(Doug Casey Interviewed by Louis James, Editor, International Speculator)
July 21, 2010
L: Doug, one of the most common replies we hear from the bulls who think the global economy is on the mend – or soon will be – is that China has huge cash reserves and a huge middle class with savings who will keep buying cars and houses and that will save the day. I know you don’t buy this line of reasoning – why?
Doug: Well, the problems we have can’t be solved by having people consume more. The problem is basically overconsumption, which has resulted in huge debt. But that’s a different topic.
Still, I have to say that those people are partly right. China will likely be the dynamo that provides most of the world’s capital and technology in this century. China has already totally transformed itself over the last 25 years; when I first went to Beijing in 1986, the road from the airport into town was only two lanes, and there were farmers with oxcarts along the shoulder. Now it’s bumper to bumper traffic on eight lanes. The airport itself wasn’t much bigger than Aspen’s.
That’s typical of what’s happened across the whole country. There’s never been anything like it in the history of the world. The historic ethos of China is to revere wealth; Maoism was just a brief aberration of 30 years, under a particularly bent and stupid emperor.
China’s full of ambitious, hard-working people who save what they earn. The 21st century will be China’s century. That said, as we’ve touched on briefly before, I don’t think China can be counted upon to pull the west’s bacon out of the fire, and I’ll tell you why.
For one thing, the Chinese economy is still heavily export-driven, and the exports are almost all consumer goods. Americans and Europeans are simply not able to spend the way they did pre-2008, and they won’t be for years to come. That’s going to affect tens of thousands of Chinese factories and tens of millions of Chinese workers. They’re geared for patterns of consumption that no longer exist, and are going to have to re-orient themselves. They’ll eventually do it, of course, but there will be lots of unemployment and business bankruptcies along the way. Basically, China’s growth this decade was joined at the hip to the West’s unsustainable debt-driven consumption pattern – it’s the biggest bubble in the global economy that has yet to pop.
In addition, the Chinese government has created trillions of yuan to keep their economy going – including building lots of things that may seem like a good idea to some bureaucratic planner, but for which there’s no actual demand. A developing country can’t afford too many “bridges to nowhere” – not that anybody can. And those trillions of new yuan will result in a wave of inflation at some point. That’s potentially disastrous when almost all saving is done with that paper currency.
It’s not widely reported in the media, but China has many thousands of riots and other civil disturbances every year. Any significant sustained cooling of their economy could cause them serious problems. The cadres in the Communist Party – which everybody knows is just a scam enabling its members to live high off the hog – know they’ve got a tiger by the tail. If they don’t keep the masses busy, now that hundreds of millions of them have moved into the cities, and expectations have been raised tremendously, anything could happen.
L: Are there any hard stats on that?
Doug: You can’t trust the figures from any of these governments, least of all China, but there are more problems. As we discussed in our conversation on real estate, I recently sold my apartment in Hong Kong for about 25 times what I paid for it. I’m convinced there’s a real estate bubble within the larger China economic bubble that could rival, or even surpass, the U.S. real estate bubble.
I read that there are now 65 million vacant apartments in China, owned by investors, not people who plan to live in them. The people who put their money into these things think they have made safe investments, but they could get wiped out. With demand for China’s products likely to decrease and stay low for years, and an oversupply already glutting the upscale Chinese housing market, many of those apartment buildings are likely to become decrepit, ill-maintained, vertical slums. The same is true for the world’s largest shopping center, built by the Chinese, still empty. Many giant office buildings as well. We’ve run a video clip before on China’s empty cities. That middle class you spoke of is going to take a serious downsizing, and in China, that could lead to social upheaval. I did a long article on this some months ago in the Casey Report, and since then prices have come off considerably. It feels good to have picked the top, but we’re a long way from the bottom.
L: I’ve seen this misallocation myself. The last time I was in Beijing, I went to the central business district, and from one street corner, I saw not one, but five or six brand new, empty, padlocked office buildings – and more new buildings being built within sight.
Doug: It’s going to be a disaster – one the Chinese have no experience dealing with. They’ve had plenty of experience with disasters, of course, but this will be a new one. It’s said that China has something like 10 billion square feet of office space currently vacant, under construction, and in final planning. It sounds like every man, woman and child in the whole country is going to have a private office to shuffle papers in all day.
