China Bled White

According to this report China is going down hard.

The Chinese economy is in the final stages of largest Ponzi scheme ever devised. Minsky outlined three distinct phases in the credit cycle: In the first phase known as the hedge phase; economic actors borrow money to invest in order to create goods to sell for profit. In the second stage, the speculative phase, more economic actors join the economy, borrowing money to invest in assets in the expectation that these assets will rise in value. In the last stage, known as the Ponzi stage, economic actors borrow in the hope that conditions will improve. This borrowing is designed to avoid insolvency during what is perceived or hoped to be a short to medium term setback in economic conditions.

Some may argue that the Minsky market driven instability hypothesis is not suited to China and that they are chiefly a centrally planned state controlled economy. This reflects a fundamental misunderstanding of Minsky’s work. The Western economies’ attempt to centrally plan economic activities from the consumption end, the state based capitalism that China has become known for attempts to centrally control the economy from the production side.

The Chinese production economy cannot be seen in isolation from the consumption economies of the West; debt based consumption provided the umbrella under which the Chinese miracle grew. When the GFC collapsed Western debt based consumption reacted by providing the last line of Minsky Ponzi financing via government bail-outs. Governments faced with banking collapse chose keep the system going by transferring debt from private hands to those of the taxpayers.

The Chinese, faced with a massive collapse in export income, chose to keep the economy functioning by stimulating the economy with massive capital works and lending. In both cases the government was the provider of the last line Ponzi financing to keep the economy rolling. Now that this Ponzi financing has been near exhausted in both the West and the East, profound collapse is the only logical outcome.

But it is not jut the 1/2 to 3/4 trillion dollars China pumped into its economy at the start of the crisis.

The exponential growth in Chinese debt and mal-investment and the very unlikely return of Western demand means the system will become insolvent in the short to medium term.

The number of investors who have suffered losses due to widespread fraud is growing exponentially and the list of those that have racked up substantial losses includes some of the leading investors in the world. This list of investors includes investment legends like Anthony Bolton one of Europe’s most well-known fund managers, legendary investment icon John Paulson have been the victims of fraud, the scale of which has never been seen in economic history.

This gets to the heart of the matter. A lack of transparency in China. And too much faith in the Chinese system by global investors.

The problem with Sino Forest was that most of the forests the company claimed as assets simply didn’t exist. Rather than being a few isolated cases, these examples signal an epidemic of systemic fraud and corruption that pervades entire Chinese economy. This systemic fraud directly correlates to Minsky’s final Ponzi phase: cheap credit, floods the economy, eventually exhausting useful ways it can be utilized. This, together with the lack of systemic controls that accompany cheap credit, initially causes mal-investment into projects that will never return enough to service their debt. Then, having exhausted all reasonable avenues of mal-investment, large amounts get siphoned into the hands of criminal opportunistic economic agents who game the system.

In December another Chinese stock research firm Citron came out with this report Qihoo : Fraudulent Financials,Terminal Business, Or Both….You Decide. Citron maintains price target of $5. In late February 2012 they submitted this report to the SEC Citron Reports to Securities and Exchange Commission. Australian, John Hempton of Bronte Capital, famous locally for uncovering the Astara Trio Capital Ponzi scheme, has been instrumental in uncovering a long list of Chinese frauds including: Longtop Financial Technologies, Universal Travel Group, China Media Express, and China Agritech

A few weeks ago, Boshiwa Holdings the licensee and manufacturer of Harry Potter related toys plunged 42% on news that its auditor had quit. In late February Puda Coal raised a $100M from US investors based coal assets that were never there: A Fraud Went Undetected, Although Easy to Spot.

By now you get the general idea. The article goes on to discuss Chinese history and culture and how business has been done in China for over a thousand years. This lack of transparency is nothing new. It is just the scale of it all. Plus the total corruption of the Chinese Communist Party. The current rulers of China may soon loose The Mandate of Heaven when the whole mess totally crashes.

Note to readers: most of the links above are from me (Simon). If you are unfamiliar with what is going on you may have to do some searching to keep up. It is worth it.

Update: 27 June 2012 1436z

W. R. Mead is looking at this from a slightly different angle. The conclusion is the same.


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3 responses to “China Bled White”

  1. Rob Avatar
    Rob

    I live in China and own a small business. That is the best article I’ve ever read on the subject of the Chinese economy, thanks for directing me to it.

    I’m not sure that it’s really “fraud” though. It’s a combination of Confucian ethics (support the king/statism) and the pseudo-communist ideology that gets taught now (economic growth justifies the ruling class). “Fraud” is the opposite of honest trading, but in Chinese culture, in every deal, someone gets screwed. They feel everything is a zero-sum game, so there is no limit to what you can do to win. There’s no such thing as a “square deal”.

    Anyone that invested in a Chinese owned business is either and idiot or hopelessly naive.

  2. Luke Lea Avatar

    Nice post. I saw you link over at WJM’s. I’ve been reading the classic novels of late Ching Dynasty: The Dream of the Red Chamber, All Men are Brothers, The Scholars, The Golden Lotus. Systemic corruption is a constant theme, woven into the fabric of everyday life. Haven’t gotten to The Three Kingdoms yet. Cheating on the civil service exams is another constant. The Chinese have no indigenous sense that lying, cheating, and taking bribes are wrong. What is most important is family and clan loyalty. There is no real unity in Chinese society, no rule of law, no concept of the rights of the individual. If this is to change it will be as a result of foreign influence. Right now I’m reading God is Red, about the indigenous growth of Christianity in China, There may be hope there. Can’t imagine where else. Keep up the good work.

  3. […] This will of course hurt the US economy and China’s economy. […]