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Made in China Part #2

Made in China Part #2

Drop a pebble in a pond and eventually everything in the pond experiences the change in conditions as the waves radiate from the point of impact.

As we have been reporting for some years, China has dropped its pebble and and the ripples are hitting Australia’s shores.

Following our Made in China post last week, illustrating that the transition from economic growth dominated by fixed asset investment to a consumer-led model, is both painful and fitful, it has emerged this week that January imports are down 14.4 per cent year-on-year. Expectations were for a 1.8 per cent rise in Yuan terms.

And in a further sign that the world may be slowing faster than expected – despite years of quantitative easing – Chinese exports also missed analyst expectations of 3.6 per cent growth, printing a 6.6 per cent decline.

Two of our concerns relate to the currency.  First, China’s foreign reserves may be running down faster than central bankers are comfortable with. And second Chinese companies borrowing in US dollars will suffer enormously if the Yuan is devalued.  As Kyle Bass has warned, compared to the size of its economy, China has two to three times the debt the US had in 2008 – a total of $34 trillion.  As the Chinese economy slows, a growing number of businesses will be unable to pay their debts putting pressure on the banking system.

Total losses from debt defaults could be four times US losses in the 2008 crisis.

In US dollars, the economic picture for China is even worse than the recent import and export numbers suggest.  Exports are down 11.2 per cent and imports have declined 18.8 per cent.  The latter was expected to fall 3.6 per cent.

According to reports, coal imports fell 9.2 per cent year-on-year and crude oil imports declined 4.6 per cent.

For China to ‘rebalance’ its economy at, for example, a GDP growth rate of 5 per cent, fixed asset investment – which was previously responsible for 70 per cent of China’s growth when GDP was much higher – must plunge to below 5 per cent growth.  That the crash in infrastructure spending is underway is reflected in statistics such as the price of rebar (concrete reinforcing). Since 2008 a ton of rebar has fallen 64 per cent to 2,000 renminbi (US$300), the lowest price for more than 15 years.

All of this is consistent with reports from Nils Andersen, CEO of Maersk Group, the world’s largest container shipping company, that it is suffering a “massive deterioration” and that “it is worse than 2008”.

Of course China’s reported economic data is backward looking but it its somewhat telling that the leadership in China are no longer keeping up even the appearance of growth and prosperity.

The waves emanating from China’s dropped pebble have already hit Australia’s west coast.  One suspects that as those waves hit landfall their velocity slows, but it looks like the east coast of Australia is still going to get wet.  Indeed of particular interest might be anecdotal reports from Melbourne bayside suburb real estate agents, that Chinese buyers have completely dried up.  One experienced agent has apparently been warning peers it will be a bad year for real estate adding ‘offload your stock quickly’.

We reiterate our warning that share market investors in anything but the highest quality businesses – those with bright prospects for the profitable reinvestment of incremental capital – should be cautious.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Bearishness on China is way overdone. Sure, the next couple of years are going to be rough but its economy will make the transition to a consumer society.

    Certainly, if you were a business owner of a strong Western consumer franchise, there is no place you’d rather be than in China for the purpose of ensuring your company’s future growth.

  2. Hi Roger, do you think the China middle class consumption story is still intact, or potentially is going to follow the weakness in the resources, property and manufacturing sectors?

  3. Interesting article Roger! Good call btw previously with SGMS and BKS- are you shorting any other US stocks? :)

  4. Tristan Harrison

    Quite the grim picture you paint there Roger. That brings about 5 questions in my mind:

    1. Can China do anything to avert this looming crisis?

    2. What can/will Australia do?

    3. What can the rest of the world do, particularly the USA?

    4. If it’s inevitable, will China recover quickly or could it take many years to get back to growth?

    5. It half sounds like you’re calling a Chinese-led GFC..will you be holding even more cash in light of this?

    As always, interested in your thoughts Roger.


