- Marc Faber
How do you say 'bubble' in Chinese?
We ask because, looking ahead, it may be a good word to know. For there is the latest...and perhaps the last...of the Dollar Standard blow-ups.
China was in the news yesterday...and again today. Hardly a day goes by without a mention of what has become one of the largest economies in the world...and one of the most interesting.
While the developed world grows at barely 1% or 2% per year, China's economy races ahead 4 times as fast. Imports to the U.S. alone are said to be up nearly 40% this year, filling China's pearly chests with dollars, and U.S. treasury bonds.
In 1985, only $2 billion went into China as foreign direct investment. By 2001, the figure had risen to nearly $50 billion. In 1985, total foreign trade with China was just $69 billion; in 2001 it was over $500 billion.
The U.S. has a GDP of about $11 trillion. China's GDP is thought to be only about 1/10th as big. But in rural societies, many transactions are not measured in currency. And local prices are much lower, so that a Chinese meal consumed in Shanghai might be recorded as worth $1...while the equivalent in Manhattan would go for $20. Some economists try to resolve these problems by measuring economies on the basis of purchasing power. In these terms, the U.S. has an annual production of $9.6 trillion, but China's economy is much larger than otherwise thought, at $4.9 trillion.
"You are so skeptical of everything else," began our friend Michel at lunch on Wednesday, "but you seem to believe every word about China. You seem to forget that the country is run by communists who lie about everything. In particular, they lie about economic statistics in order to make themselves look good. That's what the Soviets did right up until the whole system fell apart. And Western economists believed them! And now they believe the Chinese. Even you believe them!"
We do not really believe the Chinese numbers, dear reader. Then again, we don't believe the American numbers either. Instead, we take them all like dabs of paint on a Seurat or Pissarro painting. No number is reliable in itself, but stepping back, we're able to get an impression of something we recognize.
And what we see developing in China is the familiar face of Richard Nixon's Dollar Standard system: money floods into a country; a boom results...asset prices get marked up to absurd levels...factories and office buildings go up everywhere...finally, overcapacity and overpricing creates a bubble...that inevitably blows up.
But wait...we see something more: we also see - in broad strokes - the end of the whole system.
As the U.S. consumes more and more products from China, the Chinese accumulate more and more dollars. The average Chinese saves 25% of his income, so savings in local currency are building up, too - as much as 1 trillion dollars' worth is in interest-bearing accounts already. The money is lent out by commercial banks, and has triggered a typical boom...followed by a typical, Dollar Standard era bubble.
"Bad loans looming as a big cloud over China," warns today's International Herald Tribune. Visitors to China report that there are skyscrapers going up everywhere. Yet, 17% of the new buildings are already empty...and rents are slipping.
While the offices are empty, the factories hum with activity, day and night. The more Americans buy from the Chinese, the more the Chinese are encouraged to produce. As time goes by, more and more goods reach the U.S. at lower and lower prices. And so does the correction come into view. For as prices fall, profit margins fall, too. Soon, businesses - in the U.S. and in China - are no longer worth the money invested in them. Then, capital values drop, too.
At the same time, on the other end of the exchange, consumers cannot buy an infinite quantity of TV sets and automobiles. In America, the income of the average person rose only modestly in the last 30 years...and is presently dropping in real terms. How can these people be expected to buy more products? They have no more income; they have less.
And thus does the whole abstraction of credit, reserve currencies, debts, profits, and trade imbalances suddenly come clear. Stepping back, we see a ghastly picture.
But stepping back from the rush of everyday life, we get the impression that everything corrects sooner or later: financial trends, reputations, the wealth and power of nations. On this day in 1939, the Germans had already advanced deep into Poland (they crossed the border on September 1st, beginning WWII). Hitler must have thought that nothing could stop him...because, for a long time, nothing did. As he and Stalin subdued the Poles, the 'phony war' with France and Britain began. It was no war at all, because neither side wanted a fight. Later, he moved against the French and drove the English into the sea at Dunkirk. By 1942, Hitler controlled Europe. Had he stopped there, things might have gone better for him. But everything that swells up later shrinks down to about where it began. The Reich that was meant to last 1,000 years peaked out in early 1942.
It was almost as if the Fuhrer called together his generals and asked them: "How can we make a mess of this?" They soon had their answer; they found a way to do the almost-impossible...turn a nearly impregnable position in Europe into a losing situation...by sending troops to North Africa where they could be cut off by the British Navy...by picking a fight with his ally, Stalin...and by declaring war on the U.S.!
Three years later, Hitler's reputation, his army, his country, his finances...even his life itself...were fully corrected.
And now we see the Dollar Standard correcting, too. Bill Gross describes the scene:
"Since its monthly trade surplus of $10 billion+ with the United States implies a $120 billion annual addition to its dollar reserves, there will come a time when [China's] hundreds of billions if not a half trillion or so in holdings of U.S. notes and bonds look a tad too risky. In turn, the hundreds of billions that the Japanese and other Asian countries have been buying in order to keep their currencies competitive with the Chinese Yuan (Renminbi) and the U.S. dollar will be subject to a sanity check as well.
"The currency/bonds/stocks of a reflating economy engaged in guns and butter, Hummer and Hummvee spending of near-historical proportions are bad investments. Sooner, or perhaps later, our Asian creditors will wake up and smell the coffee. Perhaps their java will take the form of dollar or Treasury Note sales. Perhaps the aroma will resemble a revaluation of the Yuan and then the Yen. Either way we pay the price: higher import costs, a cutback in spending on cheap foreign goods, rising inflation, perhaps chaotic financial markets, a lower standard of living.
"Mark these words well for what they're worth (not much, some will say): China holds the keys to our kingdom, and our Hummers. Their willingness to buy our bonds, their philosophy of fixing their currency to the U.S. dollar will one day be tested. And should their patience be found wanting, all of their neighboring Asian China wannabes will move in near unison. Reflation's second round will have begun, U.S. interest rates will rise, our goods in the malls and the showrooms will be less affordable, and the process of national belt tightening and increased savings will have begun."
As we write, of course, belts are not being tightened; they're being loosened. Investors at the Krispy Kreme franchise are still feeling fat and sassy. Exactly when their attitudes will change, we cannot say. Nor can we say when the Chinese bubble will blow up.
But while it is too late to safely profit from the U.S. bubble (prices are too high), Marc Faber believes there are still excellent opportunities in Chinese stocks. Some sell for low P/Es - as low as 2 - with high dividend yields. Even China Telecom still sells for only about 8.5 times earnings. Beijing Datang - a large power company - has a dividend yield over 4%. Shenzhen Expressway sells for less than 10 times earnings. Tiny Wing Shing Chemical, by contrast, sells for less than 2 times earnings. You could buy the whole company for only about $15 million, says Andy Mantel, writing in Faber's newsletter.
The simplest China play, according to Mantel, may be the China Mantou Fund, with its offices in Hong Kong.
Bill Bonner
5 September 2003
P.S. Marc Faber is a contributor to our own Strategic Investment. If you're interested in learning more about what we expect is a rising bubble in Chinese assets, please see below for subscription information:
Strategic Investment
www.agora-inc.com/reports/DRI/StrategicInv/
Editor's Note: Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies, and the author of the free daily e-mail The Daily Reckoning (www.dailyreckoning.com ). He is also the author, with Addison Wiggin, of "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons) due out in September.