The Coming China Crisis: An interview with Bert Dohmen
When Bert Dohmen talks, smart investors listen.
In 2007 when most investment analysts and economists were downplaying the developing credit market troubles, Bert warned investors that the probability was very high that the troubles would escalate into full-blown crisis and would produce a crash of historic proportions. He chronicled the developing credit crisis in the pages of his newsletter and also published a book in early 2012 entitled, The Coming China Crisis, which provided his insightful views on the emerging crisis in depth.
Dohmen writes the widely read Wellington Letter and China Boom-Bust Analyst investment advisories. His Wellington Letter has provided top-notch forecast and analysis of U.S. and global financial and economic trends since January 1977. His newsletter has received many #1 ratings by the top ratings services and has forecasted every bear market using sophisticated technical analysis. Bert also frequently appears as a guest on financial television, including CNN's Moneyline, CNBC and FOX News. Over the last 30 years he has been a favorite speaker at the largest investment conferences.
On December 18, I spoke with Bert concerning his forecast of the coming China crisis, the global economy, the U.S. "fiscal cliff" and the likelihood of another worldwide financial crisis. Following is a transcript of that interview.
Q: You just returned from a trip to China. What can you tell us about it?
Dohmen: I learned something that just confirmed what I already knew. You can learn a lot more from a country from your desk using the Internet than you can visiting a country and being wined and dined. I spoke with hedge fund managers, institutional investors, heads of corporations, etc. The first story they give you is that 'everything is wonderful in China' and that the country is only experiencing a short-term lull with the economy. But when they find out you know more, they open up and give you the true story: 'We're stagnating, the economy is weakening, etc.'
Q: In your book, The Coming China Crisis, you mentioned that your work strongly indicates China is now going through what the U.S. did in 2007-2008.
Dohmen: Yes they are, but it will be a different kind of crisis because China's institutions are different. What we experienced was a financial crisis where institutions went out of business or had to be bailed out. The repercussions were actually a downturn in the U.S. economy. In my opinion, the next crisis will be an economic crisis for the U.S. and globally where all the stimulus that has been put into system is wearing off and has less and less effect in helping the economy. I see signs that it's being counterproductive.
Q: Please elaborate.
Dohmen: The Fed's monetary policy is destructive if you look behind the scenes. It gives the central banks no way out. The Chinese government is doing everything it can to keep its banks afloat. For instance, the banks in China have 21 trillion dollars worth of loans. That's a huge amount considering there are only 3 trillion in China's reserves. It's estimated by accounting firms that bad loans on banks' books is as much as 40-50 percent of total loans. That's 10 trillion in bad loans on the books total and it's unsustainable. This could cause a huge crisis.
The Chinese government may not be able to continue these bailouts eventually. In the future that will be the limiting factor. Emerging markets like China have always been a problem when money starts flowing out. Foreign capital flows out and then the problems begin. We saw this late last year and earlier this year and discussed it in our China Boom-Bust Analyst newsletter. Foreign direct investment has since gone from largely positive to negative. Money is flowing out of China. For emerging markets that's always the first big warning sign of an approaching crisis.
China has more foreign currency reserves than others; it will delay the problem but not cancel out an eventual crisis. When China goes into severe contraction, the world economy will suffer.
Q: Chinese industrial demand obviously influences the price levels of major commodities. Where do you see commodity prices headed in 2013?
Dohmen: Raw material prices will be on the weak side. China will start new stimuli for various sectors. But they can only build infrastructure that use raw materials and they don't use enough of it. They have huge stockpiles of copper and steel and are still producing but unable to sell it. Many larger cities have populations of more than 1 million people. These cities have steel mills and are large employers. Governments of these cities hesitate to shut down because they don't want unemployment, so they keep producing.
When you're analyzing China don't look at production numbers, look at sales numbers which are much harder to get. There's a big difference between steel production and steel sales. For instance, a big headline a few months ago was that car sales hit new records in the U.S. But the fine print is that these sales are by manufacturers which stuff the cars into retail channel and sell to auto shops. The retailers were screaming, 'Stop sending us these cars, we can't unload them!' It's called channel stuffing in the U.S. and they do it in other countries, too. These are the numbers you see reported, not the actual numbers.
Q: Can China become truly great under its present Communist regime?
Dohmen: A year-and-a-half ago we wrote that the Great Leap Forward had hit the Great Wall of Communism. For China the easy stuff is over, such as low labor rates and wages. They were able to get all this wonderful Western technology free of charge. The Western multinationals all signed over the details of their patents to their Chinese partners. That's gone now. China got about 100 years of development in the West for free.
Now there's a point in the lifecycle of any country where entrepreneurs would be taking over and helping develop, but in China they don't have freedom. In China you see it every step of the way; everything is controlled by the government. Unless China finds someone like Gorbachev to dismantle the Communist regime, China will languish and its growth will decelerate. The private sector is over there is already in recession. The GDP numbers which they advertise at 7 percent is totally phony. The government says people shouldn't use it as being accurate, but as a 'guideline' [laughs]. It's being overstated and the numbers are unreliable. To measure what's really happening we use private sector numbers like electrical consumption, which has declined for 1 ½ years. How can this be if China's economy is growing?
Q: How big is the real estate bubble in China and has it burst?
Dohmen: Yes. People are still talking about Beijing apartment prices being sky high, but the rest of country has had big declines. Development companies have been selling units and dropping prices 30-50 percent. This makes prior buyers angry and they want to cancel sales. There are no land sales in China because only government can own land. They're 50 year leases, long-term leases. Recently there have been very big new leases at record rates. These are also phony. Companies take lands and lease to developers, which gives them 50% revenues to run hospitals, fire departments and other municipal services. In the real estate plunge last year developers weren't buying anymore and municipalities lack of income. So they make deals with developers. The lease rates has to be at new highs so people get enthused and think real estate is rising. It's another form of market manipulation.
Q: On page 119 of your book you noted that the growth rate in China's money supply had declined from a hefty 30% annual rate of growth to around 12.5% in late 2011. What does China's current money supply growth rate look like?
Dohmen: I don't have the numbers in front of me right now but it continues to decline, money velocity is declining. Everything is ratcheting down. The only entities getting bank loans are State Owned Enterprises (SOEs). The 'princelings' in China are the children of high party officials, and it's only they who get the loans. It's total corruption. Small entrepreneurs have a difficult time competing with larger companies and can't get these favorable bank loans or any loans. When they start encroaching on SOE territory, the SOEs have a way of getting them out of business. Credit lines get cut. They're better connected and can eliminate competition easily. You can't have a growing economy with this going on.
Q: Recently there have been signs of a Chinese economic rebound. Do you see this as being a temporary "dead cat bounce" or can this reversal be sustained?
Dohmen: The head of the Communist Party Congress will manipulate a bounce with statistics, as we said last month in our Wellington Letter. When you compile the numbers you can make the economy do whatever you want. The real economy doesn't respond to that, however. In March 2013 China will have a new 5-year plan. Until then things will look rosier, then reality will hit. You just have to look at free market numbers like freight indices. The Baltic Dry Freight Index is a good one to look at. That is now scraping at the bottom of 2008 crisis. In 2008 that index collapsed 93 percent. Freight rates dropped by that much. You could rent a large 1,000 foot carrier at that time for the same cost of a 35-foot boat on Lake Tahoe in 2008! When goods aren't being shipped they're not being used. Freight rates are a much better indicator than GDP numbers.
Q: If China goes into a major recession, what effects will this have on the U.S.?
Dohmen: This will be like a tsunami going through the economies of the globe. China has been the big locomotive for the world economy. China's stimulus was four times the size per GDP than that of the U.S. They were four times as aggressive as the U.S. Fed in stimulating their economy. This caused a commodities rebound, stock market rebound, etc. Australia was also affected by China's demand for commodities.
Looking forward, I can't understand where any good news is going to come from. We have our analysis and scenarios we go through and every day we review everything and ask if anything has changed that would make us wrong in our predicdtions or confirm our analysis. Today we found out that China has cancelled a 300 ton soybeans order from the U.S. What does it mean? Does China have too many soybeans? Are the Chinese people not hungry? Are prices too high?
Another factor is that we have some proverbial 'canaries in the mine' in that China is trying to conserve foreign currency outflows. When China buys goods from West they pay in foreign currency, not renminbi. Are they starting to conserve foreign currencies because they're being depleted of all that's leaving the country? We're seeing cancellations and reductions in China left and right. One of our clients sells high grade seafood to China. He told us recently that a big order from a major client from China was cancelled because they couldn't get dollars, foreign currency, from their bank.
So when demand from China goes down it effects the global economy. You don't see this in the daily newspapers or on TV. You don't get this information from a visit to China, either. The China bulls are always touting the fact that China has 1.3 billon people and those numbers will supposedly translate into obscene riches. But the number of people doesn't necessarily mean the country in question will have a beautiful economy.
Q: Before we go I have to ask you the question of the hour. What are your views on the U.S. "fiscal cliff"?
Dohmen: In our Wellington Letter for December we discussed that. Nobody knows if there's going to be an agreement among the Democrats and Republicans. The popular view is that there will be a compromise by year end. But as you know, the popular view is usually wrong. I can see a situation where there's a lot to be gained by Democrats by letting the country go over the cliff and then blaming the Republicans. 'The Republicans made us do it' will be the excuse.
I just don't see why so many analysts are bullish on 2013. Companies are going to be hit by huge new costs for employees. There have already been huge price increases for restaurants, etc., with prices up 20-30% in the last six months. I think we'll continue to see inflation in supermarket prices and deflation in good we can do without, durable goods. For instance I've noted that Costco has made price increases of 25 to 35 percent recently. How will the Federal Reserve deal with this? A trillion dollars next year they'll put into the system. It's nothing to them. This new stimulus, how are they ever going to exit this policy of zero percent interest rates? Someday the market will put an end to that and paper money will become worthless and the market will know it.
Right now we have 80 to 90 percent of Treasury securities purchases being conducted by Fed through their stimulus. When the Treasury finances all their expenditures with freshly printed money, you can see in history how this will end. There will be no happy ending to this. Can you imagine when you see real inflation rising, could be 10% or higher, what will people say? Finally they'll have to stop inflation. When there's the smallest sign that the Fed is reversing course you'll see a collapse in financial markets. Whenever it comes, be it next year, 5 years or more; it's coming.
For ordering information on Bert Dohmen's book, The Coming China Crisis, visit his web site at www.DohmenCapital.com]