Q. What do these names have in common? Bass, Chanos, Chang, Chu, Dalio, Druckenmiller, Edwards, Faber, Li, Odey, Soros and Xie?
A. They belong to just a few of the people who in recent years have all made bold, dire proclamations about China’s prospects; and none of them, not one, has been correct.
A Brief History of Bears
The grandfather of this class must be Mr. Gordon Chang. Gordon wrote a book in 2001 with the self explanatory title ‘The Coming Collapse of China’. He predicted this within five, ten at the very latest, years. He’s gone on to repeat the same ever since; and here we are in 2017 and, er? Not only has China not collapsed (d’oh!) but many of it’s institutions are stronger now than they’ve been for centuries.
In 2010 Mr. Jim Chanos and Mr. Li Daokui, respectively, assured us the Chinese property market was “Dubai times 1,000 – or worse” and “The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis,..”; aaand?? No property related financial crisis, no physical market property collapse. In fact, developers this year are likely to record record high earnings as buyers continue to queue outside developments.
Charlene Chu, whom the Wall Street Journal described in 2013 as “..the ‘Rock Star’ of Chinese Debt Analysis”, was warning a year earlier, in 2012, about problems ahead in 2013 and 2014. Problem loans, she said, could “burn through the [banking] sector’s entire pre-provision profit for both years, as well as half its equity.” They didn’t.
At this point, and in the interest of brevity, I’ll spare others above their blushes and move along; but not before noting, again, that none of their bearish predictions have come close to the observed reality of actual outcomes. None; nada, zilch, zip.
Scribblers And Operators
Before I get down to the specifics of systematic forecasting failure I want to digress briefly into the broader subject of motivation.
The noisiest China bears can be sorted into two camps. Either they’re paid commentators who seek to make a living selling their views, the scribblers or, they’re market agents seeking to profit from position taking, the operators.
Both groups suffer agency bias. For the operators their bias is clear. They’ve taken a position and are seeking to frighten the bejesus out of the rest of the investing public and, if all goes well, precipitate a stampede from which they can profit.
The scribblers are motivated by two forces. First, if you’re seeking to be paid for views you had better make your points loudly and emphatically. Nobody will pay for a newsletter that concludes, on balance, things will likely muddle through. Second, and many may not realize they’re doing this, you must address customer zeitgeist. Clients think China has a debt problem? Don’t tell them not to worry, tell them how smart they are to have spotted this and give them some charts they can paste onto slides ahead of their next investment committee meeting.
My point here is a general one about all financial ‘analysis’ in the public domain. Be clear you understand the motivation of the propagator. Hedge fund Titans aren’t providing their views to news organizations because they believe in a greater public good; and scribblers are usually paid in relation to how much noise they generate, not how right they’ve been.
Specifically
There are five areas bears seem to spend most time fretting over with regards to China and a look at each will help demonstrate how and why concerns have been so misplaced.
The Hard Landing. Surely the economy has been run hot for too long and the law of big numbers says this can’t continue? A rapid deceleration is inevitable and at that time excesses from go-go years will be exposed? Well, not really. From around 2014 the government not only recognized the need to jump the economy onto a new, shallower, growth trajectory but it’s also been busy making this happen. Gone are blank cheques for dirty and/or dopey SOEs. Gone are hard growth targets for local cadres in favor of more holistic assessment and gone is the rampant build-it-and-they-will-come mentality with regard to infrastructure spending. Here’s your hard landing then. Uncomfortable for some; but hardly the wall-slam predicted by bears.
Financial System Collapse. The banks are lying about the true level of NPLs. The Shadow Banking complex is out of control. Local governments have been crafty borrowers hiding true levels of indebtedness from an out of touch Beijing. Sound familiar? Let’s deal with these tropes one by one. The banks are lying about NPLs? It’s possible that the audit teams from the world’s largest accountancy firms that comb over bank’s books are being hoodwinked; but all of them, all the time, year after year? Probably not. The Shadow Banking complex is out of control. No. We have numbers from the banks on wealth management product creation, we also have numbers from the Trust Funds on their balance sheet expansion and we know pretty much what the insurance companies are up to; and if we do, so do the regulators. Local government borrowing? A problem identified as far back as 2009 and addressed by a series of rolling audits and investigation. Problems here and there in the system? Yes, but dealt with swiftly and decisively by muscular and energetic overseers.
