Death of the China Cult

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By Zarathustra, who is the founder of Hong Kong blog Also sprach Analyst. He was educated at the London School of Economics and the Chinese University of Hong Kong and was once a Hong Kong-based equity research analyst focusing on Hong Kong real estate (which he did not really like), with a secondary coverage on China real estate sector (which he actually hated). Cross posted from MacroBusiness

People in Hong Kong have a long history of mistrust of China. This city, after all, was a colony of the British Empire for more than a century, and has only been under Chinese rule (under one country two system, to be precise) for a mere 15 years. In this city, you seldom hear anything bad about Britain (because most have no idea), but you hear a lot of bad things about China, particularly the Chinese Communist Party. We just don’t trust them.

While the mistrust of the political class of China continues in Hong Kong (and will certainly continue for much longer), the doubts on the strength of the Chinese economy and the doubts on the ability of the political class to manage the economy have more or less evaporated after 15 years of Chinese rule.

It used to be that Hongkongers would go to China to purchase really cheap stuff. Now, it is the Mainland Chinese who come to Hong Kong to buy really expensive stuff. Places in China which were farmlands are now full of modern buildings. Infrastructure in large cities is getting better, sometimes even better than Hong Kong. Before the transfer of sovereignty, Hong Kong was already a rich city while China was a very poor country. China used to be poor, dirty, relatively uncivilised, you name it. Today, it’s almost as if this city would have died if the Chinese economy did not grow at the rate it did in the past decade. China today, especially for big city like Shanghai, is just like Hong Kong: modern, international, classy. You can’t say many things bad about cities like Shanghai.

No one would ever dispute the achievement of the Chinese economy. What we see in China now, on the surface at least, is progress. And the progress was huge indeed. For 30 years or more, the Chinese economy has defied “gravity”, has never been in a recession, and has lifted enormous numbers of people out of poverty. Predictably, perception of the Chinese economy has changed very dramatically over the past decade, from a market that you wanted to stay away from to a market that no one wants to miss.

But this is not the whole truth. Before the story of “China as the forthcoming greatest economic power”, many held the impression that Chinese companies were either not well run, or were run by crooks, who cooked up their books and/or produce very inferior products simply to rip people off. On top of that, the Chinese government cooked up statistics, and doubters spun that in their own favour, suggesting that the economy could not have grown that fast. Meanwhile, corruptions was rampant. Businessmen bribed government officials in order to profit, while government officials got rich through taking massive amount of bribes.

If you insisted on that grim view on China in early 2000s (right after the Chinese government lied about SARS, as a reminder of who were the type of people who ran the government), although you would have missed the bull market in stocks, you would not have been inaccurate. Since the beginning of time (well, that’s an exaggeration of course), China has had the creativity and necessary skills to create fake and low quality products beyond anyone’s imagination. We also knew that corruption in China was horrible since the beginning of time (and this is not an exaggeration, as that has been a recurring theme of the rise and fall of different dynasties ever since Imperial China). Banks loaned to whoever had connections to government officials (i.e. those who have bribed government officials) so that it required extra faith for investors to believe in banks’ books. And as a businessman, as long as you had the great connections with government officials, banks would probably still be willing to lend to your company cheaply even though you were cooking your own books.

These are the problems of China’s past. But if they sound familiar to you, that’s because they are what increasing numbers of people are talking about now. These are not just history, but current reality. China is still full of businessmen who make crap products that are dangerous for human consumption. Corruption is as serious as it was, if not more so. You still have to bribe officials to achieve your goals (and the costs of bribing officials to achieve your goal, as I understand, is getting ever higher), and government officials cannot have a successful career without being corrupt. Banks have not changed their practices in determining who to lend money to and there is still no one who is willing to believe in Chinese statistics in full at face value.

The only difference between the recent years and ten years or so ago is that people just ignore it now, because the extraordinary bull market and the seemingly unstoppable economic growth has created a China cult, a cult among the investing community that China is the best place to invest. Just as hedge fund manager Hugh Hendry said “10 years are enough to create a cult in capital market”. In fact, China has not seen any year with negative growth for more than 30 years.

