At a recent event at the Wine Country Conference, Jim Chanos of Kynikos Capital Management, one of the world’s foremost experts on China’s economy and one of the world’s most prominent short sellers, explained the financial crisis that China has already started, and the dominoes that look like they are ready to fall.
The pillars of Chanos’ thesis are the property bubble, corruption, rising costs and growing dissatisfaction among the nation’s workers. The Chinese property bubble is something we’ve looked at several times before, but the situation isn’t getting any better. Chanos lays out the massive structural issues in simple terms.
A shadow banking system, made up of Local Government Financing Vehicles, Trust Products, and Wealth Management Products, is driving an increasingly expensive and highly leveraged property bubble. These products, along with others, facilitate corruption by hiding money in property.
The bulls are reliant on the theory that China will see a massive wave of urbanization in the next ten years in order to justify the incredibly high price of property. To see 80-85 percent urbanization, 600 million people need to move. Jim Chanos estimates that only 250 million are likely to be mobile, meaning property is incredibly over valued.
It is difficult to find out who exactly is buying the properties, but anecdotal and media evidence suggests that much of the money may be coming from a small group of very wealthy speculators. Chanos highlights the “Grandpa of Property,” a senior police official in the province of Guangdong who was fired after it was revealed he personally held 192 properties.
The draw of urban areas and high wages compared to farming and other regional activities, might be a driving force in the country’s downfall. Wages in China’s factories rose by 20 percent in 2011, and 16 percent in 2012. That level of cost increase is unsustainable and might put “the workshop of the world” out of business. Economic slowdown would reduce the attraction to the cities, and result in a property collapse.
Margins and profits in Chinese factories are already being squeezed, and factories have already begun to relocate from their “high cost” positions in China. China is not the haven of low cost production that it once was, and things are not likely to return to the “good old days.”
Popular dissatisfaction in China is growing, revealing yet another mechanism by which the country’s economy could be thrown into chaos. In 2010 there was an estimated count of between 180,000 and 230,000 mass incidents in the country. China spends more on internal security than it does on its military according to Jim Chanos.
The issues that the Chinese populace is most concerned with mostly go hand in hand with the other problems in the country’s economy. Pollution and quality of life remain an important concern for the country’s urban population, including worries over the quality of the country’s food supply. A second issue prominent on the mind of the country’s populace is corruption among highly placed officials.
The Chinese government has announced policy programs that seek to deal with that corruption, but citizens appear to be losing faith in the ability of the government to reign in the activities of local officials. The Chinese governments use of Cold War tactics, like the artificial conflict with Japan over the Senkaku islands, is a particularly telling trend according to Chanos.
China is sitting on a property crisis that is either about to happen, or is already under way. The country has a huge amount of corruption, particularly among the high ups in the provinces and the basis of its industrial economy and low cost manufactures is eroding, and the country’s populace is becoming increasingly unhappy with the government.
What Chanos has outlined in his presentation is not just one mechanism by which a financial crisis could happen in China, it is several competing trends that could lead to such a crisis. The sheer number, and severity, of these mechanisms leads to the conclusion that China is probably headed toward a contraction, and that contraction may already have started.
This spells trouble for the entire world economy. This is not a small aberration, this is a notable trend. China’s future is not going to stick to the path market bulls have set for it, and its problems belong to the globe. Western investors need to take note.