Li Shufu, described by some as the Chinese Henry Ford, has just bought Volvo from Ford.
Meanwhile, the Chinese authorities have locked up four Rio Tinto executives for taking bribes and obtaining commercial secrets, with little apparent resistance from the West.
As Robert Peston puts it on his BBC blog, these two events reinforce the “most significant shift in power from West to East since the demise of the Soviet Union.” Or at least, that’s the way they’ve been perceived.
There’s no doubt that China is hugely important to the global economy. But the ‘unstoppable rise’ narrative seems a little over-egged.
China has plenty of its own problems. Edward Chancellor at US wealth manager GMO recently put out a list of ten red flags flying over the country – let’s take a look at a few…
The ten red flags flying over China
“China today,” says Edward Chancellor, “exhibits many of the characteristics of great speculative manias.” Chancellor believes that you can identify bubbles before they pop. This shouldn’t be a controversial stance, given the number of bubbles we’ve seen in the past century. Yet the likes of Federal Reserve chief Ben Bernanke would still say that cleaning up afterwards is better than attempting to identify them beforehand.
This seems daft, given the damage that bubbles can do to investors’ capital. We’d rather be forewarned. So what red flags does Chancellor reckon are flying over China?
There are all the ones you’ll be familiar with from the likes of the tech and Western property bubbles. As Chancellor points out, China has the first component needed for making a bubble – a great story. The idea that there are more than a billion people, all desperate to buy stuff, is a very compelling and easy-to-grasp investment idea. On top of that, you’ve got rampant credit growth – never a good sign – and soaring property prices.
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Chancellor also points to investors’ faith that the Chinese government can somehow control the path of the economy through the clever use of various credit tools. This “blind faith in the competence of the authorities is another typical feature of a classic mania. In the 1920s, investors believed that the recently established Federal Reserve had brought an end to ‘boom and bust’.”
Blind faith in Beijing means more moral hazard
And this blind faith leads in turn to our old friend, moral hazard. Chinese banks have a “history of poor lending decisions”. Indeed, many had to be recapitalised at the turn of the century. Yet many people believe that China’s banks can’t and won’t be allowed to fail. After all, most are controlled by the state. “They are a key instrument of Beijing’s economic policy”. With the government backstopping them, there’s no reason not to invest in them.
Yet investors don’t have to look too far back to be reminded that this is just nonsense. “In the 1980s,” says Chancellor, “large Japanese banks were also seen as fulfilling the policy objectives of the Ministry of Finance and as being protected from future losses.” Japanese banks were the world’s biggest by market cap at the time. Then of course, came the bust. And over the course of the lost decade, Japan’s banks made losses “equivalent to twice their initial capital.”
None of this means that things will go pear-shaped in China overnight. But the current shape of the Chinese economy depends very much on it growing by at least 8% a year, reckons Chancellor. If it grows much more slowly than that, then among other things, “the real estate bubble would burst and the banking system would face a rash of non-performing loans.”
Why you shouldn’t avoid Asia altogether
But just because China looks like it might be bubbly, that doesn’t mean you should avoid Asia altogether.
In the current issue of MoneyWeek magazine, my colleague Merryn Somerset Webb interviews Angus Tulloch of First State Investments. Tulloch is a well-respected fund manager in the Asia Pacific area, with an enviable track record.
He’s cautious on China too. His big concern is the stimulus package, and whether China can wean itself off the money without difficulties. As he points out, the historical experience of most countries suggests that they can’t. “I have an old-fashioned belief that if you print money, at some stage people suddenly ask what it’s really worth… Then inflation suddenly picks up.” And as he points out, in China “there is a strong link between rising inflation and social unrest.”
At the same time, he believes that if you’re selective, then Asian stocks are the best investment bet for the long run. But how do you do this? Helpfully enough, my colleague Cris Sholto Heaton talks about the best sectors in Asia to buy now in the next edition of MoneyWeek, out on Friday. And if you haven’t signed up for his free weekly email, MoneyWeek Asia, then you can do so here.
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