China and its Perplexing Investment Strategy

It was a blah day in New York trading. The futures here in Australia indicated a lower opening. But we’re going to take a big step back from the market action today and look at a second dip on the global recession, drilling for oil seven miles under the ocean, and China’s perplexing investment strategy. Also some reader mail!

But let’s start with sovereign wealth fund of China, the China Investment Corporation (CIC). CIC was set up in 2007 with US$200 billion of China’s nearly $2 trillion foreign exchange reserves. It’s been shopping ever since, with mixed results. Last year, for example, CIC stood pat and only invested US$4.8 billion outside China. It preferred to ride the bubble in Chinese bank stocks, which worked out pretty well for it.

Yesterday, however, Reuters reports that CIC is now cashed up to the tune of $300 billion and ready to buy again. “It will not be too bad this year,” says CIC chairman Lou Jinwei. And here’s the good part. “Both China and America are addressing bubbles and we’re just taking advantage of that. So we can’t lose…We have to be in everything because you never know what’s going to happen in this world.”

Come again?

There’s a charitable way of reading these comments and there’s a straight forward way. The charitable way is that Lou and the rest of China’s economic mangers know that their $2 trillion in forex reserves (which are mostly in U.S. dollars) are in perpetual danger of devaluation. If you had a pocket full of $300 billion in monopoly money, trading it for anything-anything at all-would be the sensible strategy.

You’d want to trade it for a real tangible assets or equity before asset sellers started treating your money with disdain. This is why CIC “can’t lose.” Better to trade it for something now then watch it turn into nothing later.

The straightforward interpretation is that the Chinese wealth fund managers have lost their marbles. Counting on more bubbles to increase your wealth is a portfolio destruction strategy. Chinese fund managers may end up being every bit as stupid as the hedge fund managers and bankers and CEOs at U.S. banks who ran their respective institutions into the ground making the worst leveraged bet of the century on U.S. housing.

The only real difference, as far as we can see, is that the U.S. bets were made with borrowed money (often borrowed from Chinese creditors, we reckon), whereas China is investing the fruits of its productive labour over the last twenty years. It is a massive gamble. The U.S. managers, who may have been criminal rather than stupid, did tremendous damage to their country’s economy. Will China’s managers replicate the feat?

This also makes you wonder how much the emergence of China itself is a function of a global bubble in fiat money since August of 1971, when Richard Nixon took the U.S. dollar off the gold standard. Sure, there are tens of millions of Chinese people working in real factories making real products out of real raw materials (many sourced in Australia). These people have real dreams, ambitions, and economic aspirations, not to mention real savings (in gold and paper money).

But is it possible that China’s time at the centre of the global economic stage is limited because China’s economic model itself always depended on cheap credit and fiat money? Yes, yes. It goes against the whole “next economic empire” way of thinking. But if China’s official asset managers are counting on bubbles to make them wealthier, you wonder how sound the model is, and how long the wealth will last. We wonder anyway, which is our main job at the DR.

Empires. They sure don’t make them like they used to. Rome lasted a good long while, with a big lead up as Republic. The 1,000 year Reich didn’t last ten years. The economic and political clock seems to be speeding up these days.

That would be something. A twenty-year global boom from fiat money that simply accelerated the depletion of natural resources and the misallocation of capital to projects that are uneconomic at lower levels of household and business debt. Hmmn.

Speaking of resources, two notes that prove oil is still out there, but getting harder to find and more expensive to produce. PetroChina will spend $2 billion to buy a 60% stake in the MacKay River and Dover oil sands projects in Canada’s Athabasca oil sands. Canadian sources reckon there are 5 billion barrels of bitumen on the properties. But turning bitumen into oil isn’t easy or cheap. It takes lots of water and energy, neither of which are money.

The other note is that BP says it has found as much as three billion barrels of oil in the Gulf of Mexico. It found it by drilling 10,685 metres below the Gulf of Mexico, or 35,000 feet. So BP drilled the equivalent of a Mt. Everest underwater to find the oil. Actually, Mt. Everest plus another six thousand feet.

