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    Hi Guys

    An interesting view of china I have received in an email:

    by Karim Rahemtulla

    Last week, I spent several days in Beijing and Shanghai, hosting a Supper Club Venture Capital meeting.

    China is a conundrum. It makes no sense. And people accept that as normal. It is a country that has collided with capitalism and is now trying to manipulate it. It is country with a government that is adept at sleight of hand. What remains to be seen is whether China is pulling off an economic miracle, or just the wool over the world's collective eyes.

    After having a few days of pondering the puzzle of China, visiting with companies and catching the local real estate scene, our group sat down to discuss what it was that did not make sense about the commerce that we were seeing.

    We looked at a bunch of Chinese companies. Most of them were leveraged to the hilt with more debt than equity. Most were government spin-offs that were now private and publicly trading in the U.S. OTC market. When asked about how they were able to pay their debts - loans owed to the state-owned banks - they replied almost in unison that the loans were a low interest rates and renewable in perpetuity, and that the banks really did not force them [expect them??] to pay them back until they became profitable. One way around this, one executive intimated, was to keep two sets of books, one perpetually showing low profits or a loss. I asked point blank if this "government subsidy" was commonplace, and the answer was a resounding yes! The comment that was most telling was when one company officer, a U.S. trained MBA blurted out, "This wouldn't work in the U.S." I guess not, unless you were WorldCom or Enron!

    The conclusion that I reached from this research was that China is not a transparent country, the government is subsidizing every level of the economy, from pensioner to taxi driver to major corporation, and that there will be a day of financial reckoning when many businesses go bust because the government will not bail them out by injecting more capital into already debt-ridden banks. And, you cannot trust any statistic that the government publishes.

    Chinese banks, a.k.a the government, are saddled with hundreds of billions of dollars in non-performing loans. That is, if you use their published numbers, which are shaky at best. Yet, they continue to lend businesses whose owners are making money, not from product they sell, but from how much they can siphon out of the company knowing they are not being held accountable. As I see it, it goes something like this: You get a loan that you don't have to pay back. You produce goods that you then sell below market to generate cash flow. You then show a loss from operations, since you spent more to make the product than you are selling it for. You pocket some of the cash flow, since the debt service is non-existent. You use your newfound profits to put deposits on new office space and apartments that you are planning to flip - since in China you don't have to pay for the space until it is completed, and by then if prices have collapsed, you can just walk away. And since few Chinese pay taxes in this "voluntary system," most of your "earnings" are also tax-free. So why does the government put up with this?

    There are two reasons that I can come up with. First, corruption in the Chinese government is about as common as smog in Beijing. The skids are being greased at every level. Capital is being provided for these companies via share sales in the global markets to keep the party going after the loans run out. Basically, this is how business is being done. Now, this may not be the case for every Chinese company, but elements of this type of chicanery cannot be isolated incidents or the number of bad loans would be much lower.

    The second reason, and just as troubling, is that the government cannot control the new capitalism that has been unleashed across the country. People are seeking a better lot in life and finding it through commerce. With 1.3 billion people, it could be an ugly scene. So, the government is filling the trough of liquidity, basically subsidizing the entire urban population, to avoid an uprising. Money is flowing, goods are being sold, buildings are being built - and all within an artificial cost structure.

    While Beijing has a relatively short history of modern capitalism, Shanghai has a long relationship with money. Known to some as the Pearl of the Orient, and to others as the Whore of the Orient, Shanghai is truly one of the world's great metropolises...when you can see it.

    When you CAN see the city, you see modernity surrounding you. Subways, massive freeways that fly through the city center, suspended 40 feet above ground, a Maglev train to the new airport that I clocked at 430 kilometers per hour, and a port second-to-none. In my estimation, Shanghai, home to over 13 million people, has more skyscrapers than Manhattan. It is also more polluted, more gridlocked, and just as much fun.

    I thought Beijing had the best markets, but Shanghai has even better ones. Here you can find all manner of goods and services that are available in the world's largest and most cosmopolitan cities. Five Star hotels abound, modern theater, huge malls with every imagineable offering from Europe and the United States, a McDonald's around every corner. If it wasn't for the smells and strange rooflines, you could very well be in any modern capital. (Speaking of McDonald's, The Economist magazine has long put out a Big Mac Index as a measure for valuing whether a currency is over or undervalued. I have been using this index as a guide for more than a decade and it has proven quite accurate. My Big Mac meal in Shanghai set me back $2.19 - about half what it would cost in the United States. This is a good indication, along with the 15 cents I paid for a Snickers bar and the 30 cents I paid for 16oz Pepsi, that the Yuan could appreciate quite a bit from current levels).

    Of course, the lower strata of the population do not see it this way. As in any big city, there is a lot of poverty in Shanghai, and it is in your face everywhere. Parents with invalid children begging for pennies, people walking around picking every trash can clean of its putrid treasures - you name it, and you will see it in Shanghai.

