Best of the Week
Most Popular
1.Canada Real Estate Bubble - Harry_Dent
2.UK House Prices ‘On Brink’ Of Massive 40% Collapse - GoldCore
3.Best Cash ISA for Soaring Inflation, Kent Reliance Illustrates the Great ISA Rip Off - Nadeem_Walayat
4.Understanding true money, Pound Sterling must make another historic low, Euro and Gold outlook! - Marc_Horn
5.5 Maps That Explain The Modern Middle East - GEORGE FRIEDMAN
6.Gold Back With A Vengeance As Bitcoin Bubble Bursts - OilPrice_Com
7.Gold Summer Doldrums - Zeal_LLC
8.Crude Oil Trade & Nasdaq QQQ Update - Plunger
9.Gold And Silver – Why No Rally? Lies, Lies, And More Lies - Michael_Noonan
10.UK Election 2017 Disaster, Fake BrExit Chaos, Forecasting Lessons for Next Time - Nadeem_Walayat
Last 7 days
UK House Prices Momentum Crash Warns of 2017 Bear Market - Video - 22nd Jul 17
Crude Oil, Gold, ETFs & more: Pro-grade Market Forecasts - 22nd Jul 17
Warning: The Fed Is Preparing to Crash the Financial System Again - 21st Jul 17
Gold / Silver Shorts Extreme - 21st Jul 17
GBP/USD Bearish Factors - 21st Jul 17
Gold Hedges Against Currency Devaluation and Cost Of Fuel, Food, Beer and Housing - 21st Jul 17
Is It Worth Investing in Palladium? - 21st Jul 17
UK House Prices Momentum Crash Threatens Mini Bear Market 2017 - 21st Jul 17
The Fed May Show Trump No Love - 20th Jul 17
The 3 Best Asset Classes To Brace Your Portfolio For The Next Financial Crisis - 20th Jul 17
Gold Stocks and Bonds - Preparing for THE Bottom - 20th Jul 17
Millennials Can Punt On Bitcoin, Own Safe Haven Gold For Long Term - 20th Jul 17
Trump Has Found A Loophole To Rewrite Trade Agreements Without Anyone’s Permission - 20th Jul 17
Basic Materials and Commodities Analysis and Trend Forecasts - 20th Jul 17
Bitcoin PullBack Is Over (For Now): Cryptocurrencies Gain Nearly A 50% In Last 48 Hours - 19th Jul 17
AAPL's 6% June slide - When Prices Are Falling, TWO Numbers Matter Most - 19th Jul 17
Discover Why A Major American Revolution Is Brewing - 19th Jul 17
iGaming – Stock Prices - 19th Jul 17
The Socionomic Theory of Finance By Robert Prechter - Book Review - 18th Jul 17
Ethereum Versus Bitcoin – Which Cryptocurrency Will Win The War? - 18th Jul 17
Accepting a Society of Government Tyranny - 18th Jul 17
Gold Cheaper Than Buying Greek Villas in 2012 - 18th Jul 17
Why & How to Hedge the Growing Risks of Holding Stocks - 18th Jul 17
Relocation: Everything You Need to do for a Smooth Transition Abroad - 17th Jul 17
A Former Lehman Brothers Trader: It’s Time To Buy Brick And Mortar Retailers - 17th Jul 17
Bank Of England Warns “Bigger Systemic Risk” Now Than 2008 - 17th Jul 17
Bitcoin Price “Deja Vu” Corrective Sequence - 17th Jul 17
Charting New Low in Speculation in Gold and Silver Markets - 17th Jul 17
Bitcoin Crash - Is This The End of Cryptocurrencies? - 17th Jul 17
The Fed's Inflation Nightmare Scenario - 17th Jul 17
Billionaire Investors Backing A Marijuana Boom In 2017 - 17th Jul 17
Perfect Storm - This Fourth Turning has Over a Decade of Continuous Storms to Come - 17th Jul 17
Gold and Silver Biggest Opportunity Since Late 2015, Last Chance at These Prices - 17th Jul 17
Stock Market More to Go - 17th Jul 17
Emerging Markets & Basic Materials Stocks Breaking Out Together - 16th Jul 17
Stock Market SPX Uptrending Again After Microscopic Correction - 15th Jul 17
Global Currency Reserve At Risk - 14th Jul 17
Picking Great Gold Stocks - 14th Jul 17
BBC Tree Expert's Verdict on Sheffield Amey / Labour City Council Tree Felling's - 14th Jul 17
SPX Cycles, Fed Funds and Gold - 14th Jul 17
Should Platinum Be More Expensive Than Gold? - 14th Jul 17
What's Next for US Dollar, Stocks, Bonds and Gold? - 13th Jul 17
India Gold Imports Surge To 5 Year High – 220 Tons In May Alone - 13th Jul 17
Gold and Silver: Your Stomach Is Probably Wrenching Right Now - 13th Jul 17
Gold Industry Is In A Deep State Of Dysfunction, Delusion And Denial - 13th Jul 17

