A Contrarian’s View of China

by Inya Ivkovic, MA

It appears that China is losing its appeal among many contrarian money managers. To contrarians, the country’s economy looks susceptible to adverse macroeconomic factors more than it knows or is willing to accept. And, there is another emerging economy threatening to take the bigger piece of the pie, perceived only as a sleeping beauty until recently. It seems India might be the new China.

According to some emerging markets’ observers, India’s economic output could grow an amazing six percent in the next two years and, going forward, an even better eight percent. How is that possible, considering the havoc the global recession has wreaked? Simply, India’s economy is much less dependent on exports and thus its growth is much more sustainable, because it comes from within.

What is China’s problem? Well, it’s not as if China is the only one to blame. First, there is the proverbial drowning-in-debt American consumer, who still hasn’t come to terms with his $12.0-trillion rude awakening of last year. And, until the American consumer fully comprehends the extent and consequences of last year’s economic and financial meltdown and until this debt load of historic proportions is dealt with, there can be no true recovery.

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American consumers are also at the crux of most strategic problems for China, which, tightly burrowed in its communist cocoon, somehow missed the fact that its economy cannot recover without them. It seems that China just doesn’t get it that its growth models won’t work until it fully understands that, in the post-global recession world, the out-of-control world consumption will cease to exist, and that it cannot depend upon credit-crazed Americans, always ready to borrow more to buy more stuff no one really needs, still being there either. The “buy-buy-and-then-buy-some-more mentality” will become something for the history books. Yet, China seems oddly unfazed by all of it.

Another conundrum plaguing China is its absurd relationship with the U.S. dollar. On the one hand, for all of lack of confidence in U.S. Treasuries, China has accumulated about $700 billion worth of them. China’s foreign trade gains with the U.S. had to be recycled somehow, so the country put them back into U.S. bonds. But, as soon as the trade with the U.S. declined, after the American consumer tightened his purse, the value of the dollar dropped, the value of the yuan rose, and Chinese exports hit a six-foot brick wall. So, unless China finds a way to sell some of its economic output domestically, eventually it may have to deal with social unrest that will not go away simply because the Communist Party says so, not even if threatened by the exercise of China’s military power.

And I really wouldn’t care all that much about China’s economic
prospects if it weren’t holding a gun to all of our heads? Let’s say, in an alternate reality, the U.S. Congress decides to take President Obama’s “Buy American” mantra to a new level and it passes some kind of a tough trade restriction specifically with China. Knowing China’s previous gut reactions, such legislation would likely be taken as a slap on the face. Not known for taking attacks on its honor lightly, China is more than likely to retaliate. Only, I don’t think it would be an introduction of “Buy Chinese” legislation.

China has a much more dangerous weapon on its books, those $700-billion in U.S. Treasuries. What if China were ever to decide to sell off all of its $700 billion in U.S. bonds, regardless of any losses it may incur? If that were to happen, China could trigger a catastrophic economic event of global proportions, similar to the introduction of the ill-fated “Smoot-Hawley Tariff Act” that ushered the 1930s Great Depression, but on a much grander scale.