- Money Morning Australia

Why China’s Hidden Debt is Bad News for Aussie Stocks


Written on 22 September 2011 by Kris Sayce

Why China’s Hidden Debt is Bad News for Aussie Stocks

“It’s our long corruption, short property play.” – Jim Chanos, founder Kynikos Associates

Jim Chanos is one of the big guns in investing. He’s up there with Warren Buffett, Jim Rogers, George Soros and Jeremy Grantham.

Chanos is “short” China. In other words, he’s banking on analysis that says China is overvalued and due for a fall… We agree.

But to be short China actually means being short something else. You can probably guess what we’re talking about. Here’s a clue. Again, from Jim Chanos:

“We’re short Chinese banks, the property developers, commodity companies that sell into China. Anything related to property there is still a short.”

That’s right, it means being short Australia. Something the rest of the world is starting to figure out. The only ones yet to get the picture are Aussie mainstream investors and the mainstream press.

But more on that in a moment. First…

Operation Disappointing the Market

We couldn’t let today pass without mentioning the two-day Federal Open Market Committee (FOMC) meeting. The key part of the Fed announcement reads:

“The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less.”

Just as the market expected, the Fed will implement Operation Twist… buying longer-term government bonds and selling shorter-term government bonds. The aim is to flatten the yield curve. That means forcing long-term interest rates lower.

The theory is it will make businesses more likely to invest in capital goods and make individuals more likely to buy a home. That’s because in both require long-term loans.

We’ll be honest, we expected the Fed to do more. Why? Because they’re mad. And mad people do mad things. In this case, perhaps they aren’t as mad as we thought… or the Fed is playing a game… trying to prove to the three FOMC members who disagree with Dr. Bernanke’s view that the Fed must do more.

The fact is, the U.S. economy is headed for another recession and depression. This will happen whether or not the Fed meddles. It’s just a case of whether it’s now and inflicts a lot of pain… or whether it’s in a few months… and inflicts more pain.

And make no mistake, what’s bad for the U.S. is bad for China. And what’s bad for China is bad for Australia.

That’s despite what you’ll hear from mainstream commentators…

No haven, only risk

…Such as our old pal, Michael Pascoe at the Age. Earlier this week he wrote:

“While Europe and Washington fiddle around fires of varying intensity, foreign central banks buying increasing amounts of commonwealth bonds are sending a message: Australia is a safe haven.”

Yeah sure. Does anyone really think the financial advice of central bankers is advice worth following?

These are the guys who sold gold before it tripled in price. The Reserve Bank of Australia sold two-thirds of its gold in 1997. (By the way, Peter Costello was Treasurer then, so for all those folks who think Costello should get the Euromoney finance minister award rather than Wayne Swan… think again!)

And as for the bright central bankers who bought Aussie government bonds for safety, well, they’ve seen the value drop 10% in recent weeks. As the “safe” Aussie dollar has sunk from USD$1.10 to USD$1.00 today.

We’ve mentioned before that it’s foolish to believe any investor sees Australia as a haven. Australia is a risky investment. Foreign investors invest in Australia as a way to invest in China.

If you believe the China resources boom will last 50 years, then why not buy into the country that’s helping support the boom – Australia. But as soon as the boom stops, Australia’s haven status will be forgotten in a flash.

Because the China boom may not be as secure as many think. Jim Chanos makes the point that while China’s government debt is low, other debt isn’t…

China’s debt bubble set to burst

In fact, according to 2008 numbers compiled by Global Finance, China’s total debt to GDP was 159%. That includes government, non-financial business, households and financial institutions.

One of the biggest beneficiaries of that debt is Australia.

What we’re saying is, don’t fall for the idea that China has bought and paid for Aussie resources. Because there’s one bit missing… it has borrowed, bought and paid for Aussie resources.

It used those resources to build tall buildings, shiny new roads, sports stadiums, and of course, consumer goods. But one day the spending will slow down and possibly stop.

Because even if China’s growth continues… even if China one day passes the U.S. as the world’s largest economy… it won’t happen in a straight line… with no bumps or recession along the way.

You can see from the chart below, the U.S. economy has had 17 recessions (shaded areas) in the past 90 years:

Real Gross Domestic Product (GDPCA)

 

That was despite it being the biggest economy and biggest consumer of resources. Importantly, the recessions in the U.S. were felt in one way or another around the world… including in Australia.