Market Oracle FREE Newsletter

Crude Oil, Gold, ETFs & more: Pro-grade Market Forecasts

Timing China's Financial Meltdown and Housing Market Crash

Stock-Markets / China Economy Dec 06, 2011 - 04:22 PM GMT

By: Janet_Tavakoli

Stock-Markets Best Financial Markets Analysis ArticleAt an October seminar of the Chicago Council on Global Affairs (CCGA), carnival economist Niall Ferguson promoted his new book, Civilization: The West and the Rest. He revealed the blindingly obvious as if it were a divine revelation: the U.S. has serious problems. He preached that the U.S. corrupted its six Ferguson-defined "killer apps": competition, science, rule of law, medicine, the consumer society, and a strong work ethic.


Ferguson claims India and China have downloaded these killer apps and compares the West with a virus infected PC and the East with a fast Mac. Never mind that competition, science, medicine, trade, and industrious workers have been in evidence in India and China for centuries. The West didn't invent these ideas, so perhaps there's more to the story than Ferguson's pat explanation. As for rule of law, that killer app seems as corrupted in the East as it is in the West. Ferguson's crowd-pleasing presentation didn't mention other "killer" apps that are prevalent in China: fraud, high debt levels, and privatizing gains while socializing risks and losses.

Ferguson claims that in 1978 citizens of the U.S. were on average 20 times richer than the citizens of China. Today, U.S. citizens are only five times richer. He apparently defines wealth as acquisition of material goods. That is important, to be sure, and the West should pay careful attention to the material economy. But Ferguson's China supremacy presentation didn't mention the negative human wealth effects of China's one-child policy on the shortage of female mates, the general disregard of public safety, and shortage of essentials like agricultural water and arable land.

Ferguson projects that China will have closed the material goods gap by 2016. This fits right in with popular group-think that China is an unstoppable growth machine. But it is this type of group-think that warned no one about the pending financial crisis in the U.S. in 2008 and now ignores serious potential problems in China.

Bailouts, Railroading, Cover-ups, and the Chinese "Miracle"

China is becoming a version of the U.S., but it's the version that builds lots of Penn Centrals in record time to connect slapped together empty cities before going bankrupt.

When Ferguson claimed China downloaded killer apps from the West, he left out one that is literally a killer in the form of reckless disregard for public safety. China's Ministry of Railroads, an entity with rapidly growing debt of 2.1 trillion yuan ($330 billion), was bailed out when the National Development and Reform Commission announced it had "government support." (See Gordon G. Chang's October 23 article in Forbes.)

The bigger problem is the shoddy construction of China's high speed railroad system, and cover-ups by railroad management. It turns out that railway bridges were constructed by untrained unskilled migrant workers and rocks and gravel were tossed into pier foundations instead of concrete. Unqualified workers also built tunnels. When tunnel problems manifest themselves, they usually involve suffocation of passengers. If you ever wondered how the Chinese can slap together an infrastructure so fast, here's your answer. It literally slaps it together. Fixing the construction problem may ultimately be more costly than having done it properly in the first place. But the social issues are an even bigger disaster for Chinese government.

