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

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“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

Kris Sayce

Kris Sayce

Publisher and Investment Director at Money Morning Australia

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 editor of Tactical Wealth — where he reveals ‘special situations’ he’s discovered in the markets. 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.

Kris Sayce is the Publisher and Investment Director of Australia’s biggest circulation daily financial email, Money Morning Australia.

Kris is a fully accredited advisor in shares, options, warrants and foreign-exchange investments.

Kris has close to twenty years’ experience in analysing stocks. He began his career in the biggest wasp’s nest in the financial world — the city of London — as a finance broker back in 1995.

It’s there where he got his ‘baptism of fire’ into the financial markets, specialising in small-cap stock analysis on London’s Alternative Investment Market. This covered everything from Kazakhstani gold miners to toy train companies.

After moving to Australia, Kris spent several years at a leading Australian wealth-management company. However he began to realise the finance and brokerage industry was more interested in lining its own pockets with fat fees, commissions and perks —rather than genuinely helping out the private investors they were supposed to be ‘working’ for.

So in 2005 Kris started writing for Port Phillip Publishing — a company which was more attuned to his investment outlook.

Initially he began writing for the Daily Reckoning Australia— but eventually, took over Money Morning. It’s now read by over 55,000 subscribers each day.

Kris will take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money! Whether you agree with him or not, you’ll find his common-sense, thought-provoking arguments well worth a read.

To have his investment insights delivered straight to your inbox each day, take out a free subscription to Money Morning here.

Kris is also the editor of Tactical Wealth — where he reveals ‘special situations’ he’s discovered in the markets that you could profit from. If you’d like to learn about the latest opportunity Kris has uncovered, take a 30-day trial of Tactical Wealth here.

 

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26 Responses to “Why China’s Hidden Debt is Bad News for Aussie Stocks”

  1. Peter Fraser

    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.

  2. MaxPower

    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.

  3. Peter Fraser

    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.

  4. TRB

    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.

  5. SG

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

  6. Peter Fraser

    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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Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@moneymorning.com.au