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China: Bubble pop just got louder

Posted Dec 11th 2007 11:50AM by Aaron Katsman
Filed under: International markets, China, Economic data

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With news that consumer prices in China soared 6.9% in November, investors should take this as just another sign that the bubble that is the Chinese stock market is in "popping" mode. Investors shouldn't get fooled by analysts saying not to worry about what actually is happening in the economy because growth is so strong. Surging inflation is usually a good sign of what's in store for an economy. Emerging market investors should look at other markets like Israel for instance. I don't want to be a conspiracy theorist, but could it be that the big institutions continually say not to worry, because, with the Chinese stock market still being quite illiquid, they are trying to unload all their positions?

Peter Brimelow had a really interesting piece about the potential for a crash in China. He quotes former investment banker Mark Hutchinson:

"To see why a crash may be coming, it is worth examining the behavior of the China Investment Corporation, the $200 billion sovereign wealth fund set up by the Chinese government in September ... Six weeks ago, the power of sovereign wealth funds was celebrated and China Investment's moves into the market were awaited with bated breath.

"Well, so much for that. A third of China Investment's portfolio is to be invested in Central Huijin Investment Company, a purchaser of bad loans from the Chinese banks, and another third will recapitalize China Agricultural Bank and China Development Bank, to shape them up for privatization.
"The lackluster investment strategy of China Investment exposes a central flaw in the Chinese economy, its lack of a rational system of capital allocation. For more than a decade, Chinese state-owned companies have made losses, and have been propped up by the banking system. Since 2004, loss-making state-owned companies have been joined by overbuilding municipalities, erecting white-elephant office blocks in attempts to turn themselves into the next Shanghai. None of these losses has resulted in bankruptcy; instead the cash flow deficits have been covered by the Chinese banks. As a result, the Chinese banks have an enormous volume of bad loans $911 billion at May 2006, according to a later-withdrawn estimate by Ernst and Young, which must surely have ballooned to $1.2 trillion-1.3 trillion now ...

"A $1 trillion problem in sub-prime mortgages has caused even the U.S. money market to seize up and has required frequent applications of sal volatile by the Fed. Since China's economy is around one fifth the size of the United States' the Chinese banking system's bad debt problem is in real terms about five times that of the United States, about 40% of its gross domestic product. "

With everyone so worried about the subprime mess in the U.S., perhaps the real focus should be on the potential crash of the Chinese banking system.

Look out below.

Aaron Katsman is the lead Portfolio Manager and Managing Director of America Israel Investment Associates, LLC. and Senior Editor ofI sraelNewsletter.com.

Tags: China, emerging markets, EmergingMarkets, inflation, Peter Brimelow, PeterBrimelow

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Last updated: July 06, 2009: 11:48 AM

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