Could be a critical year for China

UPDATE: The Dec 15 CNBC video doesn't show up properly for some reason :( Click here to go to the relevant CNBC page and check out the video on the left, in the article.


I thought China was going to be a big issue in 2009. I was wrong. Nothing happened.

But I am maintaing my stance. Is it still vulnerable to an implosion? Mike Shedlock links to two China bears, Doug Noland and Jim Chanos, who think China may be reaching dangerous territory. Mike Shedlock has also written in the past about his bearish views of China.

I'm not a fan of Doug Noland (too perma-bearish for my likes) but I do pay attention to Jim Chanos. As you may know, Jim Chanos is perhaps the most successful short-seller in the last 30 years. There are others, like Jim Paulson, who profitted off short-selling mortgage bonds but they are not short-selling specialists; they go back to a long-only portfolio afterwards. Chanos, in contrast, is a specialist and very good at detective work. But his techniques are sometimes questionable, and he is, for those not aware, one of the short-sellers that was attacking Prem Watsa's Fairfax Financial.

One thing about Chanos is that he, like most short-sellers, uses propaganda so you have to be really careful (another person who is an even better media influencer is William Ackman of Pershing Square.) I notice that Jim Chanos floats stories to the media and uses that to influence perceptions. For instance, he was apparently the first person to pass along the questionable techniques of Enron to the journalist at Fortune magazine. Without the media publicizing the Enron story, I don't think Enron would have imploded quite the way it did. Enron probably would have collapsed a bit and had to pay huge fines but there is a possibility it wouldn't have declared bankruptcy. I'm not saying what Chanos does is wrong; he isn't doing anything wrong. All I'm saying is that short-sellers love to use the media.

Anyway, the bearish China call appears very different from Chanos' past, successful, bets. Chanos is very good with short-selling individual securities but I'm not clear on his track record on macro bets. If I remember correctly, he was bearish on the Dubai real estate boom but I'm not sure if he made any money. Jim Chanos has been bearish on China for more than an year now and been completely wrong. It remains to be seen if he ends up being right.

Mike Shedlock links to a New York Times story, picked up by Yahoo! News, touching on Jim Chanos. Nothing new in the article but it's a good recap of the battle between bears (like Chanos) and bulls (like Jim Rogers):

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China's hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like "Dubai times 1,000 -- or worse," he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

"Bubbles are best identified by credit excesses, not valuation excesses," he said in a recent appearance on CNBC. "And there's no bigger credit excess than in China."

A lot of this seems like hyperbole. I don't think there is anything that is 1000x worse than Dubai. Really! I mean, Dubai has a ski slope in the middle of the desert! Dubai has a Tiger Woods golf course that needs something like 100,000 gallons of fresh water a day—again, in the middle of the desert with shortage of fresh water.

So, maybe in terms of dollars. China is much bigger so the number will look big. But the problems are not as bad as Dubai IMO.

Still, betting against China will not be easy. Because foreigners are restricted from investing in stocks listed inside China, Mr. Chanos has said he is searching for other ways to make his bets, including focusing on construction- and infrastructure-related companies that sell cement, coal, steel and iron ore.

Chanos probably got burned badly last year, given the spectacular rally in nearly all assets, but, of relevance here, commodity businesses like coal, steel, etc. But Chanos is a long-term investor so the question is what happens over the next 5 years.

The simplest short-selling strategy is to sell short the ETFs or invest in an inverse ETF. For instance, one may short sell the FXI ETF. I suspect that is not how you make money. Given how short-selling only has a maximum upside of 100%, it is probably best to bet big that something will completely implode (an index won't completely implode.) The best thing may be to short sell individual securities. Because of capital controls, as well as various distortions—for example, most of the major Hong-Kong-listed Chinese companies are majority owned by the government—it is hard to find something that will be profitable.

Short-selling commodities that depend heavily on China, like iron ore, are probably worth considering. I don't know how easy it is for small investors but this would be a clean strategy. Jim Chanos, in the video linked near the bottom of the post, suggests some techniques.

"I find it interesting that people who couldn't spell China 10 years ago are now experts on China," said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. "China is not in a bubble."

Colleagues acknowledge that Mr. Chanos began studying China's economy in earnest only last summer and sent out e-mail messages seeking expert opinion.

But he is tagging along with the bears, who see mounting evidence that China's stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans.

"In China, he seems to see the excesses, to the third and fourth power, that he's been tilting against all these decades," said Jim Grant, a longtime friend and the editor of Grant's Interest Rate Observer, who is also bearish on China. "He homes in on the excesses of the markets and profits from them. That's been his stock and trade."

Mr. Chanos declined to be interviewed, citing his continuing research on China. But he has already been spreading the view that the China miracle is blinding investors to the risk that the country is producing far too much.

"The Chinese," he warned in an interview in November with Politico.com, "are in danger of producing huge quantities of goods and products that they will be unable to sell."

In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

Here is the CNBC video from December (click here if the video does not show up):

It's interesting that Chanos implies that gold is not in a bubble. He doesn't really discuss it but does say that "no one is building anything out of gold."