This is ample evidence of Peak Oil. It shows that oil is getting harder to find and more expensive to produce. Technology has improved, of course, allowing exploration companies to look further afield than ever before. Oil companies can increase reserves this way. They’re finding oil. But it is not the cheap, easy, free-flowing stuff once found in the oil fields of East Texas or Saudi Arabia.

By the way, if you’re wondering what could cause a second dip in the global recession, we have an answer: government stimulus. Yesterday was full of stories on how the stimulus spending by the Australian federal government made the recession less worse than it might have been and produced positive GDP growth. This has everything backwards, although it’s being swallowed whole by the financial press.

A rebound based on monetary inflation and government spending isn’t a real rebound at all. It gives the appearance of normalcy and economic health through rising asset values and more transactions in the economy (which GDP itself measures). But unless there’s a big pick up in private investment, the economy is not on any sounder long-term footing.

In fact, it’s worse. The illusion of prosperity created by stimulus spending induces people into maintaining debt loads they might otherwise reduce. Consumption patterns which ought to change in order to put the household and corporate balance sheets back in working order aren’t changed at all. And when the government stimulus is withdrawn later—as it must be before higher fiscal deficits lead to rising interest rates-the economy reverts back to its pre-stimulus levels of growth-only without the underlying issues of over consumption and too much debt having been addressed.

Or the short version: there is no easy way out of this mess. The government can’t create wealth by borrowing money or taxing people and spread the lucre around to favoured groups at the expense of others. That’s theft and it’s immoral. But the real issue is that the whole economy needs to reduce leverage. The housing bubble has to pop. And the nation has to quit living above its means (we remember writing this about America five years ago).

How about some reader mail?

Hi Dan,

Just letting you know: The content you present on DR might be interesting and valuable but I can’t get past those adverts promoting seemingly loopy get-rich-quick schemes. Their appearance destroys DR credibility.

Gene A.

Not this first time we’ve heard this and won’t be the last. We write about outliers and Black Swans. Those topics are controversial, which is why the mainstream media is afraid to express a real idea about them. What’s more, getting people’s attention in this economy is tough. Sorry you don’t like the ads. But don’t expect them to change.

For one, we have to pay the bills. As much as we like writing the DR, there’s an entire publishing operation to support that provides research to paying subscribers. Secondly, we wouldn’t describe any of our publications as “loopy get-rich quick schemes.” We know how much time and research goes into each monthly report. We stand behind all the ads and have a hand in a fair a few of them to make sure they’re telling the stories we think you can profit from. If you really don’t like them, you can always just ignore them.

–Hi Dan

I thought you might enjoy this story.

I meet a young Irish couple last week on a 12month working holiday in Australia. I got talking to them about the property crash in the republic. Unlike many of their friends who now languish trapped in inappropriate homes (bought in up and coming areas as an investment) with negative equity, they narrowly avoided purchasing their first home 2 years ago. They are now living their dream exploring an exotic continent while their friends are enjoying contributing the banker’s bonuses.

But that is not the story I wanted to share.

She made a comment about property article she read in an Australian major daily recently. In her lovely lilting accent she told me it was unnerving the way in which it seemed to have been lifted word for word from an Irish paper two or three years ago.

Keep up the most entertaining work.



As someone who has recently emigrated here from the UK, I witnessed the incredible rise in the UK property market a few years back. I also said that it would fall when others were saying it would do no more than stabilize. Here in Australia property prices are (allegedly) still rising – I do not agree as my current rental lease is up soon and when looking at the rental prices I think they are lower than a year ago. All this is neither here nor there in the bigger picture.

The simple truth is that, particularly in Melbourne where I live, property prices are so far removed from average earnings that they cannot rise eternally, as too few people will be able to afford to buy. Prices in all markets are a bit like an elastic band, it will stretch so far, but once its limit is reached it pings back. I personally believe that within the next 18 months the Australian property market will release the energy of being overstretched and fall heavily – irrespective of whether the country weathers the current economic storm or not.



Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Yippee! Finally a chance to correct one of your errors.

“The 1,000 year Reich didn’t last ten years”, seems to imply it lasted less than a decade.

It actually ran from 1933-1945. 12 years and some.

Apart from that, another great article. Keep it up.


Actually, the 1000 year Reich lasted for more than 12 years.

Next thing will be that you will tell us that the Germans bombed Pearl Harbour!

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