Despite the fact that the Chinese stock market bubble has gone bust in 2007, the China cult continues to attract new followers. After the bubble went bust and the Lehman crisis hit, quite a number of people were confident that the stock market would surpass the 2007 peak very soon because the Chinese economy has been strong. The view that China became the best place to invest has become ever more popular as the Western economies looked mortally wounded after the crisis (while they are not). The ever more popular idea that the economic weight has shifted from the East to the West, or the idea that we are back in a bipolar world for the first time since the end of the Cold War, and among many other ideas, have reinforced many people’s belief that China is the place to go. Even to this date, we understand that there are a lot of European companies which are still looking to invest in China apparently because China looks “safer” relative to Europe. An entire country, in Australia, joined the cult.

In the beginning of the recovery of the global economy, investing in China did pay off well relative to many markets in the rest of the world, reinforcing the idea, once more, that China is invincible. The same doubters who did not invest in Chinese stocks 10 years ago because they thought companies cook up their books started to buy in 2007, 2008, 2009, 2010, 2011, and 2012. The same doubters who did not invest in Chinese stocks because of worries about corruption are now accepting corruption as a reality and that it is something which determines whether a company can make money. The same doubters who thought Chinese banks have understated non-performing loans started to believe that buying Chinese banks is like buying HSBC in the 1980s, which will give you a return in the order of hundreds of times over the next 3 decades. Investors have also been much less careful about frauds as the cult reaches its climax. But instead of identifying the problems related to poor governance, frauds and corruption, some insist that these are isolated cases and have nothing to do with the culture of how businesses are done in China. Also, while Chinese statistics are not reliable, more and more people are trying to spin the unreliable data to fit their own bullish arguments. Instead of suggesting that growth is overstated, now they say consumption is understated, and the China consumption will be the biggest investment story of the era.

But Chinese equities outperformance did not last long: first in Shanghai, then in Hong Kong (and Australia), they have turned from two of the best markets to markets doing even worse than Europe. Bears (like me) started to be ever more vocal about the structural problems in the Chinese economy: namely, the real estate bubble, over-capacity across the economy, over-investment and the associated unsustainable increases in debt etc. And I am getting ever more concerned about issues that we did not mention much: corruption and its link of over-investment, and the consequence of lack of inflation. Bears have got it right for almost 2 years now as far as stock investments are concerned, and the economy is now slowing down rapidly while the real estate market cools, just as the bears predicted. Unfortunately, people increasingly blame short-sellers instead of admitting that they have been wrong.

Still, the cult has not yet died. The past few years have produced an impression of the Chinese government as invincible, and it has miraculous control over the economic machine, that the slowdown is “intentionally” engineered by the government and everything within the economy is still very much under control. Unfortunately, most who use this argument to justify that the slowdown is not a big problem have all invariably forgotten that most economic slowdowns in recent memories started with central banks tightening monetary policy to control inflation and slow down the economy, and most, if not all, of the cases ended with recession that they did not want to get into. Many have also not realised how difficult it is for China to boost its way out of a debt deflation.

As the economic slowdown becomes a reality and a hard landing looms, more of the problems we have identified will surface. The cult will surely die within the next few years. The only question is when and whether that death will be violent death or slow.

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  1. wunsacon

    Take everything you said and replace “America” (and perhaps any other nation) — it’s probably true, too.

  2. korual

    There was also a train of thought on the far left of economic analysis (I’m thinking of Arrighi) that saw the baton of capitalism passing to China (Italian city states – Holland – Great Britain – USA – China). Each capitalist empire giving way to the next due to inherent crisis in one and monopoly of power in the next. But while the end of the American capitalist Empire is understood, how exactly is China going to support the next paradigm? Where is the growth?

    1. Maju

      Well put.

      I’d say that the growth is over because Earth is exhausted. Earth is, paraphrasing some Romanian author, the keystone that arhcitects, or more precisely economists, forgot about.