In July 2011, two bullet trains on the Wenzhou Line crashed. Officials claimed a lightning strike caused the accident, and tried to suppress reports.

After officials claimed everyone was removed from the carriages, bulldozers buried the rubble and onlookers screamed as bodies fell out of the windows of the about-to-be-buried carriages. Then after it was formally announced that all of the bodies in the carriages had been removed, a four-year-old girl was found alive in the wreckage. A spokesman for China's Railway ministry told the reporters shouting at him that it was a "miracle."

Tens of Millions of Mate-less Men

China's population comprises more than 1.3 billion people. According to Unnatural Selection, China has 121 male births for every 100 females, whereas the highest natural ratio is around 106 males per every 100 females. Wikipedia's 2008 figures show that in the under 15 age group, there were already 113 males for every 100 females. I'm sure young men and women have given this ratio at least a passing thought, and it's getting much worse.

Putting aside the issues of selective abortion of female fetuses, female infanticide, and the implications of household formation, this means a growth in the tens of millions of frustrated men dispersed throughout China.

The apparent euphoria of western pundits like Ferguson when discussing China makes me wonder if they downloaded an app for a peculiar kind of dementia. Everything we want or need in life comes to us through our relationships with other people. The quality of our relationships, or human wealth, defines the quality of our lives. Ignoring this is a socio-economic hand job. China is fundamentally impoverished in a way that is irreparable in the short run.

China's Housing Price Crash

There's a myth that low leverage makes a housing price crash immaterial. Many Chinese home buyers pay cash, but others make high down payments. Some reported down payments are as low as 30%; high by U.S. "standards," but still painful when housing prices drop 30%. Some investors have bought multiple properties. Even if one pays upfront in full, a housing price decline has a huge impact on how wealthy investors feel.

Here's the most benign case. Suppose a buyer pays cash for an empty investment property. The buyer still has to maintain the property. If housing prices remain stagnant (or go down), and food prices and other prices escalate (as they have), will that buyer feel richer or poorer? Will he have a higher appetite for liquidity or a lower one? Will other potential investors observe this and want to buy real estate so they can enjoy the same delightful experience?

The critical problem is that home prices in China are sliding fast. Some analysts say the "tipping point" started in September and they expect it to get much worse. Chinese newspapers reported riots in Shanghai after developers slashed prices to dump inventory. Contracted home buyers saw prices cut 25%. Some property developments in Beijing have had price cuts of 20-30 percent. China's empty "ghost cities" are seeing price discounts of 30 percent for upfront cash payments. Mainstream U.S. financial media is now reporting possible housing price declines of 20-30 percent for major Chinese cities next year.

China's Debt and Coming Hard Landing

Nothing creates a hard landing better than a housing collapse. Property construction accounts for more than 13% of China's GDP up from around 3% of GDP in 1999 according to the China National Bureau of Statistics.

Local Chinese governments have mounting debt to fund infrastructure projects of 10.7 trillion yuan ($1.7 trillion) and depend on land sales to fund payments. According to investment management company GMO debt in Local Government Funding Vehicles amounts to around 1/3 of China's GDP. The projected slowdown in land sales will pose a huge problem, no matter whose numbers one uses.

A huge problem in analyzing China's debt problems are off-balance sheet obligations. No one knows the size of local government debt obscured by off-balance sheet vehicles. Hidden national government debt includes "support" such as for the railroad and a variety of other guarantees have ballooned China's real debt.

Then there are the obvious problems with undercapitalized banks. When most people think of "Jim" and "China" they think of China advocate Jim Rogers or China skeptic Jim Chanos. Many people haven't heard of Jim Antos, an analyst at Mizuho Securities in Asia. According to Antos, loan growth has slowed to 15% from 30%, but the unsustainable current level of bank loans stands at $6,500 per capital in 2010. Gross domestic product per capital is $4,400. On a scale of one to ten, he rates China's debt problem an eight and Greece's debt problem a ten.

