Excerpted from the January 17th edition of Notes From the Rabbit Hole, NFTRH68
As a US manufacturing person, I have been aware of and had to deal with globalization from day one. First it was Japan, with its revolutionary efficiency, automation and constantly improving quality. There was no use fighting it or complaining about it. The only options were innovate, automate or die. We chose options 1 & 2. This dynamic, with its inherent quality and productivity, is to the benefit of the entire developed planet. Continuous improvement, it's more than just a corporate buzz phrase.
In recent years, it seems that China is the new Japan... on steroids. What's more, Wall Street - through famous commodity gurus like Jim Rogers - has got the bit in its mouth and commentators far and wide continually weigh in on the global manufacturing behemoth.
So what do we have here, new global manufacturing superpower, destined through continuous improvement and shear capacity to become THE one stop shop for the world's manufacturing needs (one happy side of the Wall Street spin) or a gigantic bubble built of limited regulation, massive pollution, exploitation of human 'capital' and a noxious Ponzi scheme involving a late-stage consumerist society's increasingly worth less treasury bonds? This is of course, the dark side of the spin.
I would have to say that the answer involves all of the above. There are many obvious negatives currently in play for a 'China Story' that is promoted 24/7 by financial types who are selling abstractions as opposed to boots on the ground knowledge. There are also many positives that time should nurture to the forefront.
On the surface, we have the likes of 'China's Round-the-Clock Auto Factories Still Cannot Meet Demand' http://tinyurl.com/nftrh68a, as credit has continued to expand, despite pretense toward fiscal austerity http://tinyurl.com/nftrh68d. Beneath the surface, we have noted short-seller Jim Chanos looking into the books http://tinyurl.com/nftrh68b of China, Inc. In addition, here is an interview in which he not only looks at China, but also the commodity complex so vital and intertwined with its growth http://tinyurl.com/nftrh68c.
I decided to highlight China this week in light of the Chanos story and since it is a short position held by NFTRH, with short fund FXP still performing fairly well as its mirror image, the FXI China 25 ETF continues to look toppy. FXI has pulled a full 50% retrace of the crash from the highs, weekly MACD has remained trigger-down and the setup remains in place for an important high to be registered.
As a side note before continuing, I would remind readers that FXI (along the Hong Kong Hang Seng and Nasdaq 100, among others) was one of the leaders to the upside of Hope '09 as it made its 'higher low' in March, and as long as it persists with the current topping posture, it must be taken as a negative divergence leading the broad rally.
Two Esteemed Observers, Differing Opinions
Last week I received emails from two subscribers, one a former executive of a major auditing firm and the other, a Vice President at a well-known investment firm. Both emails centered on the 'Chanos bearish on China' story. The former knows how to 'look into the books' of enterprise and is bearish and in agreement with the NFTRH view that China may be leading the US and other global markets into a topping process. The latter is quoted as follows:
"Beware of advice/opinion you receive on China from any [non-Asian] that has not lived in that country for years. China is littered with the dead bodies of Western business execs who thought they understood how that place works.
I highly recommend you read the book "Mr. China" before you bet any significant capital against that country: http://tinyurl.com/nftrh68e. My brother has made MILLIONS undoing the destruction Western business execs have caused their firms in China."
I have seen plenty of it, as American companies fall all over themselves - even creating new executive positions like 'VP of Global Sourcing' to gain access to the Chinese miracle (and pennies on the dollar savings). Do you want to know what has been destroyed? Quality ethic. I cannot tell you how many times I have seen customers try to come back to companies like my own, hat in hand simply wishing to get the stuff made right.
NFTRH is about perspective, if nothing else. So this is not a 'slam China' piece. I have no doubt that China is setting up as one of the behemoths of the 21st century. But there are growing pains - huge ones, centering on quality, lack of regulation, human rights and its love/hate relationship (of convenience) with the US.
Meanwhile, sometimes there are happy endings for those who have been burned by the China outsource trade. In 2009 I experienced yet another one.
We have made a high quality medical oxygen component for the last eight years, never raising the price and employing 'lights out' automated production. Our customer's outsource czar found a Chinese company that would do it for .60 on the dollar, but their quality was lacking. So the customer jumped at our offer to compromise to .86 on the dollar. But the game was not over yet; the customer redesigned the component (we were not given the opportunity to quote the re-design) to make it easier to produce and was rewarded with a .40 on the dollar price! Got to love capitalism, and cheap medical components.