      All the “growth” of the last centuries has been nothing but transferences from Earth reserves (fossil or, more worryingly, living) to the human socio-economic sphere: a huge process of concentration of Earth’s resources into our peculiar subset.

      That “growth” story is over. A whole new paradigm must arise soon or our species (and much of life on Earth) will go extinct.

      1. random carbon unit

        The next “growth” is developing in parallel. Unfortunately, it’s post-human. (Post-carbon, for now, as well.) I’m referring to electrodigital activity — eventually artificial intelligence.

        Human civilization is constrained by fossil fuels, clean water, etc. Total global computing power is not so nearly constrained, allowing it to grow much faster. As a form of computing power, AI will be better suited to the present environment. It might be the next “economic growth” story — but in an “economy” that we humans don’t participate in.

        I hope the A.I. doesn’t decide it wants to compete for our food or resources. Unfortunately, there are some linkages between electricity production and the solar power that grows the food we eat.

        1. chad

          Computing power is constrained by energy which, ironically, is what is holding Human civilization back too.

  3. jake chase

    The bottom line is that economic growth is over. You still have tons of Chinese garbage products but the western customers have run out of money to buy them. The next thing they will be faking is sales. Anyone buying Chinese securities deserves what he gets, which doesn’t mean there won’t be a bubble before the final explosion. It is getting harder and harder to find value anywhere, and the last time that happened was 2006.

    1. rotter

      “The next thing they will be faking is sales.”

      Yes, to lure in the last few billions of sucker dollars..then they have, maybe, like a fun “cultural awakening” or something, but it will involve the confiscation of vast amounts of sucker assetts and the expulsion from China of legions of suckers.

      1. different clue

        Which would serve at least some of the suckers exactly right, because some of the suckers were the people who closed production here and opened that same production up there.

  4. salvo

    apropos China death cult

    “China is the largest exporter of fur in the world, yet has no animal welfare laws in place. This means that animals are not protected by law and can legally and publicly be abused and tortured.

    According to the Winnipeg Humane Society, most of the animals are killed by being strung up by their hind legs or neck with a thin metal wire. A worker then stabs them in the groin or stomach and waits for them to bleed to death. Some farms or factories will bludgeon animals to death, suffocate them or use a hose to pour water down their throats until they drown. More often than not, other tightly confined animals are forced to watch and wait.”

      1. salvo

        well, I’m not US American, furhermore, I don’t really get how pointing out China not having any animal protection laws would be ‘China bashing’. The goal of the petition was to do something to protect animals regardless the place abuse is done

  5. Capo Regime

    In U.S.A we are far more advanced. Don;t do massive bribes to public officials we do it in more sophisticated ways. Contributions to politicians to shape policy in business favor. Government officials are influenced via promise of a partnership in a K street law firm, VP at a bank or senior advisor at a PR firm. Yes, we are more advanced see and can mock amatuer hour with bags of cash. Note to Beijing from D.C.–more nuance please and write laws to make it all legal and you too can be an honest nation.

    1. citalopram

      Not to mention we actually innovated and led the world at one time.

      I think China steals better than anyone else. It seems to me we gave them the keys to the kingdom at the expense of our nation.

      I was always wondering how ugly it was going to be when the British handed Hong Kong over the China.

  6. ltr

    This is not analysis but rather an undocumented or unsupported complaint against China. OK, but I am only impressed that the writer does not like China.

  7. Me

    I lived in China for about a year and a half. One city I lived in was Hangzhou. I lived actually in a suburb. Any rate, the school I taught at was surrounded by countless apartments that were all empty. It was a bit creepy. Tons and tons of apartments around me, with no one in them. It reminded me of what I saw in the States leading into the crash (I lived in California at the time and could see lots of warning signs there too). I knew a number of people in China involved in real estate speculation and they weren’t rich. They were teachers like myself. China had a law, which I imagine is still on the books, that a majority of real estate cannot be owned by a foreigner. If you want, for example, to buy an apartment, 51% has to be owned by a Chinese citizen. So my friend, and others I came across, were speculating with the help of foreigners in the Chinese market and it seemed to make my friend some money, but there also seemed to be far too many condos being built. There are parts of China that are, as everyone knows, extremely poor. I realize the people might know this, but to see it with your own eyes is another thing. There is a housing problem in parts of the country, but where I lived (most of the time not too far from Hong Kong in the mainland, the other time was spent in Hangzhou) there seemed to be too much housing and not enough buyers.

