China - No More Gimmicks

January 17, 2010
Madhan Karthikeyan

When a Company grows very rapidly outpacing its competitors and produces a balance sheet which is less transparent, an obvious suspicion will revolve around the company. The doubt arises as there is very less data to support the growth of such company and all that you can see is glowing number in the quarterly/Annual reports. This was the exact case of Enron, the biggest bankruptcy in the history of US. Now, replicate the same analogy for a country in the current economic scenario, which grows very rapidly at a time when other countries even hesitate to say that they are out of recession. This is China for you!

In recent days, a lot of voices are being heard warning about the Chinese Bubble. This started with the Hedge fund Investor James S. Chanos who predicts that China is headed for a crash, contrary to the popular belief that the country is growing at a faster pace. He is the person who predicted the fall of Enron and similar other Bankruptcies. So, nobody is daring to ignore him. After all, that is his job and he has an impressive track record for years. Chanos, a hedge fund Investor simply bets against a Company/Country, as he believes that it will go down in few months. If his prediction is right, it results in an insane amount of money. (Especially, when they bet against the popular opinion). Classic example is George Soros, whose betting against 'Bank of England' earned him $1b in a single night. This was in 1992.

Coming back to China, Chanos suspects that "Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent". He is planning to give a detailed speech about this at the Oxford University by end of Jan'10.

Here are a few factors which raise questions about China:

The Chinese economy is largely based on Exports to US and European countries, which means the Chinese currency 'Yuan' has to appreciate less against the dollar or Euros to continue the impressive GDP growth. China being a growing economy leads to appreciation of their currency, but the Chinese central bank has prevented the appreciation and has kept the exchange rate between dollar and Yuan almost the same for past few years. This largely helped them to maintain low prices for their goods in the foreign market and thus accumulating billions of foreign reserves. Now, you may think that it's plays to the advantage of Chinese economy. But, the economy at such a mass scale doesn't work this way.

When a country has huge amount of money among its people (in a manipulated market, the Chinese central bank prints loads of Yuans equivalent to the dollars), the value of the currency itself decreases. This triggers an increase in inflation, as the price of the domestic goods increases over the period of time. So, to prevent inflation the Chinese government should at least stop the surplous flow of Yuan. This can be broadly achieved by two ways:

1. Increasing the interest of the money that is been lent by the Chinese Central bank
2. Preventing the Consumer banks from lending out more money. This can be achieved by instructing the banks to increase the limit of cash reserves.

However, during the time of recession, the Chinese government infused a stimulus package of around $600 billion dollars into the economy to prevent any huge recession impact. So, this stimulus money along with the existing flows triggered a real estate boom in China, where the prices of lands/home rapidly increased every month and thus creating a 'Real estate Boom'. Now, the government is highly worried by this boom as they have just witnessed on how the US hosing market turned into bubble and got burst.

This is clearly evident from the fact that the government has just announced that they are backing off the stimulus package and have also announced few strict measures to bank on the lending policy.

Now, the Chinese have to control the interest rates, imports and exchange rate similar to adjusting the volume equalizer in a music player. They have keep adjusting the numbers as and when the other value changes.Since the market is in a bubble stage, a small miscalculation can result in disaster.

Moreover, there is more pressure on China from world countries to stop manipulating the Yuan against foreign currencies. Recently, when China surpassed Germany as the world's second largest exporter, Germany had put lot of political pressure against China to stop the currency manipulation. Apart from Germany, other countries are applying similar pressure, as the cheaper Chinese goods are flooding their markets which eventually slows down the growth of in-house industrial houses. Also, there are also threats from other countries that they will stop buying Chinese goods.

All one can conclude is, China will not grow at the same rate as earlier. If it continues to do so, it will not last long for even a few months before which the real-estate boom market will turn into a bubble. For sure, China can expect heavy backlashes from world countries for its continued currency manipulation.

Madhan Karthikeyan, an IT professional in the US finance industry, writes articles passionately on Business & Economy. He blogs about these topics at www.itonion.com. All views expressed by Madhan are his personal views.
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