Beware the ripple effect of a slowing Chinese economy

By: AVNER MANDELMAN
Published Friday, Oct. 07, 2011 6:39PM EDT
I like to hear views different than my own for two reasons. First, because I may be wrong, and it’s better to learn this before I invest, not after. Second, because listening to those who are most often wrong reminds me what not to do.
For the second reason, I like to listen to PBS.

A few months ago, one of their star interviewers chatted with a retired South Asian statesmen, an ultra-rich ex-dictator. The PBS reporter deferentially asked the former leader for his views about China. I listened intently as the avuncular politician replied that China was fine and that its current economic stresses were no reason for worry.

I waited for the obvious follow-up questions. How much of your own wealth, Mr. Retired Statesmen, is invested in China? Are you putting your personal money into the country – or taking it out?

The questions never came, alas. So I switched off the TV, and shorted more Chinese stocks.

Which leads me to today’s topic: China’s slowly crumbling economy. You will not hear the talking heads on television speak plainly about the country’s problems. They fear losing access. They’re blinded by the country’s recent success.

Stratfor, a U.S. company specializing in geopolitical analysis, is one of the few observers to deliver a critical assessment. “This Asian giant is reaching a point of crisis,” Stratfor wrote in a report last month. “China’s economic model prioritizes flow-through of money, or growth above profit. Like a Ponzi scheme, it’s exactly the kind of model that breaks down rapidly under crisis.”

I’ve been making a similar point for the last two years. Based on my sources, China’s economy is slowing down. This has important implications not just for those invested in the country but for Canada as well.

As its economy slows, China’s demand for commodities is bound to shrink. So too will commodity prices – and currencies tied to commodities, such as the Canadian dollar and the Australian dollar.

I think the loonie will soon fall below 90 cents (U.S.). On the positive side, this will provide a boost for Canadian exports and attract more tourists to Canada. It means your U.S. investments will be worth more in terms Canadian dollars.

The catch? It will be more expensive to buy foreign goods – including stocks. And those who are heavily invested in China may find themselves saddled with losses.

Part of my skepticism about China emerges from the generally gloomy global outlook. Copper prices are one of the best economic forecasters because of the metal’s widespread use in industry and construction. The recent fall in copper prices is signalling economic weakness around the globe – and that includes China.

Oil prices are also a good indicator of growth prospects and they too have been dropping. West Texas crude has slipped to $83 (U.S.) a barrel from more than $110 this spring, and I think it’s going lower.

Most ominously, loans to Chinese builders are finally coming home to roost. The country’s red-hot property market is showing early signs of cooling, raising the question of whether property developers will ever be able to pay back the large amounts of money they’ve borrowed from Chinese banks and well-heeled investors.

As the government tries to cool off the housing sector, the banks are turning off the taps to developers. Meanwhile, flattening real estate prices are discouraging speculators from advancing short-term loans through so-called “trusts” that lend money against collateralized units.

If big projects are delayed or not sold and speculators start dumping their units, there’s potential for a repeat of the U.S. mortgage blowup, as creditors take ownership of partly finished projects and try to sell them, driving down prices even furrther.

The next few months will tell the tale. Consider Greentown, a real estate company in Hangzhou. It has almost 7 billion renmimbi ($1.1-billion) of cash, but double that amount of debt maturing in less than 12 months.

There are many other developers facing a similar crunch, so the potential for a U.S.-style debacle is not negligible. If China falters, as I expect, and its growth rate slows from more than 9 per cent to 6 per cent or lower, the ripple effects will be felt throughout the global economy – and will be reflected in falling commodity prices and a weaker loonie.

A 90-cent loonie is on the way. Meanwhile, avoid Chinese stocks.

http://www.theglobeandmail.com/globe-investor/investment-ideas/features/the-buy-side/beware-the-ripple-effect-of-a-slowing-chinese-economy/article2195152/