L: My Chinese friends tell me the country needs to maintain 8% GDP growth or better, or they face serious social unrest.
Doug: China is so large and diverse as to be completely unmanageable – not that it should be managed, which is itself a ridiculous conceit. It amounts to a domestic empire; it is no more one nation than the Soviet Union was. There’s a great deal of ethnic and cultural diversity in China, with the two main languages of Mandarin and Cantonese being just the tip of the iceberg. Regions like Manchuria, Inner Mongolia, Xinchiang, and Tibet aren’t integral to the country; their native populations are extremely resentful of the Han. Even within Han China the ethnic and cultural differences are huge. It was a place basically ruled by various warlords until the communists took over. I wouldn’t be surprised to see things devolve back to the way they were in the ‘30s again.
L: I just saw on BBC news that the Chinese authorities in Xinjiang are preparing for possible trouble this month, being the first anniversary of the rioting there a year ago that left 197 dead.
Doug: Whether or not something happens there this month, it’s likely to get worse. That province has 100 million Muslims of Turkic and other ethnicities. The global crisis may or may not push China over the edge soon, but I could see China breaking up into a number of smaller countries and autonomous regions, and Beijing losing control. That wouldn’t, incidentally, be a bad thing, at least after the initial chaos and confusion that would result. China’s tremendous progress of the last few decades is entirely due to less central control, and more freedom. The breakup should accelerate the trend. Trying to run an empire is counter-productive.
L: Okay, but unlike the U.S., the Chinese have more than two trillion dollars in cash reserves. That should help them hold things together for a while, shouldn’t it?
Doug: Having two trillion dollars is not the same as knowing what to do with it, as you can see from the enormous misallocations of capital we’ve discussed above. But more importantly, as you and Terry discussed last week, inflation always wins in the end, and the end for the dollar as we know it may not be that far off. China’s two trillion could easily dry up and blow away, and they know it – they have to be watching other players very closely these days, not wanting to trigger a collapse of the dollar by dumping their dollar reserves, but also not wanting to be the last out the door if someone else starts dumping first. It’s certainly a problem for the U.S.: if the Chinese don’t have it to lend, where is the U.S. government going to get the trillion dollars or so it needs to borrow every year to fund its wars, bailouts, and general foolishness, like Social Security and Medicare?
But the slide of the dollar is not China’s only financial worry; the top three banks in the world are now Chinese, and they’re riding for a fall. With encouragement from Beijing, they’ve been flooding the country with credit: US$615 billion in 2008, about $1.5 trillion in 2009, and early figures for 2010 were running twice the rate of 2009. The M1 money supply was up 35% in 2009. Remember, Japan had the biggest banks before the collapse of its economy in 1990. Same for the U.S., before the collapse of the U.S. economy. I think China’s next.
Those banks have lent a lot of that money – money saved by over a billion Chinese – on speculative and largely uneconomic real estate projects. And to a lot of factories that are going bust. And a lot to huge parastatal companies that employ hordes of people in make-work enterprises. At some point they have to recognize that capital has been dissipated. When those billion Chinese want their savings – which is to say 20-50% of everything they’ve earned over many years – back, many will get nothing, because the bank is bust. Or they’ll get worthless yuan, because the government prints them up to bail out the banks. It’s big trouble either way. I hate to think how a billion unhappy people are going to react.
The fundamental truth here is that China can’t defy gravity forever. There is such a thing as the business cycle, and the next leg for China is down.
L: It’s called the business cycle, but its roots lie in government action.
Doug: How perversely true. Governments “stimulate” economies because politicians want to get re-elected more than they want to do what’s right, and that creates artificial booms that must eventually result in very real busts. China is no exception, and the fact that they had cash to spend stimulating their economy doesn’t change the fact government spending misallocates capital.
L: By definition: if the venture were a good – profitable – idea, the market would invest in it.
Doug: Just so. Don’t get me wrong, though. For just that reason, a lot of the progress China has made is sound and genuine. The life of the average entrepreneur in China is easier than in the U.S. or Europe. He’s got much lower taxes, and much less regulation. He doesn’t have to deal with all kinds of legacy health and social insurance issues. And the average worker is much more motivated and self-reliant. Even though they’re coming from a low base, and even though they’re riding for a big fall, the Chinese are on a long-term path to success. I continue to believe the odds are that America, and especially Europe, will serve mainly as sources of houseboys and maids for the Chinese in a couple of generations.
