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Chanos vs. China

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by Peter Switzer

With Wall Street selling-off overnight, which is no surprise given how far the stock market has risen since late August last year, legendary prophet of doom and short-seller Jim Chanos is beating his drum that China is about to implode.

This is nothing new. On 7 January, the New York Times reported he said China would crash. By September, he was calling China the next Enron and then on 17 November, CNN reported that he said the world’s second biggest economy was about to implode with a spectacular real estate bust.

He was at it again in February this year saying: "Fixed income investment is now a record 70 per cent of the Chinese economy."

Looking at this bucket of around $3.5 trillion, Chanos argues about $100 billion goes into high-speed rail and other infrastructure investments. Instead, most of that $3.5 trillion is in real estate.

Now looking at the West, he points out that with their property bubbles this sort of fixed asset investment didn’t even make 20 per cent.

Now to be objective, Chanos of Kynikos Associates, who runs a fund that is primarily in the shorting game, got Enron right and then took a set against Macquarie Bank in 2007 and 2008. He’s a dangerous operator and has been accused of incorrect analysis by those who he has pursued on the market. However, the media gives him a lot of oxygen. I’m doing that right now!

Big issue

However, Chanos versus China is a big issue, given that Australia and the world economy would suffer greatly if China went to hell in a hand basket. It would mean stock market down, economy down, dollar down, interest rates down, unemployment up, bankruptcies up and even the possibility of a Great Depression.

This is a big issue and I think he’s wrong and I can’t believe that every central bank, every ratings agency, investment bank and office of Treasury around the world would not have stress-tested the sustainability of China’s economic growth model.

If companies such as Rio Tinto and BHP Billiton haven’t looked at the risk management issue with their dependence on China, then they shouldn’t have so much money locked up in a pipeline to invest in the Australian resources sector.

This is the pipeline that threatens inflation here, higher interest rates and a tough Budget next week.

Sure China will eventually hit a roadblock and slow down substantially but imploding is a massive call.

I believe markets get ahead of themselves and bid up commodities and their prices ahead of where they should be and these bubbles can be pricked but it doesn’t have to mean a collapse — just a significant price pullback. This hurts the speculators and helps the real world businesses, which actually buy commodities to make real things.

The Chanos view

Of course, if Chanos is right, the Australian economy would be right in the way of the rubble that would be sent flying if China collapsed and so what did he tell CNBC overnight?

Firstly, he told a porky when he said he has been talking about this for a year but, as I have pointed out already, Google shows he was spruiking this on 7 January 2010. And in fact, in the December before, he was talking about it on CNBC.

He argues that Chinese growth is driven by real estate investment, which is unsustainable. He says the consumer and net exports are becoming less important.

He points out that the Asian Tiger economies in the 1990s had a real estate construction investment to GDP ratio of around 35 per cent but China is closer to 70 per cent.

He calls this unprecedented!

Right now China’s economic growth is around 9.7 per cent and industrial production was up 14.8 per cent on the most recent reading.

He also challenges what he calls a myth about the shift of the population from the country to the cities. It’s said to be 15 million but the latest data, he says, showed only eight-and-a-half million people moved.

Chanos says China is on a treadmill to hell and his big claims need to be tested. While he’s not shorting Australia, he has set himself against BHP Billiton and Rio Tinto because of their links to China.

Watch this space

I think he’s wrong (though China can’t grow forever) but I believe he’s a short-seller talking his own book. That said, I am determined to test his thesis.

Watch this space, as this is clearly a critically important matter.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Wednesday, May 04, 2011

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