Put simply, of its top 10 trade partners in 2010, one-third of China’s trade involved the U.S. and Germany… add in Japan’s basket-case economy and you’re looking at one-half of China’s trade.

Like it or not, a recession in the Western world (U.S. and Europe) will impact China.

And so, at some point, China’s economy will slow. That spells trouble for Australia because foreign investors buy Aussie assets for one reason: China.

Let’s get is straight: Australia isn’t a haven for foreign investors. And the Aussie dollar isn’t a reserve currency.

So when we’re told a U.S. or European recession won’t affect China… and therefore won’t affect Australia. We don’t believe a word of it and neither should you.

Cheers.
Kris



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Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

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26 Comments For This Post

  1. neil Says:

    You are probably correct Kris and with Chano’s going short, something may be a foot. Demographically the time for China to peak is 2020 (baby boomers hit an age where they save & do not spend as much), so we may have another decade of Aussie boooooming – I hope so! China also has over 50 million young men who will not find a wife in China, because of the one child policy……they might come here to Oz and build all our new cities & infrastructure for the ‘continuing’ mining boom!

  2. SvetlanaBabe Says:

    Will these 50,000,000 Chinese males get ‘Southern Cross Tattoos’?
    I can smell a business opportunity…also think of all the cargo shorts we can sell them!
    There is money to be made.

  3. james holt Says:

    tattoos are for losers. as for those cargos u wanna sell them they are probs made in china any way. may be you should get of ur ass an find your self a job, get some more cargos an a another southern cross tattoo in your face….

  4. Peter Fraser Says:

    Wow – the Dow is down over 500 points, the Aussie $ is below 0.97 USD, Gold is more than 12% off its highs, and Silver is down a massive 10% overnight, Oil is dropping below $80.

    Impressive falls.

    Glad I have cash and real estate.

  5. Greg Says:

    pf@4. Real estate’s time is coming. As sure as night follows day. Remember that this is where the whole “thing” we’re witnessing started.

  6. J.C. Says:

    PF@4,
    No doubt that’s what the headlines in the papers will be screaming: safe as houses. But in your typically singular outlook, you forget that house price booms and bubbles are part of the reason why the world is in this particular situation. But today will be one of wrong-headed smugness around the water cooler with uncle Pete leading the sermon of collective calm and misinformation.

  7. TRB Says:

    Is gold a safe haven?
    Too early to say, however should gold be at $2000 ounce by now with all the fear of hyperinflation and the FED?
    We maybe heading for a minsky moment where everything falls except cash!
    That includes Real Estate PF.
    Go Jim Chanos!

  8. Peter Fraser Says:

    JC – I very much doubt that any media will scream that headline.

    But I do live in and enjoy the comfort of a home, and that value to me remains constant regardless of whether the nominal value rises or falls. Perhaps you don’t understand that, or perhaps you do, who knows.

    I was more pleased that I got out of shares some time ago (post recovery) and converted to cash until I can see some stability in the market.

    I’m not sure how you get misinformation out of that. Did cash and real estate in Australia fall markedly overnight as well?

    I think that before you judge something as misinformation, you really should be able to qualify why you consider it misinformation, or doesn’t reality count in your world? Is froth and bubble more important?

  9. Peter Fraser Says:

    TRB – Yes I agree real estate can and probably will fall, but what does that matter if you need a house for your family.

    Gold is a safe haven – that is why it rose so much when confidence fell in the market – Oh – wait a minute – gold and silver tanked. Wow what spectacular falls – looks like my new watch has lost a few dollars in gold value.

    Bummer…..

  10. J.C. Says:

    PF@8,
    The idea that owning a home or pumping all your wealth into real estate puts you in a relatively better position is just smug nonsense as well as showing a naive understanding of why the world is in the situation we’re in. Of course, in a previous month, you’d be ranting on how house prices are justified because of the Australian “safe haven” status. It’s misinformation at its finest and just side-tracks the real issues. Furthermore, the suckers who have bought property believing in its superiority as an investment class might not be feeling as smug as you (and for good reason). Being safe and secure in your own home is beside the point. The streets don’t suddenly become full of homeless people because of a financial crisis (in the short term anyway).

