We’re All China Now

Despite the overnight celebrations (US markets up more than 1%), we’re starting to see the first major cracks emerge in China’s property market. But China is exporting more than just misery (or coming misery) to our iron ore miners.

The streets of Melbourne yesterday also had the look of China about them. Heavily-armed police fired rubber bullets into a peaceful crowd to disperse them from the Shrine of Remembrance.

This was after protesters tried to negotiate a peaceful exit back towards the city via the same route the police corralled them hours before.

I watched the live feed of events yesterday afternoon. The mainstream media description of the protestors as thugs, far-right activists, and NAZI’s is laughable. While heavily dominated by out-of-work tradies, there were people from all walks of life present.

While the media continues to rewrite press releases from the government, and the elites in their well-paid jobs continue to tut-tut and condemn the protests, this thing is only going to grow.

Victoria has a public holiday tomorrow for a football match being played on the other side of the country. Will the number of protesters swell? It’s certainly going to be interesting.

The tradies have undoubtedly received a solid education in politics this past week. Their union leaders have abandoned them, siding with the politicians instead. Power corrupts.

Welcome to the real world boys and girls! We are in the degenerate stage of capitalism, where easy money has eroded principles as well as purchasing power.

And while people are being denied the right to work if they don’t take Scott Morrison’s non-mandatory jab and being fired on for protesting about it, our fearless leader is in New York at a UN gabfest, talking to HIS bosses.

Although, he did find time to condemn the protestors, repeating the PR release of them being disrespectful and boorish at the Shrine of Remembrance — no mention of the fact the protesters were driven there after being fired on in the city.

Meanwhile, over in mainland China, the communists managed to avoid a ‘default’ on the bonds of property developer Evergrande’s debt. For now, anyway. To be honest, no one really knows what’s going on.

It’s believed that Evergrande will pay the interest due today (or at least a portion of it) to onshore bondholders. That is, domestic, Chinese bondholders. But the situation for offshore holders, those outside the mainland holding USD-denominated bonds, is much less certain.

For now, though, the market doesn’t care. The narrative is that the big, bad default that everyone thought likely to occur today has been avoided. Buy, buy, buy!

But it could easily turn to ‘Sell, sell sell!’ while you read this, as the fate of the offshore bondholders will soon be revealed.

In reality, it doesn’t really matter. The bigger picture is clear. China is trying to wean its economy off the addiction to property without blowing it up and leading to a revolution.

With most household wealth tied up in property, Xi Jinping cannot allow nominal prices to fall too much. It will bankrupt both the middle class and the banking system.

He will have to engineer a real price fall over many years.

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I don’t think that’s possible without at least some problems along the way.

The reliance on property in China is extraordinary. Local governments fund themselves via land sales to the property developers. The developers borrow huge sums for the land to build towering apartment blocks on them.

They then rely on home buyers and speculators (mostly speculators) to borrow to buy these overpriced, often unfinished, and often unlived-in apartments.

Try turning this tap off and expecting nothing to go wrong!

So how do you engineer a real price decline while keeping nominal prices stable?

You do it via inflation. But it’s much easier said than done.

One thing I think you’ll see is weakness in the Chinese currency, the yuan, in the years ahead. As you can see in the chart below, the yuan (black line) and the iron ore price (blue line) have tracked each other pretty well over the past few years:


Yuan and Iron Ore Price Outlook

Source: Optuma

[Click to open in a new window]

That’s because they reflect strength/activity in the economy. But the yuan has completely ignored the recent collapse in the iron ore price. That suggests to me that the People’s Bank of China is working hard to keep the currency stable.

It may also reflect their increasing control of the financial centre of Hong Kong. In years gone by, Hong Kong banks were a conduit for capital to escape the mainland.

But in the past year, with China imposing their control over the island, this conduit may no longer work as well as it once did.

Still, in order to deflate the property bubble in the years ahead without destabilising nominal price falls, China will likely need to print more yuan…lots of it.

A falling yuan is generally not a healthy environment for the global economy.

If the iron ore price is a leading indicator of what is to come for the yuan, then the cycle may be starting to turn down again…

Regards,

Greg Canavan Signature

Greg Canavan,
Editor, The Rum Rebellion

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Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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