Monday, August 14, 2006

Chinese market sucks

Call me a China bear… it’s unbelievable how messed up China’s financial situation is. I came here thinking that an inefficient market would breed profitable investment opportunities. Inefficient it is indeed, but not in a good sense. Here, the inefficiency is not so much investor inefficiency or hidden value. Here, the inefficiency is on an infrastructural and fundamental level the market system. I guess I had to have seen it with my own eyes… but the bottom line is that the Chinese stock market really sucks, but nobody seems to care. The valuations are through the roof!

Though I cannot say I have looked at all Chinese companies to know if all Chinese stocks are as bad as what I am about to mention… I’ve seen enough of how the system works to know that without the proper frameworks, China is only a façade of capitalism. Of course, things should get better slowly from here as the Party is trying very hard to set policies favorable towards the development of the capital markets. But the way it seems right now, real lessons will probably only be learned if a severe fundamental correction that really hurts happens within the next five to ten years. Only then can the widespread pseudo-wealth of fiat currency created through bad bank loans, the bogus financial disclosures that detail very much but say very little, and the horrible conflicts of interest that exist on almost every level of finance be wiped clean.

But anyway, enough with the small-talk… I have five reasons why China probably won’t be able to sustain its meteoric rise in the next five to ten years. Although I cannot say that China would not be a good investment in the long-run, I’m fairly certain that at the rate China is growing presently, a severe fundamental correction will take place in good time. A simple explanation of why:

(1) A bad case of bad loans outstanding caused by numerous conflicts of interest between politics, economics and guanxi.

(2) Which brings crazy growth in money supply that cannot find value-generating investments. Which brings inflation on intangible/big-ticket items such as real-estate, commodities, and equity (in a way this goes for the entire world too)

(3) That causes social inequality, and the “income gap” continues to widen, with the government continually having to find itself subsidizing the poor mainly in rural areas and urban slums who have virtually no investment opportunities available to them to keep up with the times and yet have enough will to live and breed at an increasing rate. They in turn…

(4) Continually bring inexpensive labor on the market and continue to consume inferior goods and services on a second-tier economy (sometimes black) that is tied to a currency—the Renminbi—that continuously loses value domestically due to inflation, and increases in value paradoxically relative to the rest of the world because Mr. America thinks inexpensive Chinese products are a result of an undervalued currency and not a result of an excess labor market and an overflow of people desperate for work. So that when the Renminbi actually appreciates in value, strangely enough domestic inflation will also go up (as China is not an import economy) with exports failing and unemployment rate rising.

(5) In turn, so long as there are enough currency in circulation for the wealthy to continuously invest in projects with negative value or intangibles, manufacturing, commodities, and excess export capacity will continue to grow at an alarming rate without regard to margin… and even the most saturated of markets will be subject to ever-increasing investment because, where else would the glut of currency go? Until all falls down as loans must be written down, and money supply must naturally contract.

Oh! What’s the catalyst? One might ask…

A slowdown in international demand for Chinese goods I say! Value will quickly contract then. People speak of domestic demand picking up that could perhaps offset the slowdown in international demand… that might be the case, except for one small problem: the majority of Chinese are poor. The high and middle class cannot possibly create enough demand (and do not have enough logical reason to buy) for goods that are propping up the Chinese economy: cheap apparel, cheap electronics, cheap toys, etc.

Wealth disparity is one of the most economically disastrous problems… for the rich get richer to buy goods produced by the poor… and the poor produces hordes of supply that cannot possibly be consumed, which must be sold for ever lesser values, while the wealthy have nowhere to invest except intangibles such as tulips, imaginary stocks, and commodities like gold (gold is another story altogether)… until one day *poof* money goes away magically, just like it appeared as mere flickers on a bank-machine.

At least America invests in intellectual property and innovation… where do the Chinese invest? You guessed it… bad businesses, intangibles, and U.S. treasuries (at least they are long-term treasuries that destroy value and burn excess money as U.S. interest rate hikes continue).

I’m very bearish on the Chinese market. Cash will get burned… bad habits won’t change until their short-term advantages turn into short-term woe…

And you know what? Shorting is illegal in China, and there is no active bond market… in short, the transfer of risk to stupid people who deserve to get their money burned does not exist…

Let the anti-climax unfold! (I must remind readers that this anti-climax might happen next year, or five years from now, even ten years from now… however long the Communist government can inject money into the system to pretend everything is alright… but alas! The longer the denial the greater the demise. Such… is life :D)

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