GMO reports that Fitch estimates that 35% of bank loans are directly or indirectly tied to the Chinese property market, and UBS estimates it at 40-50% of outstanding loans. No matter which is correct, a pullback will be brutal. ("Between Errors of Optimism and Pessimism," by Edward Chancellor, GMO, September 2011, and "China Real Estate--Final Destination," UBS, August 25, 2011.)

These loans don't count active private lending frauds that fleece entire towns and enrich local bureaucrats, accomplices of "property developers" turned con artists.

Swindles have become so commonplace that James Grant, of the Grant's Interest Rate Observer, calls China "The People's Republic of Madoff." Research firm Muddy Waters gives foreign investors ample reasons to be wary. It's been documenting suspicious numbers reported by a plethora of small cap Chinese reverse merger companies listed on foreign exchanges. Muddy Waters' skepticism about a larger company, Sino Forest, caused its stock price to plummet.

If that weren't enough to make investors nervous, Jim Chanos, President and founder of Kynikos, told Bloomberg that many large cap shareholders don't realize that all they have is an operating agreement with mainland companies, not control of hard assets.

China has loaded itself up with debt. Unfortunately for Chinese citizens, China also down-loaded the "killer app" of socializing credit risk. Bank deposits are low yielding and the borrowing rate is either very low or negative which encourages explosive loan growth, also known as a debt bubble. ("China Financial Markets: Time to relax credit?" by Michael Pettis, Guanghua School of Management, Peking University, October 31, 2011.)

As for China's official growth figures, one has to be suspicious of government numbers when ministers have already shown they will try to bulldoze over horrific facts. Discovery of the truth takes a miracle.

When Will Strain Lead to a Crash?

China is on track for making as much of a muddle of its economy as many countries in the West have done. While being a fast-growing creditor country helps mitigate the consequences of its folly, the consequences are catching up with China. Are these problems overstated? That's impossible to tell without reliable numbers. The question to answer is how quickly and to what degree will China's problems affect its economy? After all, one wants to be able to get in a good short trade just before it all falls apart, if that is where this is headed.

Dylan Grice points out that anecdotal evidence can be misleading and China may "keep the plates spinning for a few more years." ("Popular Delusions: On China's swindles: how big is the bezzle?" by Dylan Grice, Societe Generale Cross Asset Research, November 4, 2011.)

It would be useful to come up with a measurement that indicates when things are just about to fall apart. Based on my own anecdotal experience in Iran, one cannot predict the timing of a collapse with certainty, but a good leading indicator is when rats start leaving the sinking ship in droves.

Chanos ("China Chaos") Derivatives

Grice provides a clue for the timing of China's collapse. Since 1990 around 18,000 officials have fled taking an average of around $7 million per flight. Special purpose credit derivatives (perhaps you prefer the term "discredited" derivatives) are a leading indicator for China's hard landing. I call these 'China chaos" derivatives, or "Chanos" derivatives.

If the rate of change of public officials fleeing the country, df/dt > x, where x is yet to be defined, or the acceleration in fleers, d2f/dt2 > y, where y has yet to be defined, or the rate of change of the average amount of loot dl/dt > z, where z is yet to be defined, then conditions of the Chanos Equilibrium have been violated and destabilization will occur.

Stated differently, when you see the absolute amount of embezzled wealth fleeing the country suddenly increase, or when you see a sudden increase in the absolute number of Chinese officials leaving the country on "holiday," or when you see an acceleration in the number of officials leaving the country in a stealthier way, you'll know China is sinking.

To read the original pdf by Janet Tavakoli with links click here.

By Janet Tavakoli

web site: www.tavakolistructuredfinance.com

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

© 2011 Copyright Janet Tavakoli- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife