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Sino Turbulence Shows A Failed State In Motion

Wednesday, December 17, 2014

There’s a tendency to forget or overlook that everything in China revolves around a communist dictatorship, and the true meaning of the word “communist” has absolutely nothing to do with the regime and how it operates. Period! However, most gurus project the Chinese future as if nothing will ever change, politically speaking, or as if a smooth path to democracy is the inevitable way forward. Big mistake! At the G20, Chinese President Xi Jinping assured the world that “China's economy will maintain strong, sustainable and balanced growth,” and his words are being treated as gospel. What else should he say? That was political talk and not a revelation, and please watch what they do, not what they say.

Oh yes, the IMF declared the Chinese economy the largest in the world based on purchasing power parity. The assertion is as meaningless as the IMF itself, and the article “China’s Questionable Economic Power” provides the unbiased logic.

And China’s per capita income – a more accurate measure of economic sophistication – amounts to only 20% of America’s, and will take decades, at least, to catch up (if it ever does).

Then there’s talk of an “acceptable” lower GDP, and China is the only country that I’m aware of where GDP numbers virtually match expectations without a major surprise -- ever. They’ve mastered the art of economic nonsense to a higher degree than how to produce useless trinkets! Are these people for real and do they think that everyone else is stupid? Here’s some comic relief with a touch of truth, courtesy of “a senior economist at the Chinese Academy of Social Sciences (CASS), who declined to be identified,” talking about GDP.

"I think it should be seven percent if there are no more surprises. But it cannot be lower than seven percent, otherwise there could be employment problems and debt default problems."

But let’s look at Japan for a second, a country on the verge of a panic attack, whose economic model was adopted by China. I still remember when “Made in Japan” implied low quality, and one cannot compare China with Japan for a myriad of reasons which I shall leave unstated. Japan has embraced currency devaluation to stimulate exports, their economic bread and butter, and while debt keeps rising, GDP shows a new recession, aided by a sales increase from 5% to 8%, with 10% being the final step. Plenty of economists were disappointed, but how else does debt get paid?

Now to the larger and core Chinese issue. South China Sea diplomatic skirmishes were truly the first step, an attempt to feed nationalistic sentiment and distract from the domestic problems. The second step taken by the Politburo was to fight corruption and cronyism, and while some view the “project” as a step in the right direction, it is no more than a carefully crafted message being delivered to the Chinese people as an assurance that the political elite is there to protect the people’s interests. No, not really! Certainly plenty of scapegoats are being slaughtered, regardless of previous relationships, and considering that the rule of law is subjective at best, it never ceases to amaze how they prosecute the culprits so expeditiously. And why is corruption now a problem when it has been around forever, and still is, and is now made so publicly visible in a nation that censures everything? The third step was to point the finger at foreigners -- Apple (AAPL), Microsoft (MSFT), Qualcomm (QCOM), et. al. -- as the culprits that are making the people’s lives miserable. There’s an interesting point to be made regarding Qualcomm, which highlights typical behavior in China where there’s always a craving for getting something for nothing.

The chipmaker, however, said Chinese smartphone makers are either not paying the licensing royalty or under reporting their selling value, affected Qualcomm's earnings dramatically since 30% of its revenue comes from licensing fees.

In short, China’s central command and control is running out of answers and gimmicks, while the promise of a shift to domestic demand from an export model continues to make the rounds. Let me be very clear: Chinese consumers do not, and will never behave like American consumers. Get it? If the Fed’s silly monetary maneuvers have failed to stimulate the American consumer, a group that is predisposed to buy every widget under the sun and pile on debt, what do people think Chinese stimulus will do? More trains? More bridges to nowhere? It looks that way as “Beijing launches intensive infrastructure projects to boost economy,” also known as Keynesian theory on steroids for dummies. To add perspective to the purported domestic consumption, here’s the progression of China’s retail numbers, year-to-year, and does anyone with an ounce of intelligence think that it will get better as China’s “customers” continue to feel economic stress?

Certainly the recent rally in Chinese stocks provides a smoke screen and hides the underlying malaise, especially to outsiders, but not all is as it seems, as the report “How China’s Interest-Rate Cut Raised Borrowing Costs” indicates.

The PBOC move misfired as it triggered an 18 percent surge in the Shanghai Composite Index (SHCOMP) of shares, prompting investors to raise cash by selling bonds and seeking loans, driving interest rates higher. Costs for riskier issuers of notes rose as regulators banned the use of riskier debt as collateral for financing. Investors dialed back expectations for further monetary easing as policy makers seek to cool the stock rally.

Another interesting development was the decision to open the Chinese stock market (FXI) to retail investors around the world, coupled with easing rules on foreign investment. Now they want foreigners? It’s the tell-tale of despair, and let’s not lose sight of the fact that the ultimate goal is to preserve the political structure. But we also have Hong Kong -- a British creation, not Chinese -- where protests are only a microcosm of what is to come, and the report “China asserts paternal rights over Hong Kong in democracy clash” summarizes it well.

For Beijing, Western-style democracy conjures up visions of “color revolutions” and the “Arab Spring”, of chaos and instability that could pose a mortal threat to the ruling Communist Party.

Going forward, the Chinese government must and will crack down on any attempt to dethrone the communists, and although their efforts to maintain control and a grip on power will fail in the long run, eventually we will have a country that will find itself in a post U.S.S.R. condition. In addition, the real numbers will come out, and, as it stands, “China has ‘wasted’ $6.8tn in investment, warn Beijing researchers.” Really? How shocking! Adding insult to injury, “Record China Downgrades Test PBOC as More Defaults Seen.”

Rating companies say defaults in China will spread as the central bank’s interest rate cut will do little to stop a wave of maturities from worsening record debt downgrades. Chinese credit assessors slashed grades on 83 firms this year, already matching the record number in all of 2013, according to data compiled by Shenzhen-based China Investment Securities Co. Companies must repay 2.1 trillion yuan ($342 billion) in the first six months of 2015, the most for any half, data compiled by Bloomberg show.

Lastly, and if you’re one of the “global retail investors” enticed by the new found openness in Chinese stocks, take the time to read the article “Why Beijing’s Troubles Could Get a Lot Worse.”

People are crazy if they believe any government statistics, which, of course, are largely fabricated. In China, the Heisenberg uncertainty principle of physics holds sway, whereby the mere observation of economic numbers changes their behavior. For a time we started to look at numbers like electric-power production and freight traffic to get a line on actual economic growth because no one believed the gross- domestic-product figures. It didn’t take long for Beijing to figure this out and start doctoring those numbers, too.

I could consume the better part of a week with facts and figures about China, but this succinct picture suffices. In short, the IMF’s fascination with China’s GDP surpassing America’s has been fulfilled and celebrated, but the hardly bright people behind the institution’s pointless movement are missing the broad view. Then again, when did the IMF get it right? There’s a lot of emotion riding on China as the ultimate global savior, which is the same as expecting a sardine to rule the ocean, and let’s not forget that the talk about BRICS taking over the planet is nowhere to be found. Silly humans!

Take a deep breadth, look around, and digest everything that has been done by governments and central banks over the last seven years. Then look at the results and where we are, still pumping money and embracing zero interest rates like they’re the love of our lives. On a broader note one thing is certain: The next one (hint: SPY, QQQ, IWM and all the others) will not rebound like it was 2009, and it will take a generation to recover!

Happy Holidays and a Safe and Prosperous 2015. Till Then!

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