The Biggest Load of China Bull

China’s been in the spotlight all week. And it will finish off that way too. By around 12pm Australian eastern time today, China’s chief bean counters/statisticians/magicians will present a whole bunch of data to the world.

You’ll hear about China’s economic growth figures for the second quarter (yes, the one that finished just two weeks ago), retail sales, industrial production and fixed asset investment. We have no idea what the data will show. Given the recent China gloom, perhaps they’ll paint a picture of ‘not as bad as expected’?

This wouldn’t surprise us. We’ve been on the China beat lately. Actually we’ve been on the China beat for a while now. But last week we released a presentation outlining our case against the Middle Kingdom. The way the market gods work, we wouldn’t be surprised to see some data that forces us to question our conviction.

Which is sort of how the market works… You come to a conclusion on something. Then you see a data release or price movements that force you to question your theory or ideas. Your conviction takes a hit. So you review your thesis to make sure you didn’t miss anything.

In many cases, the market is so maddening it just makes people give up. Just when you’re very sure of something the market will crush your confidence. It’s why it’s so addictive. It’s why it attracts hubristic and egoistic types. They think they know better than everyone else. But the market eventually crushes them too.

We take the view that when it comes to the market, we really know nothing. We are sure of nothing. But that makes us work very hard in order to form our opinions. And opinions are useless if you don’t believe in them. Sitting on the fence is for economists.

Renewed Hope or False Hope for the China Bulls?

This is all a long winded way to say that today’s data dump may (or may not) provide hope for the China bulls. It may suggest the centrally planned behemoth is not slowing down as fast as we think. But it doesn’t really matter. It’s data based on one month or a quarter.

Credit busts inevitably follow credit booms. How the bust plays out is the mystery. What usually happens is that they play out slowly enough for long enough to continually provide false hope to the bulls…and doubt for the bears.

Speaking of China bulls, they’ve been a bit thin on the ground lately (which is why a short term, hope based rally in China-related resources wouldn’t surprise us). But they are still out there. And if the following is any guide to their thinking, they have just about lost the plot.

We came across it in the Financial Times Alphaville Blog. What caught our eye was the title, ‘China as a post-capital economy’. This should be interesting, we thought. Turns out it wasn’t interesting at all…it was plainly absurd.

A Big Load of China Bull

The Financial Times draws on an article written by James White from Australia’s Colonial First State. It basically makes the argument that China doesn’t really need to worry about earning its cost of capital on investments. The financial rules that apply everywhere else don’t really apply to China’s economy. In other words, China is different.

James says, ‘These foundations seem brittle to western investors used to judging the health of an economy through the returns on capital. But the Chinese are comfortable with low capital returns if the pay-off is a stronger economy. This has been the case.’

So the pay-off from low returns on capital is stronger economic growth? Seriously…

Economic growth is like a company’s income statement. It’s the amount of income growth an economy achieves during the reporting period. But any decent analyst will tell you that looking at an income statement in isolation is useless. Income growth of 7% might look great but if it took a 30% increase in assets to achieve that growth, then maybe you have a problem.

What matters for real wealth creation is how productive the assets are that generate the income growth. You identify this by looking at returns on capital invested. Oh wait…that doesn’t matter for China’s economy. And dumb Westerners like us just don’t get it.

Here’s another nugget:

‘By not using capital returns as a scorecard for economic progress, China improves the allocation of capital in its economy and raises living standards. Effectively, China takes a broader perspective to the value of capital in an economy. Such an approach seems fraught with danger but there’s more protection than global markets seem to understand.’

By giving no concern to returns on capital, China improves the allocation of capital? Huh? This is too absurd for words. How does the state, or entrepreneurs, know where to invest their capital (and therefore allocate it efficiently) if there is no price signal (the high return) directing them to do so? Hey, it doesn’t matter…this is China y’know.

Lastly, James reckons losses on capital projects don’t matter because the Chinese government has ample cash to pick up the tab…and there are always taxes.

‘First, and most obviously, the government has the ability to fund losses on individual capital projects through the accumulated financial reserves, totalling at least $3.2 trillion. Second, and most importantly, the Chinese government, as ultimate capital allocator, can recoup returns from projects by capturing the positive externalities from projects in the form of higher tax revenues created by higher levels of activity. Third, the failure of individual projects does not discourage investment elsewhere if other projects can still add value to the economy as a whole.’

The first point is bollocks — plain and simple. As we’ve pointed out about a thousand times, China’s reserves are not available for use as a bailout fund. They’re an asset and a liability. The asset is foreign government bonds (US Treasuries mostly), while the liability is yuan denominated reserves in the domestic banking system. So China’s reserves ARE the savings of the Chinese population. Double entry accounting makes them look like separate things, but they’re one and the same.

And higher tax levels from higher levels of activity? When a credit bubble bursts, credit contracts. That means LESS activity and less tax receipts.

We don’t mean to pick on this bloke. Maybe his bosses told him to write a bullish China article to encourage fund flows and get a bonus. Or not.

But these sorts of justifications for why ordinary rules don’t matter for some, usually communist countries, just infuriate us. It’s the same things a whole bunch of Soviet sympathisers thought about that economy before it crumbled in the 1980s.

The State can leech off its people for only so long. At some point, it sucks them dry and the rules finally become apparent. We don’t know how long China can continue leeching off its people before they revolt or run out of cash. But in our opinion, the process has started.


Greg Canavan
for Markets and Money

From the Archives…

How to Survive Inside China’s Financial System
06-07-2012 – Greg Canavan

China’s Economic Policy of Denial
05-07-2012 – Greg Canavan

The Question China Has To Answer Fast to Save Its Economy
04-07-2012 – Callum Newman

How Investing in Commodities Can Prevent a Personal Financial Crisis
03-07-2012 – Dan Denning

Wouldn’t it Be Nice to Not Lose Money on the Australian Share Market?
02-07-2012 – Dan Denning

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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8 Comments on "The Biggest Load of China Bull"

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“a stronger economy”


“stronger economic growth”

are not one and the same. The former can speak of resilience and capacity building, while the latter can be speaking only of the process of stealing from your grandkids.


I bet the ‘China Bulls’ like Swannie and the regular tabloids will fail to mentionj that the number of Chinese aged 0-14 is shrinking as was reported by demographers on Bloomberg last week, including the fact that China was shutting down 280,000 primary schools due to ‘shrinking’ numbers of children. The China Bulls tend to ‘selectivly’ ignore the China Demographic Collapse…issue. But then again,our ‘Bow-Begoire-China’ crowd tend to exist in a parallel universe.


I bet the ‘China Bulls’ like Swannie and the regular tabloids will fail to mention that the number of Chinese aged 0-14 is shrinking as was reported by demographers on Bloomberg last week, including the fact that China was shutting down 280,000 primary schools due to ‘shrinking’ numbers of children. The China Bulls tend to ‘selectivly’ ignore the China Demographic Collapse…issue. But then again,our ‘Bow-Before-China’ crowd tend to exist in a parallel universe.

James White
Hi Greg, Thanks for posting this. I would probably describe my theory as total economic returns. Returns in an economy flow to labour, capital and government. In the west, and particularly the US profits have been an outsized share of the economy in recent years. This is also the case in much of the emerging world, the BRICs ex China. My point about China is that strong capital investment necessarily leads to lower returns on capital but they also raise productivity faster which leads to faster real wage growth and higher tax incomes for government. This should allow faster sustainable… Read more »
Nick Mason

Calm down Greg. You raise some semi relevant points but miss the big picture, that is the government of China by providing the people with first class infrastructure, roads, rail, subways, airports etc.. are giving the country an important competitive advantage over other countries which don’t have this necessary infrastructure. Where would you prefer to do business? By supplying the people of China with this competitive advantage they can accept very marginal returns knowing the big payoff is further down the line…. when China is the biggest most productive and advanced country in the world. Enjoy your weekend.


It’s going on …

“The China Bashing Syndrome”


100% agree that the James White article mentioned on FT Alphaville is just about the biggest load of crap I’ve seen in a long time. One has to wonder whether Mr. White is getting paid to write this drivel.


My theory on recessions is they happen when the populace becomes downcast. It is a state of mind that happens when the people feel misled or tricked by their betters e.g. governments, CEO’s on high pedestals.
Why will the Chinese feel deceived? When? How did it happen?

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