this?  Because we see shades of the same mentality in the dispute between China and Google over censorship and cyber attacks.  Chinese censorship has been dubbed the “Great Firewall of China,” and its intent is the same as the original Great Wall–to keep the foreigners out.

It’s hard to know in advance what the tipping point, what the proverbial straw that breaks the camel’s back, would be that would cause China to economically regress or that would cause foreign investors to lose faith in the “Chinese miracle.”   But we would not at all be surprised if future historians point to this event as just such a tipping point.  Only time will tell.

Meanwhile, the Chinese property and capital spending bubble continues to build…

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

In July, Rodney Johnson wrote about “Possibly The Best Business Model In China,” which was, of course, to open a gay bar.  Yahoo News reiterated exactly why this was such a good investment idea:

More than 24 million Chinese men of marrying age could find themselves without spouses in 2020, state media reported on Monday, citing a study that blamed sex-specific abortions as a major factor.
The study, by the government-backed Chinese Academy of Social Sciences, named the gender imbalance among newborns as the most serious demographic problem for the country’s population of 1.3 billion.

Link to article: “Skewed China birth rate to leave 24 mln men single“

The number of “excess men” we have quoted in the past by independent demographers is 32 million, but the fact remains that China is facing an acute shortage of women.  With no prospects for a traditional family life, many men who might normally have stayed “in the closet” in the interests of having children might, at the margin, decide to come out of it.

Chinese authorities had better hope that they do, because the alternatives are troubling.   Abductions and trafficking of women are already “rampant in areas with excess numbers of men,” according to the article.   Forced marriages and forced prostitution are also on the rise.

For decades, there has been a flourishing “mail order bride” trade from the countries of developing Asia to the West.  Perhaps another growth business might be a similar trade from China’s poorer neighbors into China.  Or, given that this is China we are talking about (a country with…shall we say, a questionable record on human rights), might we see forced abortions of male fetuses in an attempt to “fix” the imbalance going forward?  Or perhaps arbitrary arrests or forced conscription to get “excess men” off the streets?  Who knows.

In any event, the gender imbalance in China will almost certainly be a source of instability and social upheaval for the foreseeable future.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Once in a while you come across an article that you wish you had written yourself, an article that completely summarizes everything you were thinking on the subject and makes you say “me too.”

Peter Tasker published that article this morning in the Financial Times: “Beware the Lure of GDP When Seeking Stocks in Brics.”

Investors have been pulling their money out of developed markets like the United States and Europe and aggressively plowing it into emerging market stocks and mutual funds.  The consensus view is that emerging market economies are growing–growing quite quickly, in fact–while developed economies are not.  So why not participate in that growth by allocating a large slice of your portfolio to emerging markets?

As you might imagine, Mr. Tasker has a few reasons to think twice: Read the rest of this entry »

Cool graphic from the Economist comparing China and Japan:

It’s telling to watch Japan’s relative importance in the world economy (measured here as its GDP as a share of US GDP) fall over the past two decades.  Japan, as an industrial society, is a country in inexorable decline.  And with an aging and shrinking population, there is no reason to believe this can be reversed.

In 2010, China should surpass Japan to become the world’s second-largest economy. This is a major accomplishment for a country that only a few decades ago was among the poorest in the world.  But will the success last?  Or will China follow Japan’s recent history and suffer a bubble burst followed by a decade or more of debt deflation?

The Economist would argue “no,” writing:

China is still far poorer than Japan was at its peak, and thus has more room to improve productivity. A transition of surplus labour from agriculture to industry and services would increase efficiency and bring its economy more in line with the developed world…  But in the long run, a shift away from investment and exports towards domestic consumption would make China’s output more sustainable, and help it to avoid experiencing a bubble like Japan’s.

Unfortunately, the Economist is ignoring the proverbial elephant in the room — demographics.  China’s current economic model relies on an endless stream of young migrant workers from the countryside.   This simply cannot and will not continue indefinitely.  China is one of the fastest-aging countries in the world due to the effects of the One Child Policy over the past three decades.  The number of young Chinese who are in their prime moving years is set to begin a long, multi-decade decline in 2010.  This could mean that China will be facing serious issues with overcapacity in the years ahead, as infrastructure was built for people that might never migrate.  And with overcapacity comes…you guessed it…deflation.

Related post: A Christmas Carol of Sorts, Starring China as Ebanezer Scrooge

This wraps up 2009 for the HS Dent Blog.  Here’s to a prosperous 2010! 

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

One of our Demographics School attendees forwarded us two articles we thought we’d pass on:

“The American Who Manages the Decline of a Japanese Hamlet“  Wall Street Journal

“In Aging China, A Change of Course” Washington Post

It’s a week before Christmas, and we can’t help making a comparison here to Charles Dickens’s A Christmas Carol.  In this case, China is Scrooge and Japan is the Ghost of Christmas Yet to Come.

The difference is, unlike Ebenezer Scrooge — who had the ability to change his ways and avoid his unfortunate fate –China’s future cannot be changed.

In comparing China to Scrooge, we are not referring to Chinese labor practices or implying that China’s labor force consists of millions of unfortunate and underpaid Bob Cratchits.   It’s not China’s wages that we consider misery, but rather its birthrate.

Demographics are the future that has already been written, and China’s future looks bleak indeed. But first,let’s look at Japan.  The Wall Street Journal article above tells the story of an American whose job it is to manage the slow death of a small Japanese village.  While one village might not be particularly significant in the grand scheme of things, the same is occurring throughout Japan.  The island, with the exception of a small number of large cities, is slowly being depopulated.  Falling birthrates throughout the post-WWII era have insured that Japan will continue to shrink for the foreseeable, with serious consequences for the stability of the country.

China isn’t to this stage yet.  But after 30 years of the One Child Policy, it is only a matter of time before the day comes.  Even if China were to suddenly reverse the policy — which is unlikely — the damage has already been done.  And, as the Washington Post article recounts, Chinese families have become accustomed to the One Child Policy.  Many simply cannot afford to have a second child even if they wanted one.

So again, unlike Ebenezer Scrooge, it is almost certainly too late for China to change its ways.

Related post: “Some Geopolitical Musings”

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy