"The major uncertainty facing the world today is not the euro but the future direction of China. The growth model responsible for its rapid rise has run out of steam.
"That model depended on financial repression of the household sector, in order to drive the growth of exports and investments. As a result, the household sector has now shrunk to 35% of GDP, and its forced savings are no longer sufficient to finance the current growth model. This has led to an exponential rise in the use of various forms of debt financing.
"There are some eerie resemblances with the financial conditions that prevailed in the US in the years preceding the crash of 2008. But there is a significant difference, too. In the US, financial markets tend to dominate politics; in China, the state owns the banks and the bulk of the economy, and the Communist Party controls the state-owned enterprises."
– George Soros (2 January 2014 Project Syndicate article)
When I read the above-excerpted article, I was motivated to research China's shadow banking industry; with a particular focus on the risks, and, the opportunities that would surface when China's debt bubble deflates.
To aid my endeavor, I formulated the following research questions:
- Why does China have a high savings rate? Is its savings rate forced?
- How does China's growth model work?
- What is the Chinese Shadow Banking system?
- Where do the risks in the Chinese Shadow Banking system lie?
- How may the deflation of the Chinese debt bubble affect Africa?
In this post, I'll share my abbreviated research findings.
...Why does China have a high Savings Rate?
Generally, conventional wisdom holds that China's high savings rate has its underpinnings in her lack of a social safety net. Stated otherwise: most people believe that China's "excess" savings are, in essence, a self-provisioned social security buffer that cushions people when they are unemployed or when they need healthcare.
Interestingly, some quarters even assert that China's savings rate would fall if the nation establishes a public social security system. However, current research findings fly in the face of this line of reasoning: new research findings suggest that sex is the dominant driver of China's high savings rate.
In 1979, China implemented a national family planning policy that is eponymously referred to as the One Child Policy.
According to a paper by Jin, Choukhmane and Coeurdacier (2013), the one child policy had the following unintended consequence: it fueled a surge in selective abortions of female fetuses. Over time, this gender-specific infanticide skewed China's gender balance (males to females) from a natural baseline of 103:100 to 120:100. Simply expressed: there is a shortage of females in China.
Interestingly, this shortage of females has first-order effects that are being felt in China's "mating market"; the competition for females is stiff. In the cut-throat Chinese mating market, ownership of residential property differentiates the males that manage to secure a mate from those that do not.
To increase their sons' / grandsons' odds of winning a mate, Chinese parents and grandparents tend to save money. For what? Answer: to subsidize their sons' / grandsons' residential real estate purchases.
Hence, this suggests the following chain of causation:
One Child policy → Selective abortions of female fetuses → Shortage of females → Increased competition for females in the mating market → Property increasingly becomes a determinant of "mating success" → High savings rate
When a society's savings increase, it faces the pertinent problem of managing them. Generally, the most conservative port of call is bank term deposits. As Illustration 1, below, demonstrates, the interest rates that are offered on term deposits in China translate to an annualized real interest rate of -3% to -2%:
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| Illustration 1 (click on illustration to zoom in) Adapted From: Zhang, 2013 |
Clearly, depositors in China suffer from financial repression. Hence, they tend to shy away from the formal banking system.
According to Joe Zhang; owing to this reality, some banks in China lack solid retail banking franchises. Thus, banks tend to rely heavily on wholesale funding from the inter-bank market (wherein the People's Bank of China plays the role of the "lender of first resort") to finance their operations. [21]
In the last decade, the Chinese economy nominally quadrupled. However, during the corresponding period, investors in the Shanghai Composite Index (SHCOMP) and in Hong Kong-listed Chinese equities (H-Shares) made little to no money [9].
As Illustration 2 shows, the Shanghai Stock Exchange Composite Index tends not to capture China's unprecedented economic growth; it is a perennial under-performer:
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| Illustration 2 (click on illustration to zoom in) Adapted From: Bloomberg and Forbes |
Hence, Chinese investors also tend to shy away from public equity markets; they prefer to invest their capital in debt securities, which are predominantly issued through China's Shadow Banking system.
As Illustration 3 shows, China's Shadow Banking system is the predominant source of financing for Chinese SMEs:
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| Illustration 3 (click on illustration to zoom in) Adapted From: Ueda and Gomi, 2013 |
Illustration 3 also demonstrates that SME financing channels of the shadow banking system have a relational modus operandi.
***
Naturally, this all begs the following questions: 1) what exactly is the Chinese Shadow Banking System?. and; 2) How is it structured?:
...What is the Chinese Shadow banking system?
The Financial Stability Board defines shadow banking as: "Credit intermediation that involves entities and activities outside the regular banking system". Similarly, the Financial Institute of the Chinese Academy of Social Sciences (CASS) describes Shadow Banking as: “off-balance businesses of banks and activities of financial institutions other than banks”.
Otherwise put, in the China context, shadow banking can be defined as credit intermediation that involves entities that are not directly owned by local or central governments of China (GoC). Illustration 4, below, depicts the organizational typologies that are associated with the "shadow banking" moniker in China:
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| Illustration 4 (click on illustration to zoom in) Adapted from: Zhang, 2013 |
According to Joe Zhang's text which is entitled Inside China's Shadow Banking: The Next Subprime Crisis?, the term Shadow Banking refers to the following disparate organizational typologies (some of which are shown in Illustration 4): Regulated Micro-credit Houses, Pawn Shops, Guarantee Houses, Consumer Finance Houses, Curbside Finance Houses, Unregulated Trusts, and Peer-to-Peer Finance Houses.
The most prominent segment of China's Shadow Banking system is the Wealth Management Product (WMP) sector. As Illustration 5 shows, the WMP sector is not entirely divorced from China's mainstream banking sector:
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Illustration 5 (click on illustration to zoom in)
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According to Illustration 5, Chinese Banks create WMP's by establishing asset management companies. These asset management companies create off-balance sheet trusts that, in turn, create wealth management products.
By and large, these WMPs are, in essence, high yield credit securities, i.e. junk bonds, of companies that are unable to access debt through the formal banking channels.
The key distinguishing feature of the bonds is: they are not trade-able. Once an investor purchases them, he or she has to hold them until they mature (in usually three to six months) [1].
Key Facts about WMPs:
- Their (nominal) annualized rates of return range between 4% to 5%.
- They tend to be leveraged 100 times to 1.
- They do not have any regulatory oversight.
- The minimum investment amount is RMB 50,000.00 [2].
- They are predominantly employed by local government institutions, through their Local Government Finance Vehicles (LGVS), to finance public services and infrastructural investments. Interestingly, they are the staple funding vehicle for local governments' real estate projects.
- They are the financing vector of choice for mining companies that seek to capitalize resource exploration projects, OPEX and CAPEX expenditures.
- Some WMPs can be rolled over. [11]
Generally, most wealth management products tend to invest their capital pools in the debt securities of one underlying issuer. However, there are some that invest in the debt securities of a wide range of issuers as is shown in Illustration 6:
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| Illustration 6 (click on illustration to zoom in) |
These WMPs are known as "Funding Pool Wealth Management Products"
Other key elements of the Chinese shadow banking industry include (refer back to Illustration 4):
- Regulated Micro-Credit Firms: According to Joe Zhang, there are approximately 6,000 regulated micro-credit firms in China today. These institutions are supervised by the finance departments of local government units. And, they typically provide short-duration loans (ranging from three to six months), to small private enterprises, at a maximum annualized interest rate of 25% [3]. Generally, their loan sizes are capped at USD 20,000 per borrower. Chinese micro-credit houses tend to have ten shareholders who are essentially owner-managers of the ventures [4]. Micro-credit houses tend to have a capital structure that is 50% equity and 50% debt.
- Regulated Pawn Shops: They employ the traditional "pawn shop" business model. These institutions are licensed by the Police Department of each locality. And, they typically have leverage ratios in the 1-to-1 range. Generally, these institutions lend at annualized interest rates of 35%.
- Peer-to-Peer Finance: These are not an institutional typology per se. But they are simply a type of transaction wherein a member of the shadow banking industry provides credit to another member of the shadow banking industry.
- Curbside Finance Houses: These are unlicensed micro-finance houses, that are described by the Chinese government as "institutions that are worse than prostitution". They have registered a 30 year compounded growth rate in the 20% to 30% range. Typically, they lend to grey market businesses and low quality creditors. They are wholly financed using their principals' savings. By and large, their principals lend to family members, friends and acquaintances.
- Guarantee Houses: These institutions guarantee consumer bill payments. And, they employ leverage to the tune of 10-to-1 times.
- Consumer Finance Houses: These institutions provide consumer credit. Generally, they employ leverage to the tune of 4-to-1 times.
From the descriptions of the elements of the shadow banking system, one can decipher its risk areas:
To assess the systemic risks that are posed by elements of the shadow banking system, it is prudent to understand the absolute sizes of their loan books and the ratio of their loan books to GDP.
Illustration 7 shows the absolute sizes of the loan books of the constituents of the shadow banking system:
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| Illustration 7 (click on illustration to zoom in) Adapted From: Ueda and Gomi, 2013 |
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| Illustration 8 (click on illustration to zoom in) Adapted From: Ueda and Gomi, 2013 |
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| Illustration 9 (click on illustration to zoom in) Adapted From: Ueda and Gomi, 2013; Zhang, 2013 |
As Illustration 9 shows, the largest "known" systemic risks in China's shadow banking industry lie: 1) in the Wealth Management Products that are originated by banks (of which Funding Pool Wealth Management Products are the riskiest) [5], and; 2) in "Trusted" / Trust Properties.
Collectively, these sectors of the shadow banking system accounted for ~ 28.10% of China's 2012 GDP.
The unquantified risks stem from:
- Peer-to-Peer Transactions: These transactions link the portfolios of disparate constituents of the Chinese shadow banking system. And, they elevate the risk of contagion. Generally, the following rule of thumb applies: the denser the network of links, the higher the systemic risk.
- Curbside Lending Firms: One could argue that they could be the highest source of systemic risk, i.e.; if the quality of their loans is as low as people assume, and if, unlike what most people assume, they rely heavily on peer-to-peer finance.
...What's going on in China?
"Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitably subject to diminishing returns."
– Paul Krugman (November / December 1994 Foreign Affairs essay)
"In an investment-driven model, the best way to influence GDP positively is to stick another shovel in the ground"
– Jim Chanos (2013 Wine Country Conference lecture)
On the 5th of April in 2013, Jim Chanos, the founder of Kynikos Associates, famously quipped; "in China growth is the product of GDP; while everywhere else GDP is the product of growth".
This may sound like astute wordplay, but what he said accurately describes how GDP is "engineered" in China. The process that is employed to "manufacture" GDP in China is shown in Illustration 10 below:
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| Illustration 10 (click on illustration to zoom in) |
In China, members of the central committee of the ruling party pick a target GDP level. And, they use a Resource Mobilization Strategy (wherein the focal point is "inputs"), see Illustration 11, to map-out exactly how they would achieve that GDP target:
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| Illustration 11 (click on illustration to zoom in) Adapted From: Krugman, 1994 |
As Illustration 11 shows, the key constituents of the Resource Mobilization Strategy are [6] [7]:
- Employment: The key policy questions are; 1) How many new people do we have to employ, through our State Owned Enterprises (SEOs) and capital expansion projects, to reach our target GDP level?, and; 2) How many "long hour" jobs do we have to create to reach our target GDP level?
- Populace's Education: The key policy question is: How many people do we have to move into higher education opportunities to achieve our target GDP level?
- Capital Stock: The key policy question is: How do we expand our capital stock to reach the target GDP level?
Once the policy outline has been formulated, targets are passed to the leaders of local of governments [7].
***
A report that was authored by Pivot Capital Management in 2009 uses fifteen key pieces of evidence to demonstrate that China has reached the limits of the Resource Mobilization Strategy [8]. You'll have to read the report for yourself, as I'll only list the topics of the pieces of evidence, They can be summed as follows:
- China's growth is dependent on capital spending.
- The efficiency of Chinese investments is deteriorating.
- Chinese Credit is expanding faster than GDP.
- Credit is driving China's liquidity.
- China's reserve coverage is not exceptional.
- China's steel capacity is at saturation levels.
- China's cement capacity is at stratospheric levels.
- China's aluminium capacity indicates a mature industrial base.
- China's energy needs are overstated because of poor efficiency.
- China under-counts small urban centers.
- There is no physical shortage of housing in China [10].
- According to research findings that were unearthed by price-to-income ratio analysis, China's residential real estate market prices-out most citizens [25].
- China's railway CAPEX peaked in 2009.
- China's consumption growth has been lagging real GDP growth.
- China's household incomes are in a secular decline relative to GDP.
Owing to the above-mentioned realities, China's local governments have been goosing their GDP growth rates by undertaking numerous real estate and infrastructural projects. By and large, these projects are financed using credit from the shadow banking industry.
The-said borrowing activities of local governments have been the predominant driver of the increase in China's public debt, as Illustration 12 demonstrates:
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| Illustration 12 (click on illustration to zoom in) Adapted From: IMF, CEIC and Ueda and Gomi, 2013 |
Again, this demonstrates that China has reached the limits of its investment-led growth model: going forward, the country would have to employ a more sustainable growth model which is underpinned by the Knowledge Management Strategy (refer back to illustration 11).
In 2011, China introduced its 12th five year plan. The plan unequivocally demonstrates that China's leadership is aware of the need to reorient its economy towards a more sustainable domestic-consumer-led growth path.
***
Intriguingly, the actions of China's policymakers and elites indicate that they anticipate a turbulent reorientation process:
"Those who know something best, love it least"
– Hugh Hendry
"You can't predict the downside risks because they are always infinite; you can mismanage your way out of a crisis"
– Michael Pettis
If the survey findings of Bain's 2013 edition of the China Private Wealth Report are anything to go by, three out of five wealthy mainland Chinese people are looking to leave the country.
According to the report, the main push factors were/are: air pollution, the low quality of drinking water, food safety issues, education quality issues and retirement concerns.
Further, the report indicates that between 2011 and 2013 the proportion of high-networth Chinese with overseas investments doubled (to 33%).
These findings were also corroborated by a survey (of high networth Chinese entrepreneurs) that was conducted by the Economic Information newspaper in China. The Economic Information survey unearthed the following pieces of information:
- 45.71% of the respondents had emigrated, or, were in the process of emigrating from China.
- 78.57% of the respondents experienced medium to high levels of anxiety.
According to the Economic Information survey, the main push factors were: the weak rule of law in the country and the lack of regulated business norms.
The take-home from the surveys is: elites are leaving China en-masse.
***
To sum up, a recent Bloomberg article lends credence to the above-mentioned migration trends. The article reported that wealthy Chinese migrants were driving property prices up in some Sydney (Australia) suburbs; they were / are inflating a housing bubble.
To illustrate the extremities of the price inflation, the article cited an instance in which a Chinese buyer bid AUD 1 million more than the asking price of a property [13]. Owing to demand from China's elites, house prices in Sydney suburbs are 27% higher than they should be!
Naturally, this begs the question of how China's elites get money out of a country with stringent exchange controls. Illustration 13 has the answer [26]:
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| Illustration 13 (click on illustration to zoom in) Adapted From: Kynikos Associates, 2010 |
As Illustration 13 demonstrates, large sums of money exit China through a four step process that can be summed as follows:
- A wealthy Chinese entrepreneur or politician approaches a junket tour operator and transfers (say) USD 100,000-worth of Renmibi to a mainland bank account [14];
- The tour operator then arranges, for a 25% commission, a gambling tour to Macau. And, opens (with a Macau casino) an account with the net balance, on the behalf of the "high roller";
- The "high roller " then travels to Macau; where he or she can access the account with USD 70,000-worth of Renmibi;
- Once the money is in Macau, it can be converted into hard currency and wired directly to any foreign destination.
According to US-based lawyers (who conducted due diligence on potential investors between the 1970s-1990s), this convoluted process of transferring money is reminiscent of the process that wealthy Latin Americans used to transfer their wealth abroad before "trouble hit".
Hence, as Gordon Chang suggests, these wealth transfers could be taken as a leading indicator of brewing trouble in China. [12]
***
According to George Soros, China's policymakers essentially have two choices: 1) Purposefully re-balancing the Chinese economy, i.e. deflating the bubble gradually through a cocktail of proactive monetary and fiscal policy measures, or; 2) Waiting for China to reach its debt capacity limit, i.e. allowing the bubble to continue inflating until market forces deflate the financial aberration [15].
Generally, re-balancing the Chinese economy entails bringing the investment growth down and bringing consumption-up; i.e. increasing households' share of GDP. This can be achieved by [20]:
- Re-valuing the Renmibi: According to some estimates, China's currency, is undervalued by between 32% and 35.8%. An undervalued currency is, essentially, a tax on consumption. Therefore, to re-balance the Chinese economy, China's policymakers would have to allow the Renmibi to float and appreciate to its fundamental value. If this occurs, imports would become cheaper and Chinese households would consume more. Evidently, this move would punish exporters. However, it would remove the distortions.
- Increasing wages: Wage increases would, ceteris paribus, raise the disposable incomes of households. They would allow households to increase their consumption. However, this move would erode the cost-competitiveness of China's labor intensive light manufacturing sector.
Evidently, the Chinese economy cannot be re-balanced painlessly. Thus, it is reasonable to assert that Chinese policymakers face a dilemma; Illustration 14 uses the metaphor of a bubble and needles to frame the dilemma that they face:
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| Illustration 14 (click on illustration to zoom in) |
As Illustration 14 demonstrates, the question is not: "Will the debt bubble deflate?" It's: "Will it be policymakers or market forces that deflate the debt bubble in China?"
In both instances, the negative consequences of the bubble deflation would reverberate across the the globe. However, I must point out that the consequences would be more catastrophic in the instance where market forces take effect.
Between May and June of 2013, the government of China tried to rein-in the shadow banking system by reducing the amount of liquidity that it provided to inter-bank market [21] [24].
On the 20th of July 2013, this culminated in a credit crunch; some banks teetered on the brink of collapse [22] [23]. A few banks were so desperate for liquidity that they offered to borrow at annualized interest rates in the 25% range; These banks are depicted by the person who is playing tug-of-war with the "government needle" in Illustration 14.
To avert a full-on banking crisis, the government of China turned back on the money spigot after a matter of days.
***
According to a report that was authored by Pivot Capital Management, the obvious casualties will be the upstream segments of the supply chains that fed China's edifice complex. They include:
- Exporters of cement to China.
- Exporters of iron ore to China.
- Exporters of "other building materials" to China.
Over the last five years, they scaled-up their capacity to adapt to the growing demand for housing units in China. Thus, when the shadow banking system is subdued, they would be left with excess capacity [16]
...How may the Chinese debt bubble impact Africa?
China-Africa Investment statistics fail to capture the individually-insignificant-but-cumulatively-significant investments that have been made by Sino artisanal and junior miners in Africa.
These miners are generally groups of four to five young men who husband capital and collaborate with African elites in mining ventures. Generally, they employ labor intensive methods to (inefficiently) extract readily accessible subterranean assets.
One can argue that they play a pivotal role in discovering and unearthing Africa's untapped resource wealth. Otherwise put, they help to expand Africa's knowledge on the distribution of its geological assets.
By and large, these young men lack experience in mining, and, they would be classified, in any financial system, as low quality borrowers. Thus, it is reasonable to assert that they most probably secure their funding from Micro-credit firms, Pawn Shops and Curbside lenders at annualized interest rates in the 25% to 45% band.
When China's debt bubble pops, either orderly or disorderly, the shadow banking sector's supply of funds will diminish [17]. And, the interest rates that the sector charges would be forced to increase. This implies that the cost of capital of most Sino artisanal miners will increase, at a time when commodity prices are on a downtrend (owing to falling demand from China).
Otherwise put, their debt burden would increase as their capacity to service the debt falls. In this scenario, most Sino artisanal miners would find it difficult to earn a return on investment (ROI) that exceeds cost of capital (WACC).
***
Generally, most of the-said artisinal mining ventures are run in a highly informal fashion. Thus, it is reasonable to argue that they would find it difficult to secure capital from alternate sources.
Hence, it is reasonable to expect a substantial chunk of them to fail within the first two years of the anticipated readjustment. This would create the opportunity to invest in [19], or acquire, the best of these ventures [18].
Illustration 15 uses African Countries' Corruption Perception Indices and The Natural Resource Rents that African nations earn (as a proportion of their respective GDPs) to pinpoint the geographies with the best opportunities:
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| Illustration 15 (click on illustration to zoom in) |
The inputs that were used to map the opportunity space in Illustration 15 include:
- The Corruption Perception Index (CPI Index): The CPI Index is a measure of perceived public sector corruption. It is produced annually by Transparency International. This input serves two purposes. The first purpose: Generally, Western mining conglomerates shy away from countries with a low CPI Index (i.e. countries with high perceived public sector corruption). Thus, it is reasonable to assert the following: when the Chinese debt bubble bursts, there will be little competition for opportunities that are located in geographies with low CPI Indices. The second purpose: By and large, in societies with a low CPI Index, people tend to get opportunities that they don't deserve and/or can't exploit in a sustainable fashion. Thus, this simply implies that the ventures that are most susceptible to collapse are located in the regions with low CPI Indices.
- Natural Resource Rents (as a proportion of GDP): If we assume that global geology is randomized, the natural resource rents of most African countries should approach the OECD average of 5-10% of GDP as they develop economically, and, as they discover more of their untapped mineral wealth. Therefore, this simply implies that the opportunities with the greatest upside potential will be located in economies that earn less than 5% of their GDP from natural resource rents.
The template in Illustration 15 provides a good starting point for shortlisting mining opportunities that will surface when the Chinese credit bubble eventually pops.
[1] 60% of the WMPs have maturities of 1-3 months. (source)
[2] According to Ueda and Gomi (2013), "Data of National Bureau of Statistics of China shows that the average annual income of urban employees of private enterprises amounted to RMB 26,252 in 2012 and that of non private employees to RMB 46,769. This means that the buyers of the WMPs belong to the middle class or upper with money to invest."
[3] Their interest rates are capped by regulators at 25%. However, they tend to increase their effective interest rates through the application of a host of "service fees" and by requiring borrowers to prepay interest.
[4] They do not have agency issues.
[5] According to Ueda and Gomi (2013), 50% of the WMPs that are created by the Chinese banking industry are Funding Pool Wealth Management Products (refer back to Illustration 6). These products are administered poorly: they are managed as "self-contained credit securities" and not as portfolios of multiple, disparate credit securities. Further, they tend to violate the matching principle of finance: short term debt securities are used to fund long term projects.
[6] The Resource Mobilization Strategy is the strategy that the Soviet Union employed in the 1950s achieve a annual GDP growth rate of 6%. In his essay which is titled "The Myth of the Asia Miracle" Paul Krugman describes the strategy as follows:
"The immense Soviet efforts to mobilize economic resources were hardly news. Stalinist planners had moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of men into longer hours, pursued massive programs of education, and above all plowed an ever-growing proportion of the country's industrial output back into the construction of new factories. Still, the big surprise was that once one had taken the effects of these more or less measurable inputs into account, there was nothing left to explain. The most shocking thing about Soviet growth was its comprehensibility."
[7] Why has China been so efficient with implementing the Resource Mobilization Strategy? Answer: 1) China has got command political structures; such structures make it relatively easier to husband resources; 2) The Communist party is one of the best political meritocracies; local government leaders are highly incentivised to perform; 3) China has got a large, relatively homogeneous population that speaks a common language and has a common culture (Confucianism) - this makes it easier to marshal resources.
[8] In a talk titled China's Role in the Global Economy: myths and realities Dr. Keyu Jin argues that China can still maintain its past growth rate by increasing the efficiency with which it uses resources; i.e. by employing a Knowledge Management Strategy (refer back to Illustration 11).
[9] This suggests that Chinese firms have got agency issues galore.
[10] See this documentary on China's ghost cities.
[11] Here is an interesting excerpt from Ueda and Gomi's (2013) paper: "Mr. Xiao Gang, Chairman of the CSRC, criticized WMPs in a newspaper interview held in October 2012 that those WMPs which are rolled over by issuing new WMPs are basically a kind of “Ponzi scheme” and therefore there is a great risk that they default once the credibility of issuers starts to falter if only a little."
[12] The following is an excerpt of Mr. Gordon Chang's comments from the 18th of November 2011 interview with Chris Mattenson: Starting at the end of next year, the Communist party is going to change the officers of their Politburo Standing Committee, the apex of political power in China. We are going to have a new General Party Secretary. And then in the early part of 2013, the government officers change. And sometime after that, the all-important Central Military Commission has a revamp of membership. And so at this time of political transition, the important economic decisions are not being made. But it is even worse than that, because corruption indeed is engulfing the political system. It is causing so much friction in society. The Communist Party is not able to mediate conflict and its only answer is to increase coercion. [P] And that is why you have survey after survey of the rich and the super-rich, they talk about leaving China. It is not the poor who are going, which we have seen in many waves throughout the last couple hundred years, now the rich are thinking of getting out. They are getting passports, they are putting their families offshore, and this is of concern because this is a leading indicator. [P] If you go about 25 miles south of where I live, and go to Princeton, New Jersey, you will see a lot of beautiful homes. I mean, they are all paid for, they have got a wife there, they have kids, and they have one or two Mercedes in the driveway. It is the perfect American family, except one thing is missing, and that is Dad. Dad is a senior official in Beijing and he is stealing as much money as he can. And at maybe not the first sign of trouble, but perhaps the second sign of trouble, he is on the United flight to New York, because he is not going to stay to defend a regime that is shaking. And that is one of the reasons why I think we have to be concerned about the way the Chinese economy is going, because the Chinese rich are starting to see the signs and are beginning to bail out. [P] We are talking about the people who have benefited the most from this system. And they can see the problems at the top of society. We have now a weak General Party Secretary, Hu Jintao, and he is going to be followed by probably by someone who is just as weak, especially in his beginning years, Xi Jinping. This is a political system that will not be able to make the decisions and to implement them that everyone knows have to be made.And that is why, for instance, we have not seen much in the way of reform over the last five years. In fact, we have seen a reversal of reform. And most of the conditions that have given rise to China's extraordinary growth either no longer exist or are disappearing fast. And so this is an economy in trouble.
[13] Generally, money-laundering alarm bells go off when a buyer bids substantially more than the asking price of a property.
[14] These junket tour operators are usually affiliated with the People's Liberation Army.
[15] According to an interview that George Soros gave on the sidelines of the Boao Forum in April 2013, the government of China has two years to reign-in the shadow banking system; i.e. until 2015. If it fails to do so, markets will deal with the aberration.
[16] Their excess capacity would be minuscule when its compared to China's excess capacity. According to Pivot Capital Management, idle capacity in China’s steel sector is equivalent to the total steel production capacity of Japan and South Korea combined. Intriguingly, in 2009 China had an additional 60 million tons of steel production capacity under construction. Further, China currently has greater idle capacity in cement production than the entire consumption of
India, the United States and Japan combined.
[17] The sector employs leverage - which could stem from the formal banking system.
[18] By the best, I mean those with substantial verified resource endowments.
[19] The best investment strategy would be Michael Berry's Discovery investment strategy.
[20] Michael Pettis discussed these measures extensively in his 2013 Wine Country Conference talk.
[21] Most Chinese banks have poor retail banking franchises. And, they rely heavily on the inter-bank market for liquidity. In this market, the People's Bank of China plays the role of the "lender of first resort" not the lender of last resort.
[22] These banks are state owned.
[23] According to Michael Pettis, most of this demand for credit is not driven by the need to invest or put capital to productive uses; the borrowed funds are usually used to pay principal and interest repayments on other loans.
[24] 8 February 2014 Post script: articles on reform include; 1, 2, 3
[25] 19 February 2014 Post script: According to assertions that were made by Frank Holmes in a 2012 debate, the affordability of realestate in China's costal regions has improved substantially; it used to take Chinese people 30 years to pay off the mortgages for Shanghai condominiums. Now, at current prices, it takes 15 years to pay off mortgages.
[26] 19 February 2014 Post script: According to Gordon Chang, in 2012, China's reserves declined by USD 92 billion owing to illicit outflows.