Currency Crisis. Despite a closed capital account all manner of loopholes are being used by individuals and companies to get money out of China. This will inevitably lead to a payments crisis which will in turn precipitate a collapse in the value of the Chinese currency. Versions of this argument were popular back in H215 and Q116 after China had clumsily allowed the Rmb to trade in a wider band as a precondition for it being allowed into the SDR basket. Once the mistaken signal had been identified the National Team got on the case and we saw the government’s tremendous resource brought to bear on the issue. Yes, from January 2016 through to December of the same year the currency weakened; but that was against a persistently strong US$. The bottom to top move that year was around 5.5%. Bears got the direction right but magnitude wouldn’t have provided many fat bonuses. This year the 2016 move has been completely reversed, the currency is back to January 2016 levels and foreign exchange reserves have enjoyed sequential rises for each of the last six months. Crisis? What crisis?
Political Turmoil. The absence of democracy is not consistent with a developing economy and the precedents in the region of Korea and Taiwan, both of which were forced to move from autocratic to more plural political systems, highlights how precarious the Chinese Communist Party’s (CCP) grip on power most likely is. Sounds right, right? But it isn’t. Neither Britain nor America were properly democratic when they made their biggest leaps in productivity and in the region we have living examples of one-party states doing just fine at advanced stages of their economic development (Japan, Singapore). Since Mr. Xi Jinping began his anti corruption/extravagance campaigns his, and by implication the party he heads, star has undoubtedly risen. Autocracies fail when they either stop delivering for the mass or lose touch. The CCP is a good listener and these days, thanks to the channeling of dissent via social media, a better one than ever. It’s also a good provider, understanding now the need to move beyond securing just material well being for its citizens. It’s work on environmental issues is streets ahead of other countries at similar points of their economic development. You want to see political turmoil? Don’t waste time looking here.
Property Market Bubble. Wasn’t the property market fundamentally to blame for the Global Financial Crisis and doesn’t the Chinese market share some of the same worrying characteristics that preceded a collapse of developed market property values? Well, again, not really. The only similarity between China’s property market today and developed markets in 2006 is prices have gone up a lot. The differences are what’s important. China does not permit no or low-doc loans. It does not permit the wholesale bundling of assets to be sold in multi-tranche ever increasing risk form; most mortgages therefore remain with the originating banks. China does not permit the over-use of credit for borrowers; minimum down-payments start at 30% and in many cases are higher. What about over-build, ghost-cities and tumble weed infested shopping malls? Here and there I’ve seen it; but the key difference is empty properties, unlike in the West, are rarely matched with large un-serviced debts. The most famous ghost-city of all, Kangbashi in Inner Mongolia, is perhaps the best example. This development was the product of over-zealous spending by a local government awash with windfall gains from a strong commodity market. Bad capital allocation decision for sure; but harbinger of a region-wide banking collapse? No; and the same pattern repeats elsewhere. Would China Inc. be in trouble if property values were to halve? Probably; but how likely is that in an economy growing as surely as China’s is likely to for the next few years? Finally, where’s the disconnect between record property prices in an economy that’s providing it’s citizens with record income levels?
It’s Not All Roses
China does have problems. To tick off just a few. Urban migration, newcomers form a poorly educated underclass in most cities and more effort to integrate them must be made. Real social unrest will be the product if this carries on. Social welfare, Chinese save too much; but that’s because they don’t trust government to take care of their needs. Slower growth will be the result if this continues. Financial reform, the domestic stock markets are a governance joke and savers are systematically bilked by an outdated banking model. If this doesn’t change poor capital allocation will persist. I could go on.
The Single Most Important Point
Bears make a consistent error when predicting problems getting out of hand in China. They presume the system is monolithic. Most arguments coagulate around some form of ‘If present trends continue…’ reasoning; but the trends don’t continue. The system isn’t monolithic, it’s highly dynamic.
The economy is scrutinized microscopically by planners for signs of strain or imbalance. The financial system is managed by executives well aware of the consequences of excess overseen by anxious regulators with real teeth. The political system is a black box, we must live with this; but I sense if elections were held tomorrow Mr. Xi and his Party would be returned by a convincing majority; and the overbuild? For every empty property there are many, many more with occupants. The high speed rail network, which didn’t exist ten years ago, runs packed and I was in a city recently where the subway map handed out by the hotel didn’t have the line on our doorstep because it was built between the last time a map was printed and my visit. It was however already heavily in use.
Yes, bad stuff goes on in China; but there’s a heck of a lot more going on that’s constructive and well thought out that’ll beneficially affect the lives of a population for generations to come.
In Conclusion
The success rate of China bears predicting calamity that actually arrives has at least been consistent; zero.
Therefore, what weight should we give to arguments from the next partisan who happens along with a fresh batch of snake-oil pessimism? Would zero would be too harsh? Perhaps not in light of track records to date.