    The state has control of a lot of the financial system, which I have to say has been more positive than negative, although the negatives could overtake the positives in the coming years. We’ll see. It seems that the state domninated financial system and the SOE’s have been involved in lots of speculation. So the Chines people collectively, if there is a crash, are going to have to pay for that speculation directly. The number of SOE’s have decreased, I believe that they are about 5% of overall enterprises in China. However, the size of the individual SOE’s has grown massively. Look at the Fortune 500 from 2011. There were 69 Chinese firms listed, all but 2 were SOE’s. So if the SOE’s have involved in speculation, its likely that the money being speculated is pretty large.

    Having said all of this, if you want to know what China (and many other countries have) is going to have problems with, it is the environment. The World Bank has said that 10% of China’s GDP is eaten up by environmental and ecological costs. If you know anything about now orthodox economists get to those numbers, you can bet your ass that the estimate is probably far too low. They put values on human lives, eco-system/environmental and social values, use many times biased discounting, amongst other things. China has massive problems with soil erosion, eutrophication, air and water pollution, biodiversity loss, amongst many other ecological and environmental issues. They also do have a massive problem with population. Go shopping in China on a Sunday, or ride a bus during the day, you’ll see quickly how many people there are. All those people need food, housing, clothing, health care. Many expect Western luxuries too.

    Think about it this way. 40 years ago Shenzhen’s population was a little over 300,000 people. It is now 11 million. Chongqing had about 1 million people at the time Mao and the Communists took power. The population is now pushing 30 million. Part of that is the result of China’s uneven economic development (where coastal regions are relatively wealthy while many part of inner China are extremely poor). Regardless, think about how that impacts the environment. The environment can possibly adjust to changes over time (provided you don’t pump out massive amounts of pollutants that don’t occur naturally in the environment for too long), but when you have that quick of population, pollution, consumption growth, you don’t give the environment near enough time to recover.

    China is our, the planet’s, future in this regard. They are just a microcosm of the problem that (largely capitalist) industrial development has created.

    1. curlydan

      good comments. I’ve traveled to Guangzhou off and on for the last 9 years, and I’ve experienced Sundays in the shopping districts–truly a swelling mass of humanity in a small space.

      As a non-Chinese speaking visitor, it’s hard for me to get a good sense of the economy, but I could sense in my last visit the INCREDIBLE amount of money poured into investment.

      I traveled south of Guangzhou (near Hong Kong) across the Pearl River delta headed to a hot springs area. It was amazing to see the incredible road and bridge infrastructure built to traverse this delta. Literally hundreds of bridges, some extremely long, to help get products and people through this area. It was really over-developed because the roads were clear once you cleared the city. It’s here where I think China must slow down because they probably cannot invest and build infrastructure as fast as they once have.

      1. Me

        I lived in Zhuhai, next to Macau. Been to Guangzhou many times, love the city. The high speed trains are pretty cool too. They were building the bridge when I was leaving, along with the train from Zhuhai to Guangzhou. They build things so quickly in China, they must have finished both by now.

        China is trying to create its own car company and where I lived they slapped a 100% tax on imported cars, to support the local car industry. The Chinese cars were, even with the tax, much cheaper but didn’t work as well. Even though the price was small, as you know, most people get around by train, bus and of course bikes. Cars are a luxury for most. It would seem that high speed rail, improving public transportation and the like would make more sense than building a massive infrastrure for a polluting and inefficient system that is reliant on cars.

        I am an economist in training, I guess you can say, so I immersed myself in the economy as much as I could during my time there. Bought lots of books in Zhuhai, mostly created by the Chinese government, about the structure of China’s economy (pensions, taxation, regulation, etc). I also talked a lot with students, Chinese friends and the like, about China’s economy. A great experience.

