Western Fat Cats in Chinese Shorts

Quite why certain areas of the banking fraternity are hyping the concept that China will crash seems a little unclear, not just when you consider the facts of how the Chinese view investment, but also how large some of the caveats these so-called banking experts have added to their "investment ideas".

The Chinese property and banking sectors have been receiving a fairly hefty amount of press this month for one reason or another. Most of it is touting scarewords like "bubble" and "crash" as a result of a few hedge fund managers announcing they are about to go gambling against the Chinese banking and property sector (with some large caveats attached of course).

Quite why certain areas of the banking fraternity are hyping the concept that China will crash seems a little unclear, not just when you consider the facts of how the Chinese view investment, but also how large some of the caveats these so-called banking experts have added to their "investment ideas".

For example, one such fund being offered asks for a minimum 1 million USD to effectively bet on China's financial crash through debt and credit swaps, interest rates and so on. Fair enough you might think, spokespeople for the fund cite oversupply on property and construction as the bulk of their reasoning behind it - makes a lot of sense initially, as does the apparent "excessive lending" going on in China. It's only when you get further into it that things start to get a little weird.

What the fund managers are forgetting

What isn't highlighted is that most lending that does go on in China is heavily regulated and restricted (i.e. there are no "liar loans" or "NINJA loans"). Maximum LTV is 80% at best.

The other important issue that appears to have been overlooked by a number of short wearing fund managers is that the vast majority of Chinese lending institutions (the banks) are state owned. (Historically, under what the West regards as State/communist rule, private enterprise is a recent thing in China).

Surely China can still go bust?

One of course might think "So what? China can still go bust", and you would be correct in thinking that - there is extensive talk on how much cash China is printing to increase its liquidity (which it is doing at a phenomenal rate). Compared to the West (which is printing money to replace what it has spent badly) the Chinese situation looks dire. The issue is, though, that Chinas restrictions on foreign investment into the country have caused the lack of cash - not reckless and irresponsible lending to people who cannot afford it as has happened in the West.

The key thing though that really highlights the lack of conviction in the Chinese crash by these hedge fund managers is the that with the fund in question has stated that a "burn rate" of 20% per year is added until they prove their theory correct.

Throwing money at it until it works

Just to clarify what that means in case you think you have misread something here, yes, the fund will allow itself to fall by 20% per year until they get it right and make a profit. If you think about it for just a moment - the whole concept of the "investment" pans out as follows:

  • Invest 1 million USD
  • The hedge fund then bets that sectors of the Chinese market will drop.
  • The fund continues to invest in this fashion taking short positions.
  • Although it doesn't state whether the fund is open or closed (I suspect closed) the term is for 5 years, and it has limits on it allowing a 20% loss per year. (i.e. 20% growth in the Chinese economy)
  • IF the Chinese economy takes a dive - you make a profit. If on the other hand it continues to grow - you lose.

Is it any wonder at all that the banking industry is in the state it's in, and the economies in the US, UK and several major countries in Europe are in the toilet? I have said it before and will say it again, as much as there is money to be made from economic downturn, there is no justification for it.

Shorting anything is a dangerous pastime at best - you are basically betting that something is going to lose value over time, and in doing so you are encouraging it. All well and good you might say - if you get it right.

The reality is that you cannot hold open a short position forever; the markets don't and can't allow for it.

If you sell a position in something before you own it, you have to cover the position to fulfill the order at some point (basically, pay for it, regardless of whether you have made a profit or a loss), otherwise the market itself will cease to exist.

The lack of the Bowler hat-wearing fat cats

Ranting aside - hands up if you think a nation as vast as China is going to allow that to happen? Remember, China has the largest population on the planet. It has an extensive workforce and vast tapped and untapped natural resources at its disposal.

What is happening now will only strengthen its position as a financial superpower in the years to come. How? Very simple. The West is stuck in its beliefs that capitalism is the way forward, it believes in rights and has expectations (and so it should to a degree) as to how money should be made and so on. So does China, just very different ones.

Why do you think the lending institutions are state owned and not run by corporate banking fat cats looking for bonuses the size of a third world country's GDP every year? With loans only being made to local people and companies in China, when default occurs, the asset is simply going to go "back in the pot" as it were for redistribution - it hasn't had all the value sucked out of it as it would if it were in the West. I agree that the numbers coming out of China look and sound scary, but this is because they are different to what we are used to, and subsequently derived through an entirely different method.

You might think I am completely mad and wrong here, but consider this - China has never really permitted foreign acquisition of its assets to any degree, and there is no real sign that it will allow it anytime soon either. Nobody outside China has any real bargaining power as a result, and even western businesses in China aren't able to pull much out of the country in the way of profit because it is such a closed market.

The Chinese don't need Jonny Foreigner money, and aren't likely to for some time to come. Until then the mentality will stay as it is (pending any major political change) and I can't imagine them letting anyone getting in their way by betting on their economy collapsing.

If you are considering investment in China - long term and growth is the key. Quick-buck doom-mongery is for the foolhardy against this financial monolith.

- Friday 21 January 2011

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