    The irony is palpable though as you come here to confront the nutty fringe in your mainstream, “reasoned” guise. But if you gave it some thought, you would realize that many of the issues discussed here are ignored by the mainstream. Maybe your point is to say “I’m alright Jack” and you just need an audience to express it. I don’t know. It’d be good if you could actually defend your views with a wider perspective considering you seem at odds with the general thrust of the themes.

  11. TRB Says:

    PF yes I agree home is to live in and enjoy not for mad crowd speculation.

    Investors taking massive losses on small cap stocks Lynas is down over 50% in a few months.

    Macquarie Bank and Christopher Joyce pump and dump crowd are suffering large losses too.

    Christopher Joyce will try to talk the market up to get out but that game is over.

  12. J.C. Says:

    PF@9,
    If you bother to take any notice, most goldbugs are waiting, hoping, expecting a substantial correction in gold. A 10% or even 20% correction in gold overnight misses the whole point.

    You don’t get it so don’t buy gold. Of course, the mainstream media will now be pumping out articles on gold’s inherent riskiness just for people like you.

  13. Peter Fraser Says:

    JC – wow, such anger, did you suffer some losses in the recent falls, I thought that you had all of that hedged.

    I’ve never said that Australian real estate had “safe haven status” – please stop making fanciful statements. I merely noted the large falls over the last two nights and expressed my thanks that I’m not heavily in shares ATM.

    How is that at odds with the general theme, I thought that protecting your wealth in uncertain times WAS the general theme, or are you on a different wavelength to the rest of us?

    Homeless people??? Why mention them, I don’t see any homeless people on the street. I know that there are some, but I don’t believe their numbers have grown overnight, and nor am I particularly afraid of them. I’d be happy to feed some of them.

  14. Peter Fraser Says:

    JC – come on – the gold buyers here are not buying gold to make a loss – they are just as greedy as any other type of investor. They run their grubby little fingers over their holdings hoping for global trouble which will make them rich at the expense of everyone else.

    Don’t try to sell me that “I’m doing this for the greater good of all” BS – you really are indulging in the most hypocritical type of spin now.

    They don’t want a correction, they want profits. they do nothing, they produce nothing, they employ nothing. Why don’t we all just buy gold and wait a while to get rich – that is exactly the argument used to debunk the housing bubble, and yet houses offer shelter and have a rental value, whilst gold can only make a nice paperweight.

    So it has the inherrent value of a house brick.

  15. TRB Says:

    You could say the same about shortsellers PF?

    However one big difference they do offer a productive service honesty and transparency in shareholders balance sheets.

    Alot of ponzi scheme public companies need to go to the graveyard and the money used in more productive ways cheap housing,drought proofing Australian, cheap renewable energy,cheap land on the outskirts of major cities with new modern fast rail.

    I would like my superannation invested in long term infrastruture not in dodgy corrupt balance sheets that the police organisation APRA and ASIC give a tick of approval too.
    No MAC bank is not the company to do it, too much debt and massive fees.

    So shortsellers clean the system out and make a more honest open society.

    Of course 90% of the plebe population see shortsellers as public enemy number one.

  16. Jet Says:

    pf@8 Yes cash did fall last night unless you had USD. Is your cash USD?

  17. MaxPower Says:

    PF@4
    Some nice cherry picking you have done there. Australian dollar denominated real estate has also declined along with the aussie dollar if you want to compare it to the USD spot price of gold. So based on your comparison with gold, we can say that aussie real estate is more than 12% off it’s highs given the exchange rate (1.12 – 0.98) drop against the USD and a few percent more against recent price declines. In AUD, gold peaked at AUD$1815 and the spot price is now at AUD$1785, so it’s about 1.66 percent off it’s high in AUD. So maybe you should ease off on the smug a bit.

  18. Greg Says:

    pf. The penny will drop, just a matter of when and how. MOST of the so-called “value” of a property atm is being confused with its “price”. The difference? Debt. The reason why the whole financial system is in a mess? Debt. Consumers not spending? Debt. Sharemarket crashing? Debt. House prices … (clears throat) … different here. Those who own property, bought back when it made sense, understandably do not pay the debt too much mind because they don’t have it. But what they fail to appreciate is that they are at the mercy of the debt too – because the “price” of their property has been, and will continue to be inextricably linked to the size of the debt being taken on by whomever they sell it to! And there’s the rub.

  19. Peter Fraser Says:

    Hmmm – more spin – I get accused of cherrypicking by those who then proceed to cherry pick – how are we going in swiss francs or cowrie shells.

    I’m sure that you will find other measures to prove that you are right beyond any shadow of doubt, after all why use our native currency when you could choose any one of a number that almost no-one here uses.

    I don’t really have the time, so you can choose one here – http://www.x-rates.com/d/MXN/USD/graph120.html

  20. MaxPower Says:

    Nonsense. I simply pointed out that you compared 2 different asset classes using different currencies (different baselines). I then used your own methods to distort figures in the opposite direction, highlighting the fact, instead of ignoring it as you, to illustrate my point. The reality is that gold is down about 11% in USD and aussie property has fallen over 12% from peak levels if measured in USD. Or measured in AUD, gold is down 1.66% compared with aussie property which is conservatively at least 3%+ down.
    Please go ahead and try to argue over which one has fallen more…

  21. Peter Fraser Says:

    Max – I don’t really care which one has fallen more. As I mentioned to JC – I still own the house that I bought years ago. I was happy with it then, and I’m happy with it now – what has changed for me – nothing.

    As for gold – again I don’t care whether you measure it in $USD or $AUD – I have no investment holding in gold or silver, although I do own a fair amount of objects made of gold and silver. I didn’t buy them to sell them, so any rise or fall in value is interesting but not crucial to me.

    So lets look at my cash holding – you are correct that in $USD I have lost overnight, but apart from quite small purchases I don’t intend to buy much from the USA. It’s true that the price of fuel and many items will be affected by the $USD/$AUD dynamic, but I use very little fuel (hybrid vehicle) I pay nothing for electricity (I generate more than I buy) and when I do make a large purchase it will be for an Australian investment, most likely commercial property, and that will be denominated in $AUD. Any fall in real estate prices will present me with a better investment opportunity.

    Like most people I expect some challenges, so I’m happy to take some criticism. Please tell me what else I have got wrong.

  22. MaxPower Says:

    PF.
    Sorry if I over reacted but your first post just came across as being smug and deliberately deceptive. To quote your words: “Impressive falls. Glad I have cash and real estate.” So it would seem to do care and are back pedaling now to say you don’t. I know your overall views on property, precious metals etc., which differ than mine and probably most others here and that’s fine – I value some balance in the debate and to see both sides scrutinised and challenged in order to keep it honest.

    All I try to do is preserve what I have by avoiding the traps and taking advantage when opportunities arise as much as possible. I had 3 business trips to the US over the last 8 months and filled up the suitcase on the way home with durables. I am fortunate enough to work from home so I spend very little on fuel and can rent cheaper, further out from the city. Spare cash I had in AUD I bought precious metals with as a hedge against the overvalued AUD which is working out well for me so far, although I expect to take a bit of hair cut in the short term. Eventually I hope to offload them in exchange for some other hard asset like property when it becomes more realistically priced. I got out of property about 10 months ago. I don’t sell stocks, real estate or PMs for my living so I don’t have a favourite or emotional attachment. I favour only what looks the best given the evidence and try to listen to my head instead of my heart.

    I’m not ideologically opposed to your views, I think you already have enough folks on that bandwagon, and have no interest in pointing out every little mistake you might make.

  23. Peter Fraser Says:

    Max – fair points – don’t worry about the short term haircut – all assets will bounce back – the Dow will probably be up again tonight, we will see where gold and the $AUD go, but some volatility is to be expected. No-one profits or loses until they sell.

    **Something that has a value today will still have value tomorrow, the metrics are unimportant in the long run.

    Cheers …

    ** Except for HIH and Onetel shares TRB. I lost on them as well, but I can laugh about it now. Losses were small.

  24. TRB Says:

    PF the long term NEVER sell has pay off well for investors over the years.
    Warren Buffett way?
    Question I have been asking lately do we have a major psychology change in the market or just another dip to higher prices?
    This not the 1980s where buy on dips and enjoy the gains.
    Why ? because less debt in 1980s more honest balance sheets and today you have everything from CD swaps to insurance against defaults.
    Too much debt is yet to be realise.

  25. SG Says:

    PF why are you behaving like the Australian media after we lost the Rugby……whats up ?, whats getting at yah?

  26. Peter Fraser Says:

    SG – absolutely nothing is up, it’s all good.

    I don’t read the sports media so I can’t comment on that.



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