China has been getting a lot of bad press lately. Gross Domestic Product (GDP) growth is slowing. China’s much-vaunted currency reserves have fallen for the first time in many years. Thousands of U.S. investors have gotten burned by investing in fraudulent U.S.-listed Chinese stocks. And tellingly, a growing number of China’s wealthiest entrepreneurs are packing their bags, and taking their money out of China.
This also means that over the coming years, you’ll make more money by betting against the “China Miracle” than on it.
And as you’ll see below, some of those ways to bet are surprisingly close to home.
The Air is Seeping Out of the Chinese Bubble
Mine is not the consensus opinion. More than 80% of fund managers recently told Merrill Lynch that they expect the Chinese economy will engineer a soft landing. Even the newly pessimistic International Monetary Fund projects Chinese growth will only slow to 8% in 2012. Western economies can only dream of such a “slowdown.”
I’ve been a bear on China for a long time. And I believe history will show that Chinese economic statistics — especially concerning GDP and inflation — are as reliable as their Soviet and East German counterparts were. A small cottage industry emerged around studying fuel and electricity consumption as a way to gauge the extent of China’s real economic slowdown. You can argue the numbers until the cows come home. But the bottom line is this: the numbers don’t add up and it’s worse than what the Chinese government admits.
That makes China no different from other Communist economies in the bad old days of the Eastern Bloc. After the fall of the Berlin Wall, the East German economy turned out to be 40% smaller than what economists had calculated. Not exactly a rounding error. In a remarkable example of historical symmetry — in what I think is the still single most underreported financial story I’ve ever come across — the World Bank cut its estimates of China’s total GDP by 40% in 2005. If the World Bank did the same today, China’s economy would shrink to $4.38 trillion, and drop it to #3 globally behind Japan’s $5.87 trillion.
China’s Coming Lost Decade
The Chinese economy may face a “lost decade” like the United States or Japan for two reasons.
First, with investment accounting for about 50% of GDP growth in China, no economy in history has experienced growth that has been this unbalanced and distorted. Much of this investment has been financed by China’s mostly government-owned banks.
And as Beijing-based academic Michael Pettis has pointed out, yesterday’s 10% growth borrowed against future growth. An enormous amount of still unseen debt and bad investments will take a long time to work through the economy. And that’s bad news for the Chinese banking system. Yet, China has been here before. In the late 1990s, the Chinese government had to write off the equivalent of 30% of China’s GDP in bad loans to its state-owned banks. Today’s equivalent would be to write off $2.19 trillion. That’s exactly the size of Italy’s economy.
Second, China is suffering from a real estate bubble that China bear Jim Chanos has called “1,000 times worse than Dubai.” The bursting of the real estate bubble hit the U.S. economy hard. But real estate construction, as a share of China’s GDP, is nearly double what it was for the U.S. economy in 2005, right before the housing bubble burst. Even a 10% fall in property investment would cut China’s GDP growth to 5.3%. And given that housing starts fell by 25% in December, 2011, and that U.S. housing dropped 35% from less loftier levels — a 10% drop is optimistic.
The Chinese economy faces some tough times ahead.
How to Get Rich by Betting Against China
A handful of high-profile hedge fund managers, including Jim Chanos in the United States and Hugh Hendry in the United Kingdom, are set to make a fortune from China’s collapse, betting both against its economy and Chinese real estate.
Here’s how you can do the same.
First, bet against the Chinese stock market and the poorly run state-owned enterprises that make up the bulk of the index. The best way to do this is through ProShares Trust Short FTSE/Xinhua China ETF (YXI). This exchange-traded fund (ETF) rises as the Chinese market falls. With a 52.70% weighting in Chinese financials, this position should soar as banks start to write off bad loans in the coming years.
Second, tumbling Chinese GDP growth is hitting global demand for commodities hard. That’s bad news for former investment darlings, such as commodities giants like Australia’s BHP Billiton (BHP) and Brazil’s Vale (V). These are highly liquid stocks that you should be able to short in any U.S. brokerage account.
Third, and most surprisingly, buy U.S. real estate. After all, that’s what the Chinese are doing. Half of China’s 960,000 millionaires are now considering moving or getting permission to reside overseas. Their top country of choice? The United States. Chinese are now the second most numerous foreign buyers of U.S. property after Canadians. Chinese accounted for 78% of the 3,805 EB-5 applications in the United States last year through which they can get “green cards” in exchange for investing $500,000 or $1 million in job-creating U.S. ventures. Entrepreneurs in Florida are already constructing specially designed Chinatowns targeting just such buyers.
The bottom line?
Bet against China and commodities over the coming decade. And scrounge up enough for a deposit on a property in Las Vegas or Phoenix or Miami.
You’ll be glad you did.
Nicholas A. Vardy
Editor, The Global Guru