    • Hi Tristan,

      A great article in todays Australian that summarises the situation nicely…I paraphrase here: According to McKinseys, between the GFC and Mid 2014, global debt had increased by $US57 trillion to 286 per cent of GDP – 17 percent higher than before the GFC. The devaluation of emerging market and developing market economy currencies, including China’s and the dramatic collapse in commodity prices are now amplifying the problem by increasing local currency interest costs and principal repayments [right when growth and foreign capital inflows are slowing or drying up!]. Foreign Banks have lent about US$3.6 Trillion to companies in emerging markets according to the Institute of Institutional Finance. Rating agencies have said default rates in emerging markets last year reached their highest level since 2004 and a lot of the build up in debt has been funded by the Eurozone banking system which has more than $US1Trillion of non-performing loans. Within the $US1.4Trillion junk bond market in the US, the energy sector has about $US200 billion of debt securities trading below par and analyst reckon more than $US70bn of investment grade energy related securities could be reclassified as junk over the next few months. High yield energy related bond default rates are rising and will increase when hedges roll off and/or when debt refinancing rolls around. Several hundred billion of debt is at risk if oil prices don’t rise. Remember this was the intention of the Saudis all along.

      According to another article in the Australian by former colleague (we spoke together at an investor event in late 2007!) Bob Gottliebsen, “After the global financial crisis curbed big American Bank lending in high risk situations, the US developed a complex array of hedge funds, private equity partnerships and internet lenders to fund energy stocks(sic). These loans have been unsold in a similar fashion to the schemes that led to the GFC. The US learned nothing. No one knows exactly how much money is involved except that it is massive, but nowhere near the sums involved in the GFC debacle. While the big US banks are not the main players, they still face losses, so the share of many have been slashed around 20 per cent so far this year. At some point US oil production will fall sharply and there will be carnage in the finance markets.

      It is the combination of the looming effect on energy producers and financial markets that is driving Wall Street lower and bond prices higher.” The former chief economist of the Bank of International Settlements and chairman of the OECD’s Economic Development and Review Committee, William White told London’s Telegraph newspaper that the “global financial system was dangerously unstable and facing an avalanche of bankruptcies” adding “Things are so bad there is no right answer. If they raise rates it will be nasty. if they don;t raise rates it just makes matters worse”.

      And with respect to the real;ationship between China’s slowdown and Australia’s economy, keep in mind between 2008 and 2014 China was responsible for 80% of export growth and it accounts now for about a third of our merchandise exports. And, by way of interest only, George Soros has said a hard landing in China is now unavoidable.

      Citi’s chief economist Willem Buiter ( a perm bear mind you who believes the world is on the brink of a global recession) has warned that a financial crisis in China may result in large scale sales of foreign assets owned by Chinese companies. China’s state owned and private companies are significant investors in Australia’s energy, mining, infrastructure and ag assets and has a total estimated external asset portfolio of $US6.5 trillion. “A financial crunch or crisis in China would not just result in a possibly large depreciation of the renminbi but it would also trigger the sudden large scale sale of some of the tense external assets.”

      Note ANZ built a large presence in Asia under former CEO Mike Smith. Yesterday new CEO Shayne Elliott warned that credit conditions are deteriorating in Asia.

  5. “One experienced agent has apparently been warning peers it will be a bad year for real estate adding ‘offload your stock quickly’.”

    I am guessing that this is the high-end stuff that was meant to be bought by the Chinese (who have been trying to get money out of China as an insurance policy against this and / or the Chinese Government repossessing their unexplained wealth under the guise of ‘tigers and flies’ and efforts to stop ‘corruption’.

    It is not likely to be the average Melbourne unit / house for “Mum and Dad” investors that you can shift a lot easier to a wider audience…have you considered that maybe this stock was maybe overpriced in the first place purely because they were being sold to ‘out of towners’ and if the Chinese market evaporates, they won’t be able to shift them on the local market (who have a better idea of value) ?

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