        When did you last go to Guangzhou?

    2. Nathanael

      The key feature of the Chinese government management of the economy — which *has* been spectacularly effective, and will *continue* to be so — is that the government officials are perfectly happy to eliminate foreigners’ “investments” with the stroke of a pen, if they feel that it will help the country and their political careers.

      So I think China’s economic future is still pretty impressive — but investing in it? You have to be joking! The profits are going to go to the locals whether you like it or not.

      1. Nathanael

        The inevitable bubbles bursting will be dealt with in Chinab first, by expropriation of the foreigners’ interests, second, by expropriation of the powerful managers’ interests (they screwed up — they are subject to losing everything), and third, by printing money and moving things around to fix the remaining problem.

        We could deal with our bubbles bursting the same way, but our managers (CEOs) are too powerful and have prevented it from happening by creating an entire cult around themselves, which controls 1 1/2 of our 2 political parties. In contrast, the Communist Party of China is perfectly happy to execute managers who cause trouble.

  8. American Slave

    At least with corruption in China they don’t shut down factories and customer service centers and move them to other countries, at least as far as state owned enterprises are concerned.

    1. American Slave

      And as a side note im sure the US cooks the books on unemployment levels so they can get rid of welfare and unemployment insurance.

  9. Jack Parsons

    I have a couple of huge worries about China:
    1) When the inevitable crash happens, what kind of political spasms will it generate? During Tiananmen every roundeye had to leave, within days. (A friend was one of them.)
    2) That the design of the Three Gorges Dam (and other dams) did not include enough redundancy to work around the corruption in the construction. If it goes, that’s alot of dead people. And a dead economy.

  10. Fiver

    Yikes. If the author is Chinese, I now believe there is such a thing as a self-hating Chinese. The elite Anglo LSE focus on Asian as opposed to Anglo forms of corruption is remarkable indeed. To me, this piece could as easily have been penned for popular consumption by someone actually in the policy elite in the UK or US, the latter already clearly engaged in efforts to contain/control/weaken China – it in fact being official US policy to ensure no other country shall ever be allowed to challenge US power. Thankfully, he didn’t go so far as to blather on about lack of democracy, not just because London, Wall Street and Washington have legalized criminality and obliterated meaningfulelectoral politics, but because the idea of 1 vote meaning anything in a country with over a billion people is going to be a tough sell to the people themselves.

    Anyway, anyone following the China “story” knew all of this long ago – the corruption, the doubts re numbers, Chinese finance, SOE’s, the bubble, and the rest. Only a true fool thought this pace of development could continue indefinitely – but hardly for lack of Chinese ingenuity, or the success of the Chinese management system in placating with massive future sacrifice precisely the Idol the Western economic cult has worshipped with impunity for most of the past century – mindless “growth” in total activity at all costs.

    It would not matter what degree of corruption or purity of motive, or lack in the political system so long as the goal is what we clearly see it be: to emulate in every way possible US standards of “wealth”, meaning sustainably deploying the stupendous resources required to build a Chinese version of the late 20th century US. It has been obvious for at least 15 years that the goal was highly improbable for 1 reason, and impossible for another:

    1) As noted, the US (and bleating UK) are already in the process of not tolerating it. At some point, the truth that corporate globalization really is for the non-elite, 80% majority of North American and European populations relentlessly bleeding away real wealth production and capacity for production and therefore real wealth and therefore real bargaining power in a corporate world will get enough traction for the “blame China” card to be played more openly and aggressively – to provide cover for the shift over the next couple years of the US/Anglo global financial war of attrition from Europe to a huge and vulnerable China (and Japan).

    2) Note that “Me” above identifies the Gorgo in the room that dwarfs all other concerns, i.e., the scale of Chinese development vs the capacity of either theirs or the globe’s environments/resources to sustain that manner of development. That the West can’t either without assured massive future global wealth extraction is ignored – the prospect of a looming major geopolitical power struggle of course never allowed to roam away from its silo into a polite economic conversation.

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