Friday, February 26, 2016

More China Weirdness

Lack of transparency is making it very hard to figure out what is going on in China’s economy. Here’s two items for today.


First up is what hedge fund advisors think. I’m not usually one to put much stock in financial advisors’ views of macroeconomic events. But, with China, I have a strong presumption that they know stuff that isn’t being priced efficiently by markets. Here’s Kyle Bass’s investment letter for paying customers via ValueWalk:

… Banking system losses – which could exceed 400% of the US banking losses incurred during the subprime crisis – are starting to accelerate.

Our research suggests that China does not have the financial arsenal to continue on without restructuring many of its banks and undergoing a large devaluation of its currency. It is normal for economies and markets to experience cycles, and a near-term downturn that works to correct the current economic imbalance does not qualitatively change China’s longer-term growth outlook and transition to a service economy. … What we are witnessing is the resetting of the largest macro imbalance the world has ever seen.

His reasoning is that people are too focused on the relatively recent depreciation of China’s currency versus the dollar. What they are missing is that many other large countries depreciated against China first:

… This fixation misses the point that many other manufacturing economies and currencies, including those belonging to Japan, Europe, Russia, and several Southeast Asian countries, have gained significant price advantages at China’s expense.

And he thinks Chinese authorities have done the wrong thing already:

A dramatic devaluation of the renminbi is warranted to regain export competitiveness; however, the Chinese authorities have errantly fought against this so far, spending around $1 trillion to defend their currency.

So, yes, that’s just one investment advisor. But his view is ridiculously pessimistic.

FWIW: No one is quite sure, but there are rumors to the effect that the official Chinese government statement that came out this week suggesting that there would be punishment for media that didn’t support the government’s positions was targeted at outlets that intended to republish Bass’s letter. And there are rumors that a journalist was arrrested Friday for publishing it.


Next up is Balding’s World. He argues that everyone knows that China is running a trade surplus … except for people like him who are looking for it and can’t find it any more.

This is a big deal because trade surpluses add to GDP. China’s reported trade surplus for 2015 was 79% of China’s GDP growth for that year. So, China is reporting both a 7% GDP growth rate (that no one thinks is that big), and that 5.6% of that came from a trade surplus (that Balding can’t find any more).

China has generally had tight capital controls: it’s tough to get investment money in or out. But no one is rationalizing any more that investors have been fleeing China for a while. So how do they get the money out? In particular, how do Chinese citizens who have money get it out of China (to a place that’s safer for a year or a decade)?

Balding argues that they are overpaying people outside the country for imports brought into the country, with some side deal to come pick up the overpayments at a later date.

How can you tell? By the difference in reported flows of funds for exports and imports.

The export data makes sense: customs is reporting them at $2.27T, while the government’s foreign exchnge office (SAFE) is reporting them at $2.14T, and banks are reporting them at $2.37T for the past year. So, there’s some leeway there, but there all within 10% of the same number. Given that everyone, everywhere, has always smuggled a bit, this is probably to be expected.

But the import data no longer makes sense. Those same three sources are reporting them at $1.68T, $1.57T, and $2.55T. Look carefully at the scale of those differences: banks are sending payments out of China for imports that are 50% more than can be accounted for — and to the tune of nearly a trillion dollars. You read that correctly: the discrepancy is $870,000,000,000 to $980,000,000,000.

Subtract those overpayments from the reported trade surplus and you get … a trade deficit … and a reasonable possibility that China’s economy is already contracting.

Keep in mind that China has already spent about $1T out of its $3-4T pile of foreign exchange to defend the renminbi.* This missing trillion is not counted in that other spent trillion.

* Foreign exchange can be confusing. Defending a currency means a government is trying keep its value up. The way you do this is by using foreign exchange you already have to buy more of your own currency. But, what’s foreign exchange? That’s money the government already owns which is denominated in some other currency (or it might be gold too). And how do you “buy more”? You do this by paying a better price (in terms of foreign currency) than others will for your own currency. In short, Limiting the explanation to China and just one trading partner (for simplicity), this means China spent decades sending goods to America and getting paid with dollars, but now people are trying so hard to get renminbi out of China that its exchange rate is falling, and China is buying peoples’ renminbi (and shredding them) with dollars it’s no longer accumulating, and doing so at a rate that can’t be sustained for long.

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