There’s No Engine For Global Growth (China Edition)

I’ve been skeptical about China for some time. While I do believe China has made some serious economic progress as a country, I remain thoroughly convinced that ultimately its economic “miracle” will be much like that of the Soviet Union powerhouse in the late 20s: apparently awesome in scope at the time, but a total fraud after the fact.

For one thing, China remains a control economy. There is no history that I know of in which a controlled economy works. The primary drivers of macro-economic growth are innovation, technological adaptation, and increased efficiency.

In order to have this, you need to have rule of law, strong education, openness to trade, and quality institutions to establish credibility and uphold the rule of law.

China is big on trade and education, but sorely lacking on quality institutions and rule of law. Just a few of the more glaring items include:

1)   China’s obviously fraudulent economic data.

2)   Rampant corruption of Chinese Government officials (no rule of law).

3)   A lack of individual rights for Chinese citizens (again no rule of law)

4)   A total lack of credible institutions to maintain accounting standards, quality control, protection of Intellectual Property, and the like.

One could easily argue that the US suffers from some of these issues (indeed, every country in the world does). However, the US remains, for the most part, a dynamic and open economy with semi-credible institutions and which generally upholds the rule of law (I remain convinced that those who committed fraud and broke the law leading up to the Financial Crisis and since then will eventually be brought to justice).

China on the other hand experiences corruption on a scale that is truly staggering to understand. More importantly, the corruption is deeply intertwined with the economic growth story itself.

Consider the following story I recently came across.

The Chinese Government wanted to build a bridge in one of its many rural provinces. However, the retired government officials (who happened to reside in the best real estate over looking the area in question) complained that doing this would block their view. So the Government… built a far more expensive tunnel instead. It boosted GDP, kept the officials happy, but made absolutely no sense what-so-ever.

A few other items of note:

1)   In 2010 alone, 146,000 cases of corruption were launched in China (that’s 400 PER DAY).

2)   How much these officials stole is unknown. But… of the 14 cases that were actually reported in the Chinese media, the average amount stolen was 18 MILLION RMB (for perspective, the average college graduate in China earns 2,500 RMB per year).

Now, no one knows how much money the 146,000 officials stole in 2010, but one report that was verified stated that just 29 officials were caught stealing 647.18 million RMB that year. Between that figure and the average theft of 18 million RMB the media reports, it’s safe to assume that the 146,000 officials engaged in corruption probably stole a staggering amount of loot.

How staggering? Well let’s look to history:

Between 1991-2011, it’s estimated that between 16,000-18,000 Chinese officials fled China taking 800 BILLION RMB (roughly $125 BILLION) with them. Bear in mind China’s entire GDP was just 2.1 trillion RMB in 1991.

With this kind of insane corruption combined with a desire to maintain ridiculous GDP numbers at all costs, quality goes right out the window.  Case in point, it’s estimated that on average bribes comprise 5-10% of a given project’s costs in China today.

Let me say that again… if you are proposing a construction project in China, on average you’ll need to allocate 5-10% of your costs towards bribing officials.

Small wonder then that many of the “projects” behind China’s growth “miracle” are falling to pieces… literally.

Collapse of New Bridge Underscores Worries About China Infrastructure

One of the longest bridges in northern China collapsed on Friday, just nine months after it opened, setting off a storm of criticism from Chinese Internet users and underscoring questions about the quality of construction in the country’s rapid expansion of its infrastructure.

A nearly 330-foot-long section of a ramp of the eight-lane Yangmingtan Bridge in the city of Harbin dropped 100 feet to the ground. Four trucks plummeted with it, resulting in three deaths and five injuries.

The 9.6-mile bridge is one of three built over the Songhua River in that area in the past four years. China’s economic stimulus program in 2009 and 2010 helped the country avoid most of the effects of the global economic downturn, but involved incurring heavy debt to pay for the rapid construction of new bridges, highways and high-speed rail lines all over the country.

Questions about the materials used during the construction and whether the projects were properly engineered have been the subject of national debate ever since a high-speed train plowed into the back of a stopped train on the same track on July 23 last year in the eastern city of Wenzhou. The crash killed 40 people and injured 191; a subsequent investigation blamed in particular flaws in the design of the signaling equipment.

http://www.nytimes.com/2012/08/25/world/asia/collapse-of-new-bridge-underscores-chinas-infrastructure-concerns.html

True, the US suffered a bridge collapse a few years back, but in China these kinds of disasters are far more commonplace than you would imagine.