L: One more thing I’ve noticed while there; the Chinese are terrific at building huge projects in amazingly short periods of time, but they often don’t seem to understand the importance of sustaining capital. They’ll build, for example, a spectacular new hotel, and for a while it’s a great business. But they’ll glue a cracked marble fixture together rather than replace it. They’ll let the towels fray before they replace them, etc. They’ll pinch pennies while losing dollars to the next new hotel where everything is still shiny – and then it’s too late. Revenue drops, and now there is no cash to put into repairs, and a death spiral ensues. It’s not just hotels, of course – if you watch that video on the empty shopping mall linked to above, you can see cracked pavements in the background, even though the place hasn’t really even been used yet.
Doug: Yes, it seems they’ve overdone the idea of “growth”, but overlooked the concepts of depreciation and maintenance. I don’t think it’s such a problem with privately-owned buildings, but those where the state is involved are uniform disasters. It’s a remnant of that socialist mentality, where all the effort goes into creating production numbers – and who cares if the whole thing collapses after you get paid? If the state owns it, nobody really owns it, and nobody really has an interest in keeping it up to snuff. Maintenance doesn’t go into production numbers, or the GDP, so everything gets run down and falls apart quickly.
So, no. China is not going to save us. In fact, it’s very likely the epicenter of the next wave of economic destruction, as the global economy continues liquidating past mistakes. Remember, we’re still in the eye of the hurricane that started late in 2007. And I expect the next episode of the storm is going to be much more severe, and last much longer, and be much more widespread.
L: You’re Mr. Cheerful again today, I see. Is there an upside? Investment implications?
Doug: Hey, I just call ‘em the way I see ‘em. I promise I wouldn’t be so gloomy if governments hadn’t done so many destructive things for so many years, and weren’t compounding their mistakes even as we speak. Believe me, I prefer good times to bad times. And I’m making sure that I’ll be someplace where I can watch all this stuff on my widescreen TV, rather than through my front window, as things get more serious in the months and years to come. Some of our Chinese readers might want to come on down and learn how to play polo. [Chuckles]
But buy gold, for sure. It’s not particularly cheap any more, but it’s the one thing that’s most likely to soar as the dollar collapses. And the yuan collapses. And the yen. And certainly the euro.
L: And for speculative leverage on the way up, of course, the right gold stocks.
Doug: Yes, and you offer plenty of ideas for that in the International Speculator. There’s an excellent chance that, as the world’s governments wind up igniting other speculative bubbles, that not just gold and other resources, but the shares of the companies that own them, will be part of it. I’ve personally owned exploration stocks that have gone over 100 to 1 in past booms.
L: More ideas on what to buy in IS soon – I’ve been right so far in alerting readers to probable lower prices this summer. What else?
Doug: There really isn’t anything that looks especially cheap to me right now, and a good speculator waits for opportunities in which all the signs seem to point in one direction. If he’s right, he’ll get a multiple on his capital. I don’t see anything like that today, so I’m liquidating what I can, going to cash – which I nonetheless consider a potential hot potato – for the very short term. And gold. And I’m waiting for the right opportunity to hopefully hit a home run. It’s like Warren Buffet says about investing: it’s a ball game with no called strikes. You can stand at the plate all day, waiting for the perfect pitch. That’s going to take some real nerve in the chaos that’s coming… I’ve never tried playing baseball in the middle of a hurricane. [Laughs]
Doug: And don’t forget to diversify yourself, physically. Your political risk is an even greater threat to your well-being than your investment risk. You can’t let yourself be a sitting duck. Get some money out of the country you live in, while it’s still legal. Preferably, buy some nice real estate in a place you’d like to live, and with foreseeable resale value when the real economic recovery gets underway. Start building a fallback position.
L: Got it. Thanks for the warning and guidance.
Doug: You’re welcome. Let’s talk about what Clausewitz called “the extension of politics” next time – I think the odds are increasing that we may see war rear its ugly head again soon.
L: Sounds good – no, scratch that. Sounds terrible, but important. ‘Til soon then.
Read about Louis’ recommendations of the best junior mining stocks right now in Casey’s International Speculator. It’s no coincidence that every single one of his 2009 picks was a winner. More details here.
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