No tears for me dear reader, we have more than replaced this business with medical companies that understand quality is number one. But for all those who need medical oxygen, if you use the fine 'American' brand XXXXXXXXX, breathe easy. After all, they wouldn't compromise quality in the interest of saving a buck, would they? Would they?
I will distill the two subscriber's opinions into my personal view that China is leading the global rally in hope and denial into termination. But as NFTRH has noted from early on, China - along other developing situations - is an area I would look to invest in at the appropriate time, for the longer term. But first there is the sorting out of its intimate relationship with the consumer of last resort, the USA, to deal with.
The United States is in the impossible predicament of trying to convince the world that its debased treasury still deserves the world's confidence, even as it attempts to live on the creation of more debt and printing of Federal Reserve Notes, with no commensurate productivity to back up said confidence.
China on the other hand, is in a dangerous situation for the near term due to its reliance on what is in essence a gigantic macro vendor-financing scheme. Its foreign exchange reserves grew another 23% in 2009 http://tinyurl.com/nftrh68f. Is it any wonder that countries like China and India are buying gold in an increasingly systematic manner?
Hording of vital resources remains a key component of the future for China, even if it means 'over' paying by using increasingly worthless US dollars to do so. One wonders to what degree this plays into the current bubble in copper and inflated pricing in other commodities. Back in 2004, I wrote an article addressing the situation, and today I would say that the only thing that has changed is the level of urgency. Now I Get It!:
"In phase one, Americans have happily gone along with Roach's "new paradigm", where China more and more controls the means of production, and the US controls the means of production of a different kind; that of the world's reserve currency. In essence the game goes like this: "You keep making cheap stuff (wink wink) and we'll keep printing this paper (wink wink) and pay you huge amounts of it. Sure, there will be 'economic girlie men' out there saying this can't be done, but LOOK at us, we're DOING it!". I don't doubt there are legions of people taking the attitude of "if it ain't broke, don't fix it", but that's just the point, it is broke. The fallout is just not obvious to all yet."
"But something tells me a strong hint of what's to come was just flashed for all to see with the above acquisition announcements. China's planners are not so dumb after all. They'll use an advantageous labor arbitrage and currency peg to gain global industrial production market share, ship en mass to the largest consumer engine in the world, receive payment in the heretofore most trusted world currency, and for the master stroke, turn around and recycle those dollars into the very commodities, goods and resources that will be necessary for their continued growth and climb to world power."
The essential theme is that the United States feasted off of the 20th century, and for good reason; it was a country in ascension with a relative freedom of industry and private endeavor, which became the hub of global commerce and finance, anchored by the then-respected US dollar, the world's reserve currency.
But humans being subject to excess and hubris, the US transformed into an economic vampire, consuming not only its own seed corn but by leading a system of debt creation as funding mechanism (replacing the old productivity), leading much of the rest of the industrialized world into financially hazardous practices as well.
If the US goes down, China is going to go down with it. This could become a major buying opportunity as the deck chairs get rearranged for the 21st century. China, like the US, is inflating to try to keep the current arrangement in place, but this will ultimately fail, as all major inflations and bubbles eventually do. But with its reserves and status as creditor, at least it will have options when it comes time to dig out from the rubble.
The US on the other hand, has nothing but confidence to fall back on. That will not cut it when said confidence is lost. The US will need to begin the long, hard process of revaluing its remaining productive resources. That will not happen as long as the printing press keeps running in a pathetic attempt to deny reality (and re-valuation).
Given that I may not even be alive by the time America heads back up the curve, I think I will await coming opportunities out on the horizon in China, other developing regions and in commodities. Shorter term, NFTRH will continue to focus heavily on the gold sector for the fundamental reasons carried forward to date and reviewed again below; until/unless said reasons change.
In short, the China miracle is in progress and will not be stopped. But just as the US dealt with the great depression along the way to 20th century dominance, so too will China deal with a multitude of issues along the way. Not least of which will be extricating itself from the twisted and complex relationship it has going with the great consumer of last resort.
Report continues with an in depth look at liquidity/money supply, market sentiment, gold, the US dollar and more...