Sunday, February 21, 2010 2 comments ++[ CLICK TO COMMENT ]++

Jim Chanos' China bear case

You may recall Jim Chanos, a short-selling specialist, making the news a few weeks ago when he was quoted in a New York Times article laying out the bear case for China. What's interesting about the China bear vs bull fight is how many of the tradtional bears and contrarians are actually bullish on China. Strategists such as Marc Faber and Jim Rogers, not to mention the countless perma-bears who seem bearish on everything, are actually bullish on China (usually through heavily leveraged bets on China-sensitive commodities.) So, even though the China bear case is quite signficant (we aren't talking about some minor asset class or security from the middle of nowhere), there are very few bears. Jim Chanos, as well as Hugh Hendry, appear to be the only prominent ones that are on the bear side.

Jim Chanos gave a great presentation a few weeks ago, outlining his China bear thesis. Some of you may have already seen it but I just got around to watching it fully (it's almost an hour.) Thanks to Business Insider for pointing me to this view (h/t The Big Picture for bringing it to the attention of the Business Insider.) The sound quality isn't good but the content in this video is quite good. I recommended it if you are interested in macro matters or China.

Click through for a video presentation by Jim Chanos, followed by a Q&A.

Here are some key points from the video (not in any order; I'm mixing various segments of his comments together):

  • Bearish on real estate: Jim Chanos mentioned that his firm is not necessarily bearish on China in general. Rather, they see serious problems in real estate. He is not looking to short China or anything like that; he is focusing on strategies to profit from the real estate bubble. However, as implied by Chanos, and is obvious to anyone that has watched the meltdown in America, a real estate bust will impact the whole economy. As is commonly the case, the average person on the street ends up losing a big chunk of their net worth (for middle class and lower, residential homes are the #1 asset.) Chanos suggested that a real estate bust would have even more serious problems for the Chinese government than the so-called "employment problem." A lot of Chinese apparently pool as many as three or four people's resources (usually husband, wife, and two parents from either side) to purchase homes. A permanent destruction in real estate prices will wreck many of those families. Chanos implied that the bust will mostly impact wealthy people (homes appear out of reach for the average person on the street) but it can be catastrophic.
  • Massive real estate bubble: Chanos responded to a question by saying that he doesn't short companies for the sake of shorting them. Instead, he focuses on opportunities where the situation deviates several magnitudes from normal. He says the Chinese real estate bubble fits his criteria and thinks it is the biggest short-selling opportunity given the credit boom underpinning it.
  • Key bearish thesis: Chanos' main thesis is based on his belief that China's credit boom has fuelled a boom in fixed assets (for those not familiar, fixed assets refer to things like buildings, roads, airports, etc.) He implies that China won't be in a bubble if productivity growth accompanied the boom in fixed assets. Yet, what we see is that fixed asset investment increases, which causes GDP to rise. But this is not efficient and Chanos even suggests the situation may be similar to USSR (50's to 70's) and the Asian Tigers (90's.)
  • Investment opportunities (short side): Chanos thinks a good way to bet on the real estate bust is to bet against material suppliers, who supply the materials used in the houses and buildings being put up. He is focusing on Western firms since you have rule of law and will be paid if you are right. Given his outlook, he is not bullish on commodity-exporting nations that sell to China, such as Brazil, Chile, Canada, and so forth. He says these firms are the 1st derivative potential problems—even more so than the countries that neighbour China.
    • I wonder if Hugh Hendry is channeling a similar thought with his bet on Japanese steel producers
  • Investment process: Chanos made a brief comment about his approach. He said the process involves, first, analyzing who is impacted. Then, how does the Street view the situation? Is it ignoring the situation? etc. For example, a company that ships 80% of its copper to China may be a good candidate. But you need to figure out liquidity, compare against peers, and so forth. Chanos also said it's hard to time things and he is often early.
  • Miscellaneous Notes
    • I find it hard to believe—I think the year is much more distant in the future—but Chanos mentioned that China will hit a demographic threshold in 2015. I don't remember exactly what he was referring to but I believe he was suggesting that the number of people entering retirement will surpass the number entering the workforce. Anyone who has studied economics or history knows that this generally portends to slower economic growth. I think I discussed this issue on this blog (not sure) but if you are unfamiliar, it is because of the so-called one-child policy in China, which I have always maintained was one of the worst things the Chinese government, or any other one, ever did (it basically stripped individual rights and gave the state the power to control its population.) I don't want to go into this issue here but I actually think Chanos may be wrong here. I can't recall any study saying that 2015 was the year. My impression was that it was well into 2020 and beyond. (On a side note, I think China will eliminate its so-called one-child policy (it's more like 1.5 child policy) within 20 years.)
    • On another note, Chanos highly recommended one of Paul Krugman's 1994 essays on the Asian Tigers. I don't think I have read this piece (although it sounds like something I did read a while ago) and will try to cover it in detail in the future. The essay apparently was written 3 years before the blow up of the Asian Tigers and it detailed why the Asian Tigers were not as good as they were (the timing sort of reminds me of Krugman's op-ed pieces from a few years ago when he highlighted the housing bubble, when few mainstream economists worried about real estate.) Chanos suggests that the '94 Krugman essay is one of the best essays on the economics of developing countries that he has ever read.
Pretty good video... great start to the year with two great videos: this one and that Hugh Hendry roundtable one I linked last week. Who knows if any of this will make me, or you, any money, but at least it makes me think more about the world.

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2 Response to Jim Chanos' China bear case

John Y
February 22, 2010 at 1:09 AM

I dug up Krugman's essay:

It's a thought-provoking read. But I believe it is also prone to mis-interpretation. Krugman's essay was written with the backdrop of debating economic policies of the countries mentioned and whether these countries have better productivity efficient than Western countries. Krugman's conclusions on these are beyond dispute. There is no doubt one cannot project the current growth rate into distant future. But this doesn't tell us (1) when China's growth will slow down and (2) whether China's growth can shift from merely growth in inputs to improvement in productivity efficient, and thus fuel the growth for much longer.

On (2), notice Krugman's mentioned the huge per capita productivity gap between US and the Soviet. If there is a gap, there is room for improvement; there is room for more growth. Same applies to China.

p.s. I'm currently neither bullish nor berish on China. I'm simply skeptic on any forecast.

February 24, 2010 at 8:23 PM

Thanks... I'll take a look when I get some time...

John Y: "There is no doubt one cannot project the current growth rate into distant future. "

The question is whether the market is pricing in rosy growth for the next few decades or not.

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