Am I a China Bear?

There are two schools of thought on the Chinese economy right now.  The first says “It’s always darkest just before the dawn.”  The second says “It’s always darkest just before it goes pitch black.”  It’s clear that China’s economy is slowing.  But what happens next is far from clear, and the subject of much debate.

The conventional wisdom at the moment, among officials and economists, runs something like this:  China’s economy is slowing alright, perhaps a bit too much for comfort, but it’s mainly a self-induced slowdown driven by the government’s own cooling measures.  GDP growth is still above Premier Wen’s target of 7.5%, and is destined to improve in the 2nd half of the year as the government switches gears to re-stimulate the economy.  The slowing inflation rate gives them plenty of room to ease.  The real estate market has already bottomed out, and the banking system is stable.  Maybe stimulating more investment isn’t the best thing for China’s economy in the long run, but Chinese leaders have the ability to kick that can down the road for some time.  They have time.

No they don’t.  I disagree with virtually every single element of the conventional view I’ve just outlined.  Over the next few days, in a series of posts — on credit, real estate, inflation, and stimulus — I will describe how and why.  For the last two weeks, I’ve been on a bit of a hiatus from this blog, focusing on my Twitter feed @prchovanec — which if you haven’t checked out, you should.  Not only has Twitter been a wonderful way to introduce new readers to this blog, it has offered me an excellent perch for monitoring the data and news stream coming out of China, while trying to make sense of what it all means.  Several important story lines have emerged, and what I’m seeing really worries me.

Indeed I am worried — not thrilled, not vindicated — because contrary to stereotypes, I do not consider myself a “bear” on China.  In that respect, I would like to make a few points.  Because over the next few days I’m going to be saying some very negative, critical, and even scary things about China’s economy, these points are quite important.

1)  I don’t hate China.  I’m not “rooting” for China to “crash and burn.”  I realize that at least a few of my Chinese readers, when they hear me harshly criticize policy or make dire warnings, might conclude that — as an American — I’ve caught an acute case of China-envy and would love nothing better than to see China taken down a notch.  In fact, I am so critical not because I want the worst to happen, or believe it must happen, but because I hope and believe the worst can be avoided, if clear-sighted, courageous choices are made.  My wife is from Beijing, my son was born here, and we are all tied by blood and affection to a whole host of relatives in China whose struggles and aspirations we share.  On a less personal level, no matter what you think about China’s current form of government, or the implications of its rising global influence, the complex challenges and opportunities posed by a strong and prosperous China are infinitely preferable to the terrible dangers and uncertainties the world would face if China were to “collapse” or just lose its way in confusion.

2)  I’m not a “Perma-Bear”.  In other words, I’m not the kind of commentator who has been warning of China’s imminent crash for so long that eventually I’m bound to get it right, like the broken clock that tells the right time twice a day.  I’ve been traveling to China for 26 years, and living here for over a decade.  For most of that time, I would have described myself as a China “bull.”  I’ve seen an incredible transformation of an economy, an astonishing burst of wealth creation.  I’ve worked for private equity funds that invested in promising Chinese companies and helped them grow. In the past, the problems — bad debt, inefficient state industries, protected markets — were outweighed by even more positive developments: the wholesale privatization of small and medium state enterprises, China joining WTO and committing to more open markets, foreign investors taking an active stake in reforming state-run banks.  But something changed in the past few years, when China adopted state-managed stimulus and money-printing as a model for permanently boosting economic growth.  I don’t see myself as inherently a “bull” or a “bear” on China.  The fact is, I see plenty of promising areas where China can achieve huge productivity gains and realize meaningful growth — but I don’t see that happening as long as China keeps trying to insulate favored market sectors from economic reality.

3)  I’m not “talking my own book”.  Earlier this week, former Morgan Stanley strategist Stephen Roach warned CNBC viewers to ignore skeptical concerns about China’s economy.  “Beware of people who say things like this,” he told the anchor, “Oftentimes they’re just talking their own book.”   In other words, they’re talking down the Chinese economy because they have taken short positions that will pay off if it tanks, or merely if market sentiment turns negative enough.  I don’t know about other people, but I can assure you that when I express concern about the Chinese economy, I am NOT talking my own book.  I own (one) property in Beijing, which we bought at a reasonable price.  My wife’s career, with a global investment bank, rides on the health of the China market.  Virtually all of our income is in RMB, and there are barriers to moving it out of the country.  Because of my wife’s job, we are prohibited from taking any short positions in the market, at least actively — in fact, it’s very hard for us to move in or out of any China-related investment freely.  In our lives, careers, savings, and income,  we are exposed long on China — and like most people in China, can’t really do much about it.  But I’m still going to call things as I see them, when I see them heading for a cliff.

In short, I have no reason for talking down China, and plenty of reasons for wanting China  to get things right.  Keep that in mind as you read my “bearish” Tweets, or consider my negative outlook for China’s property market or my skepticism towards China’s renewed stimulus efforts.  I would much prefer to see a very different fact pattern and reach far different conclusions.

Of course, my worries may prove overblown, my facts incomplete, my vision faulty.  In which case, I’ve at least given everyone food for thought.  As Yogi Berra said (which I’ve stolen unapologetically from Fred Thompson’s latest blog post): “Predicting is tough. Especially about the future.”