    Shanghai is almost not China. There is very little overt sign of government control of this commercial Mecca. It bustles like Manhattan, entertains like LA and offers Miami-like temperatures and beaches. It is China's version of Laissez Faire economics. Anything goes here and the aura of the old money, first made by the large opium houses, abounds. On the streets, you are as likely to see a Bentley as a rickshaw. Shops range from opulent malls to back alleys where one can still score knock-off Gucci and Louis Vuitton purses (about $10 a pop if you bargain hard enough.) This selling of pirated and knock-off goods is enduring China's version of a crackdown. Instead of selling openly in the markets, you are led down a series of back-alleys to small rooms with all the goods on display. China will pacify the West on the surface, but underneath, it's business as usual.

    Spending a few days in Shanghai almost made me a believer in the China miracle. It was a real city, with real history and real money. But, it was just one city in a sea of billions of people, many who have yet to experience a working toilet in the 21st century. China has four such cash cows: Hong Kong, Shanghai, Macau and soon Taiwan will be sucked into the fold. None of them are too happy with being associated with a government that still tries hard to control every facet of life. It isn't working, and I think China will go the way of the USSR - a weird sort of capitalism with no looking back.

    China is a conundrum. It defies economic principles with low inflation, high growth, and huge money supply, and a socialist government all in one...someone is lying somewhere. My advice on investing in China is this:

    1) Trade Chinese stocks and look for emerging market like crashes as buying opportunities.

    2) To really profit from China, fly over with a few suitcases and spend as much as you can, buying goods at artificially low price


    Karim Rahemtulla
    for The Daily Reckoning

    P.S. The only thing that you should not do is to ignore China. It is THE giant of Asia and there is no country even close. India may be an established democracy, but it is does not hold a candle to the development in China. That being said, India may prove to be the opportunity that China was ten years ago. For now, China is a juggernaut that looks to be growing to the moon...and as we know from past experience, that may not be a good sign in the short-term.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

  • #2
    Judging by Karim's words, which I suspect have more than a hint of truth and reality to them, it would seem the Chinese government are printing money to support their economy. That sounds a bit like Germany in the early thirties. If China goes down it will have huge ramifications around the world. I only hope that if their financial principals fail, which they surely will, they don't resort to military ones. The China Taiwan conflict could be the catalyst. Japan, too, must be shaking in it's boots.

    Gimme $20k. You will receive some well packaged generic advice that will put you on the road to riches beyond your wildest dreams ...yeah right!


    • #3
      Government subsidies

      Thanks for a very interesting evaluation of China.
      Some extremely valid points were made in this email, and it must be stated that China is unbelievably complex.

      I think that on the surface you have managed to grasp things over here quite well though there is one point that appears to have gone under your radar.

      "...the loans were a low interest rates and renewable in perpetuity, and that the banks really did not force them [expect them??] to pay them back until they became profitable."

      In simple terms I believe this is the Chinese governments short term answer to privatisation. Why is the govt keeping these largely SOE or previously SOE afloat? Think about what happened when Thatcher "rolled back the state", what were the consequences? Yes mass unemployment.

      China knows that its mainy enterprises are no where near the efficiency that they could be, however streamlining these industries would result in a tremendous rise in those out of employment in what is already an incredibly highly competitive job market. We are talking about the livelihoods of hundreds of millions of people potentially. In that situation the most likely result is the one thing that China, a country founded on revolution, fears the most- yes another revolution.

      A look at Scandinavian economic models will show that subsidised governmental policy can work, and work well. In regards to your point on a tax free society, this has been addressed in recent regulation.

      China is a developing nation, and this means not only development of buildings and roads. There is much work going into accounting procedures, taxation, anti-corruption regulation and so on.

      Of course the markets you talk about are a great way to buy things, but this too can bring ethics into question. Is it acceptable for example to buy pirated copies of Nike shoes at a small percentage of the normal retail price? In fairness it does give the opportunity to a country still burdened with a 70% peasant population to be active in buying commodities. And lets face it, Nike are not exactly struggling for cash (don't quote me on this).

      In my estimation China is a place where significant opportunity is on offer. It is not what we are used but that is all part of its charm.

      Lets not forget the situation China was in only 20 years ago. In my opinion the government is doing a pretty good job everything considered, and are still making progress that will continue for years to come.

      Ps I certainly would NOT look at Chinese stocks as any kind of stable investment. While there have been some significant gains the market is still very immature and at times volatile. I would go the property route personally (and have)
      Todd Subritzky
      Sino-NZ Investment Group


      • #4
        To Julian
        I forgot to mention that the Chinese are absolutely dedicated to a peaceful rise. The Taiwan issue is almost 100% caused by the American attempts to destabilize the region which Taiwanese bureaucrats have seized on for their own advantage. Take it ieasy, it is all good over here. Don't believe everything you read in western papers. The Chinese don't need weapons to win the peace, they have the numbers which will proove sufficient
        Last edited by Chinese connection; 21-04-2007, 11:51 PM. Reason: spelling
        Todd Subritzky
        Sino-NZ Investment Group