‘The idea many investors have that China can make a seamless transition to a consumer-driven economy is ridiculous. There is no precedence for it. They don’t have a system, cultural, legal, economic or political, that would accommodate that kind of transition.’ – Michael Aronstein, Marketfield Asset Management
It’s good to see we’re not the only one who sees through China’s economic charade.
Michael Aronstein at Marketfield Asset Management thinks China’s days are numbered. He told Bloomberg:
‘It worries me, particularly in China, where the expectations about a developing middle class are, I think, way off the mark. The wealth China has developed has been mostly a function of either demand or capital coming from external sources.’
He’s dead right. And he’s backing it up by short-selling an exchange traded fund (ETF) that invests in Chinese stocks. Of course there’s a much better way to sell China, and it’s right here on the Aussie stock exchange…
Why China is an Anti-Consumer Economy
To hear most people talk about China’s economy, you’d think they’d created a magic formula to guide an economy to eternal success.
Some formula. The Chinese have simply spent and borrowed (yes, borrowed) to build huge infrastructure projects. When that stops, what happens next?
We had a chat about this with some old broker chums over an all-you-can eat buffet lunch (cauliflower soup, roast lamb and veg, and apple crumble with custard and ice cream) at the RACV Club in Melbourne last week.
We made this simple point. The notion that many in the West have is that China will allow its subjects (citizens would be a generous term) the freedom to become consumers.
We just don’t see it happening. A consumer-driven economy requires a free people and a mostly free market. At the very least it needs a competitive market.
It needs an economy where consumers can make choices about what they do, where they go, and what they buy.
A consumer economy is where you decide whether to use that five dollar note to buy a magazine, a bag of lollies or a coffee. Then you have to choose which magazine, which bag of lollies, or which coffee.
We’re sorry to say it, but most Chinese don’t have that choice. And the Chinese economy has no experience of a competitive market where consumers make choices. When you’re building a skyscraper you want steel, copper and glass. Those are commodities. To a large degree it doesn’t matter which steel, which copper or which glass you buy.
One of Pavlov’s dogs could run the Chinese economy. More steel? Press a button, more steel arrives. More copper? Press a button, more copper arrives. And so on.
How does that work in a consumer economy? It doesn’t. They can’t bulk order one product or service and allot it to the entire population. And if they do, it’s not what most of the people want…because it’s decided by a central planner rather than by the consumer.
Not a Cross-Section of Chinese Living Standards
Perfect examples in the West are public healthcare, schooling and housing. Forcibly paid for by taxpayers who don’t need it, don’t want it, or would prefer something else…something they could choose.
But, we hear you ask, ‘Ah, but what about the pictures you see of the rich folks in Shanghai wearing Rolex’s and driving Ferrari’s. Isn’t that proof consumer culture exists and can be successful?’
Again, we mentioned this over lunch last week. The Rolex’s and Ferrari’s are what you can see. What about what you can’t see?
Using the rich in Shanghai as a sample of consumerism in China is like taking a snapshot of consumers in Toorak, Vaucluse and Beverly Hills and assuming that’s a fair picture of all consumers in Melbourne, Sydney and the Los Angeles area.
The rich in Shanghai are consumers because their mates in China’s ruling elite let them be consumers. But don’t expect the Chinese government to give the same personal and consumer freedom to the masses.
Because the rulers know that once they lose control over what the people can buy and sell, they’ll lose power. And power is the biggest weapon the Chinese rulers have.
In China There Can Be No Freedom Without the Loss of State Power
In the May issue of Australian Small-Cap Investigator we wrote that until the Industrial Revolution, ‘There was no progress or improvement in the standard of living because no-one knew the concept of wanting to do better for themselves.’
Kings ruled kingdoms, Lords ruled their estates, and the serfs and servants obeyed their masters. They knew no better. They certainly never dreamt of becoming a King or Lord.
But once the Industrial Revolution arrived, people gained some freedom. And they got a taste for it and the chance to better themselves.
The point is it didn’t happen overnight. It took time. It needed a situation where individuals could exercise some choices. And it needed an environment where capitalists could lure labourers away from hand-to-mouth living, towards earning a wage.
At the time of the Industrial Revolution this was new to everyone. They couldn’t have known the impact it would have, and how it would result in more freedom for the lower classes and less power for the ruling classes.
But that’s not how it is in China. If they’ve done their homework, the ruling powers will know what will happen if they allow individuals to become free and make their own choices. It will mean loss of power and control.
Freedom and State power are the two extremes. You can’t have both in equal measures. You can’t have absolute power and absolute freedom. It’s one or the other or something in between. So something has to give.
And that is the last thing China’s rulers want. Consumerism in the Chinese economy won’t happen. Not without a fight.
Sell Aussie Miners – Sell China
That’s why we’re a fan of the ‘sell big Aussie miners trade’.
Companies such as BHP Billiton [ASX: BHP], Rio Tinto [ASX: RIO] and Fortescue Mining [ASX: BHP] are almost 100% pure plays on the Chinese economy.
Shares in these companies did amazingly well between 2003 and 2007. Why? Because they had what the Chinese needed – millions of tonnes of bulk materials: iron ore, copper, and coal.
You need a lot of that stuff when you’re building skyscrapers, freeways, houses and sports stadiums. But…you don’t need quite so much iron ore, copper, and coal when you’re making consumers goods.
Such as handbags, lollies, toothpaste and shoes.
Our bet is all three have much further to fall.
And quite frankly, we doubt if there’s a better trade in the world to sell China’s economy than the opportunity Aussie investors have to short sell these three stocks.
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
If you’re already a subscriber to these publications, or want to follow his financial world view more closely, then we recommend you join Kris on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.