Spate of bridge collapses trouble Chinese netizens

After three large bridges collapse in a single month, Chinese internet users say “I told you so”.

A complete section of the Wuyi mountain bridge in Fujian Province collapsed on July 15, killing a bus driver and injuring 22 bus passengers. The following day, gaps appeared in the middle section of the third Qianjiang River Bridge in Hangzhou, injuring a truck driver…

All three bridges were built in the mid-to-late 1990s. The Qianjiang bridge in Hangzhou was refurbished in 2005, but minutes from a meeting of the local transportation bureau showed that an incorrect ratio of sand to concrete was used in the maintenance, according to the China Daily newspaper.

Internet users predicted the collapse of the Qianjiang bridge several years ago. As early as 2007, posts on popular internet forum Tianya pointed out that the ratio of sand to concrete used to build the bridge was incorrect, according to the Beijing News. Other posts to the forum pointed out that the bridge was built by the same company responsible for a collapsed bridge in Hunan province, and advised drivers to avoid crossing the bridge.

Low quality infrastructure may be caused by corruption amongst officials responsible for overseeing construction projects. The China Daily reports that Zhao Zhanqi, an official responsible for the Qianjiang bridge project, was sentence to life in jail in 2007 for taking over 6 million yuan in bribes during the bidding for the bridge project and during its construction.

The world’s longest ocean bridge, spanning 23 miles, opened in Qingdao, Shandong province last month. Chinese internet users soon complained about the rushed construction of the bridge, after pictures of easily loosened bolts and incomplete safety rails along the bridge were posted online. Last year a bridge in Henan province collapsed, killing 37 people.

The frequency of bridge collapses in China leads to an attitude of cynicism among some sections of the public. “If the bridges didn’t collapse, how else could we rebuild them and boost our GDP?”, wrote one commentator on Chinese news website Caixin.

http://asiancorrespondent.com/60253/shoddy-bridges-trouble-chinese-netizens/

For those of you who glossed over that article, the key point is this: three major bridges collapsed in a single month in China. The reason? Shoddy construction courtesy of bribed officials.

My point with all of this is that the China growth story has been dramatically overhyped in the Western media. So with that in mind, we have to consider what impact this realization would have on the capital markets.

Put another way, imagine if the world found out that China’s growth and recovery post 2008 were largely based on fraudulent data and garbage development projects fueled by easy money and rampant corruption on the part of Chinese officials?

Imagine a world in which the China “miracle” turns out to be the China “lie”? The bulls and those desperate to claim that the world is in great shape would lose one of, if not the key pillars of their a growth rgument.

Indeed, by some measures China is considered the engine for the post-2008 recovery. So if this engine turns out to be not only sputtering, but broken…

         China’s steel mills braced for slowdown

Chinese steel traders are short on good news these days. Prices for steel are falling, demand is poor, loans are hard to come by, and no relief is in sight.

“There is just no demand,” says one trader in the town of Tangshan. “It’s much worse than [the last downturn] in 2008. In 2008 at least you had buyers talking to you. Not any more.”

The collapse of China’s steel market has reverberated around the world: benchmark prices for iron ore, a key steelmaking ingredient, have dropped to three-year lows of $89 a tonne, down 24 per cent in the past month alone. China accounts for about 60 per cent of global imports of iron ore, a market worth more than $100bn annually worldwide and one that is essential for the profits of global mining houses such as BHP Billiton, Rio Tinto and Vale of Brazil.

http://www.ft.com/cms/s/0/0db84534-f691-11e1-9dff-00144feabdc0.html#ixzz25cn4xBrh

So… unlike in 2008, steel traders in China find people are not even talking to them.

We see similar signs of a collapse in China in the form of iron ore prices, retail sales, oil demand, and on and on.

My point with all of this is that China is no longer going to be an engine for economic growth. The reason stocks are not showing this (at least in the US, in China the market is on the verge of breaking a MAJOR trendline), is because of the Fed’s money printing.

Indeed, this is something we all need to be extremely worried about… because stagflation becomes worse not better with money printing… and both the Fed and the ECB have gone “all in” to prop the markets up.

This is just one example of the slew of Unintended Consequences we’re going to be facing as a result of the Fed’s actions. I’ve detailed several more (all of them far worse than this) in my latest issue of Private Wealth Advisory, published just last week.

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Case in point, two of them are up 8% and 10% this week alone. And I expect all of them to be much higher in the coming months.

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Phoenix Capital Research