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Naysaying the Chinese economy

January 11, 2010

I like to follow what’s happening in China’s economy so you’ll see a lot of posts from me on this subject. This is partly because I think it’s fascinating to watch the rise of a superpower– one that is very different in nature from both the US and USSR.

I’m also interested for selfish reasons: I’ve invested a little bit of money in China. This definitely makes discussions on trade deficits and China’s GDP numbers much more exciting =) In summary, I’m long on China– but my views on investing are very long-term– 25-35 years.

Here’s a tidbit from one of the few big investors who thinks that China is headed towards a crash.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point. Full story.

From a distance, it seems like Chanos’ logic has merit. There are several issues though. The first is that Chinese markets are not transparent enough– it’s not clear whether or not the official figures from the government and firms are reliable.

A comment: China Inc. will keep going up as long as there are many more people who think it will keep going up (as compared to those who think it will go down). (Obviously, hedge fund directors and institutional traders matter more here than personal investors; you only need a few big moves to set off a run.)  If this sounds simplistic, I’m only trying to say that investors act in herds– compounded by the lack of reliable data on the fundamentals of Chinese firms and the economy. This is at least partly because there is so much information out there–  warning signs are always there in hindsight– but for most of us, these signs are just part of the noise. And I would bet that most traders and brokers are no better at parsing out the valuable information from the noise than the rest of us. In fact, we already know that index funds perform better (net) than hedge funds and actively managed mutual funds.

A second issue is that even though you see a crash coming– there might still be a nice ride to the peak– getting off the roller coaster too early means losing out on some sizable gains. Hedge funds and institutional investors generally can’t afford to get left behind their peers so even if they think there’s a crash coming with some certainty in the next 24 months, I suspect that they will try and jump off as close to the top as possible.

Still, I appreciate Chanos’ investment strategy. Hmmm…. must think about what to do with my own little stake in China Inc.

**Follow-up: I managed to scoop Thomas Friedman on this story! Here are his thoughts on the matter.

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