CHINA IS NOT DIFFERENT

since the end of november, the chinese stock market has risen 15%, while the dow jones has fallen 15%.

this has prompted many investors, foreign and chinese, to start believing that china will be less affected by the crisis than other countries, and might even save the world. a bit like a jackie chan flying through the air, defying gravity.

we would be better off reminding ourselves that except in chinese movies, people walk and stumble to the ground in china pretty much the same way as they do everywhere else.

in addition, year-on-year, the dow has lost 40% while the shanghai index has lost 48%.

andy xie, former chief economist at morgan stanley asia, in yesterday's south china morning post editorial, lays out the reasons why we should not be fooled by the apparent strength of the chinese economy. a lot of it has to do with the basic health of the chinese real estate market, which i have written about earlier on this blog.

andy's article is subscriber content, so for those who do not subscribe to the south china morning post, here are a few excerpts:

"Liquidity has been inspiring hope lately. The mainland's banking system is flooded with liquidity, and lending has increased massively since December, mostly in the form of discounted bills. The liquidity boom has inspired hope that a quick and vigorous recovery will follow. Instead, it could be a trap, leading to stagflation. China's problem is not liquidity, but household demand. Reform, not liquidity, can bring back prosperity. (...)

The lending, however, won't turn into demand any time soon. Most industries, especially capital-intensive ones, face overcapacity. The steel industry, for example, may have 30 per cent overcapacity. The shipbuilding industry is seeing massive defaults in orders; many shipbuilders are facing bankruptcy. Most developers cannot sell their properties and, if given money to build more, would only dig a deeper hole for themselves. The mainland's supply side has too much capacity. It is unlikely that more business loans would spark an economic recovery. (...)

A big drop in exports, following the bursting of the global credit bubble, and the popping of the property bubble are the sources of the shortfall in demand. (...)

To clear the property inventory (now equivalent to one-third of existing housing stock) the cost per square metre should be cut. In some cities, the average price per square metre is three times the average monthly salary - or higher. This should be halved. That is not low by international standards. (...)

Some people hope greater liquidity will improve the economy by inflating asset markets - that is, by creating another bubble. This is what then-US Federal Reserve chairman Alan Greenspan did after the tech bubble burst in 2000. Of course, his glory has become today's nightmare. But creating another bubble to deal with the consequences of a burst bubble would be irresponsible - even if it could be done, which I doubt. Some of the liquidity did flow into the mainland stock market in December and January. At its recent peak, the market had risen 40 per cent in three months. But, it is extremely hard to manufacture a stock market bubble in a difficult economy because speculators are quicker to take profits than when the economy is booming.

Further, it is virtually impossible to inflate the mainland property market by encouraging speculation (by making it easier for people to obtain funding and keeping interest rates low). The current inventory is unprecedented; it is probably the biggest overhang per capita of physical properties completed or under construction in history. It will take three years to clear even with the best policymaking. Re-inflating the bubble with liquidity is just a pipedream."

愚者闇于成事，知者见于未萌

"the fool does not recognize something when it has happened, the wise man sees it before it has even started". a quote by 商鞅 (shang yang), a 4th century bc chinese philosopher and statesman, from the 商君书 (book of lord shang).

i will leave it to you to decide which title should be reserved for steve forbes, publisher of forbes magazine, who on october 29, with the dow jones at 9000, claimed that "the worst is over".

i started this blog on october 12 last year, when the dow jones hit 8500, by predicting it would go to 4000. i would like to repeat that prediction today.

recent signs that this is where we are heading are straight-forward:

- company balance sheets still have tons of assets sitting around at pre-crisis valuations. none of these companies could liquidate those assets at these prices today, consequently, managers are pretending to shareholders that their companies are worth more than they are in reality. general electric cfo keith sherin appeared on tv last week defending this approach, saying that as long as the company has no intention of selling those assets, the company and not the market should decide their value. unbelievable, really. we can expect ge to be in serious trouble as investors will start dumping the stock over the next days and weeks, possibly triggering a liquidity crisis. should the most respected american corporation stumble, that will cause a major loss of confidence in the market.

it all comes back to us forgetting the concept of value. in 1993, chinese cartoonist 华君武 (hua junwu) illustrated this very well. are those paintings of peaches really worth thousands of dollars? people without a background in economics might be excused, but the cfo of ge?

- the fall in share prices and home values in the u.s. has so far destroyed usd 12 trillion （12兆美元）of household wealth, or 75% of gdp, as pointed out by harvard economics professor martin feldstein. more than a decade of high american saving rates will be needed to restore what was lost. you cannot recreate consumer spending, not even close to what consumers were spending before, when you've had a destruction of wealth of this magnitude. job insecurity can be expected to do its share - the stimulus packages should have limited effect on consumer spending - people will put the money in the bank.

- the portion of the stimulus packages not saved by consumers will be spent on infrastructure projects by governments. while this will definitely create jobs fairly quickly as roads, bridges, broadband internet connections and other projects will start building, there will also be a tremendous amount of wasted money, as shown by the experience of japan in the 1990's. that means after the projects are built, very limited sustained economic activity will result.

the only way therefore is down.

温故而知新，可以为师矣

the title of this post is a quote from confucius' analects, "he who through knowledge of the old, understands the new, can be a teacher." a simple but powerful idea, which lies at the heart of one of the central points of this blog: long term averages always catch up with the market.

niall ferguson, a scottish professor who teaches history at harvard university, is a strong proponent of this concept. he has recently received much attention because in his book "the ascent of money", published just as the financial crisis was starting to unfold, he predicts the crisis and describes its causes.

he is also a talented speaker, and 2 months ago, when wall street froze up with fear, he delivered a brilliant speech at the carnegie council, in a room full of very old people eating muffins.

highlights:

* so many smart people were surprised by the crisis, because they only referred to their own life's experience. the problem is that this experience is never long enough to include the 1930's, and is therefore misleading. understanding financial history over a much longer period provides a far better perspective.

* increasing home ownership in america had a political aim; home owners tend to be more conservative and therefore vote conservative, compared to people who rent

* the much-talked-about decline of american power as a result of the crisis must be seen relative to how other powers are faring, and so far, they are not faring well. this, paradoxically, is good news for the u.s.

* the post-credit crisis era will depend to a large extent on the relation between china and america. for now, china has little choice but to keep buying american treasury bonds.

this is a rare opportunity to see a visionary from the world's number one academic institution speak, on a topic that is not only relevant now, but will remain relevant as long as money and markets exist. skip the very boring introduction by the host and drag the cursor directly to 4min 15sec in the video.



the book has also been made into a tv series by britain's channel 4, and although it has been removed from youtube, below is the first program, where professor ferguson explains the origin of modern banking in the west, and its role in society.

COLD, HARD REALITY

excellent editorial by thomas friedman, author of "the world is flat", in saturday's new york times.

in his post, he claims the reason why banks keep asking for more money, is that their balance sheets are in much worse shape than they dare to tell us.

his point boils down to the same old thing which i have been writing on this blog for the last 3 months, and before that in letters to colleagues: asset prices are still way above their real value, and the only way out of the crisis is to face the cold, hard reality that companies are worth probably only half of what they are trading for today.

as of december, the standard & poors p/e （市盈率） has travelled back to its long term average, so you hear people saying that therefore the worst is over now. a look at the graph tells you that cannot possibly be true, because after you have soared way above a long term average for the last 20 years, you need to dive way below it, and stay there for a while, usually in the range of 5 to 10. add to this that corporate profits are in free fall, and a 50% discount on today's prices might even be considered not that bad.


the evidence is all around us, although, as friedman puts it, the american government and the banks are too scared to admit it. one of the reasons why bank of america needed yet more bail-out money, is obviously because last september they were forced to buy merrill lynch at usd 50bn, a whopping 70% premium over what the company was worth according to the stock market the day before. that price had nothing to do with the real value of merrill lynch, and everything with the hope that a high transaction price would calm the market.

friedman's suggestion is for obama to call all ceo's of the banks together in his office, and tell them that their balance sheets have been reviewed, given a fair value, and following that they will be either nationalized, merged, or shut down.

that would be an unprecedented move in the history of capital markets, forcing the values of financial companies dramatically down, with lasting consequences. these are unprecedented times though, and the road we are on now doesn't seem to be leading us out of the woods.

TRANSPARENCY

sooner or later, the former real estate editor of the shenzhen special zone daily (深圳特区报）will probably pay the price for creating transparency where transparency is not welcome. but for now at least, 牛刀's blog shines a bright light on the chinese real estate market with a strong grip of economic fundamentals and the courage to speak out on some serious issues.

a few posts that are well worth reading are on the economics of supply and demand, and on the cost of bribes paid to government officials by developers, which he estimates make up 30% of the country's house prices. for those of you wondering when to buy, he also offers some insights on the timing of the turn around.

he comes to some obvious conclusions - that you cannot have a properly functioning market without proper supervision ("监管的不断流于形式"), and that for the market to become healthy again, real estate prices first need to return to their real value ("房价不降到位，市场的预期就无法更改"), which they still haven't today. almost correct, as the traditional recovery process actually includes a period of prices going below their real value.

the irony is that all you need to do to avoid getting caught in the trap yourself, in china, or anywhere in the world, is simply compare the basics.

i was in bao'an last weekend visiting some apartments which a friend had recently bought. even today, the prices there are close to those in the center of my home town of antwerp, belgium, which is the second largest port of europe and controls 80% of the world's diamond trade, while 30% of the population have a university degree, and the average income is about 10 times higher than bao'an.

you do not need a university degree to understand there is probably something wrong here - either antwerp is way too cheap, or bao'an is way too expensive.