Possible Sources of a China Crisis

–Nnothing is certain in the world. Thousands of people will get rich trading paper. And millions of people who work hard, till the soil, do their duty, and follow the rules, will get screwed. The world is not inherently just, nor is anything inevitable, not even China’s rise, as Paul Monk reminds us in today’s AFR.

–“China’s ‘inevitable rise’ is so widely and so uncritically believed that it is difficult not to anticipate yet another shock to the system,” Monk writes. We painted a rosy, romantic, and optimistic future of China in our thoughts yesterday. But there are risks and what Monk describes as “sources of crisis.”

–He writes that the,  “sources of a potential crisis in China are relentlessly growing social inequality, extremely high unemployment, rampant corruption, the insolvency of many state-owned enterprises, the over-dependence of economic growth on exports, rather than on domestic consumption; the lack of effective property or contract law, the enormous environmental damage being caused by current approaches to development; looming demographic problems, due to both an acute gender imbalance and a rapid ageing of the population; and the serious inefficiency with which capital is being allocated.”

–Where to start with that list? We’ll focus only on the last one, capital allocation. We note that China Life shares debuted in Shanghai to much fanfare. The share doubled in a day, and as a result, the company became the world’s number two insurer in terms of market cap.  That is an impressive day’s work.

–The company dominates more than half of China’s growing life insurance market. That ads up to a lot of domestic cash flow from premiums. Ironically, on the heels of its highly-successful float on the local capital market, China Life announced a joint deal with U.S.-fund manager Franklin Templeton to put some of its domestic cash to work in foreign asset markets.

–Why is it ironic? Through China life, the savings of millions of Chinese will make their way back into U.S. markets, supporting U.S. financial assets. The U.S. needs the money, of course. Currently, 85% of global savings makes its way back into U.S. financial assets (subscription required)

— Is it because the assets are higher quality? The return superior? The liquidity more abundant?

–Your guess is as good as ours, dear reader. All we know is that just when we think things can’t get any stranger, they do. The financial markets, driven by the relentless need to find a new asset with a new return, are busy shuffling money. As Ken Rogoff, former head of the International Monetary Fund, said, “The growth in trade in financial assets is proceeding about 50% faster than the growth in trade.”

–Trade we understand. Two parties agree on an exchange they find mutually beneficial. They exchange goods and services, or an agreed upon monetary equivalent. Real things are built, bought, sold, and used.

–Trade in financial assets we also understand. But trading shares in ownership of an asset only makes you richer if the asset itself goes up in value. Is the world fifty percent richer because financial trading is more common? Is the sun fifty percent hotter or a cold glass of water fifty per cent more refreshing? Or are people just fifty percent more deluded in thinking you can get rich trading assets? Are they just fifty per cent closer to disillusion and disappointment. We’re twenty per cent sure we know the answer.

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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