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The Daily Reckoning | Wednesday, May 19, 2010 A bull in a golden China store...and other tales from the Middle Kingdom, Could Germany be an early victim in the euro-crisis? Plus, Bill Bonner on Beijing as the city of tomorrow and a Las Vegas bargain... Myriad Questions for the Future of China’s Economy Searching for logic in an illogical economic landscape Joel Bowman Reporting from Beijing, China... Boom or bust? Rich or poor? Communist or capitalist? Hyperbole or reality? Before we came to China, we had a million questions. Now that we've been here for a few days, we have at least a million more. Almost everyone we talk to here seems to agree that China is in a bubble. Almost no one agrees on the details. Will it end with a bang, or a whimper; a hiss or a yelp? And what should - or shouldn't - the government do to induce a soft landing, if it is even capable of doing so? Everyone has an opinion, but they can't all be right. "I think the Chinese government will, ultimately, do what is best for China," announced a friend over dinner last night, in response to a query about international political pressure on China. (Renminbi revaluation was the topic of discussion.) "I'm not quite sure they even know what's best," remarked another fellow, who also lives here in China, "never mind the measures that need to be undertaken to get there." The second gentleman then prescribed, in very clear, reasonable, mathematical terms, what he believed to be the correct course of central planner intervention. The explanation seemed logical, from what we could make out, but, looking around this bustling city of 16 million souls, the landscape seems anything but logical. To our mind, there are simply too many moving parts for a committee to account for. People don't act like bricks or concrete columns. They don't always fit together perfectly or fall precisely into place. So, how does a board of planners set quotas and caps for 1.3 billion individual lives, each of which act partly on quantifiable trends, but mostly on emotional whim and unknowable motives? Nobody has ever been able to figure it out, though not from lack of trying. The real estate market, as most here seem to agree, is almost definitely going through some kind of bubble phase. Prices in many major cities have more or less doubled in the last year alone. In Hainan Province, a resort-style island off China's southern coast, real estate projects have quadrupled in price over the last decade. Many are those who say, "too much, too quickly." Jim Chanos, for one, says the whole Chinese economy is like "Dubai times a thousand." Certainly, driving around the streets of Beijing, it is not difficult to draw some parallels. There are open construction pits aplenty and cranes mottle the hazy horizon. Shiny new buildings with fancy designs and fancier price tags line the streets. Parts of the CBD area somewhat resemble Sheik Zayed Road, only the sidewalks here are thronged by workers imported from the provinces, rather than from India and Bangladesh. And, importantly, these "domestic labor imports" are able to buy land...but probably not at current prices. The residential real estate market, the general consensus seems to agree, is particularly worrying. The numbers cooled off a little last month, but some suggest that's only because the government requested that certain high-end properties be held back from the market. One fellow told us that the Chinese people, many of whom are coming into money for the first time in their lives, see property as a store of wealth. In most cases, second and third properties are not even rented out. Putting them "to work" is seen as similar to driving a brand new car off the lot. They want these houses empty and in pristine condition. "People's choices are rather limited," he told us. "They can invest in the stock market...but they've seen that prices there can go up AND down. They can keep their money in the bank, but that pays a small rate of interest...and inflation is a problem here, too. "Alternatively," he continued, "they can invest in real assets. Many choose to buy gold or real estate. And, now that real estate is proving that it, too, can go down, people are turning to gold again." We got a glimpse at the retail gold market here for ourselves yesterday. The multi-story venue was positively teeming with customers - some young, some old...almost all of them Chinese. The first two floors sell everything from 50 ounce gold bars (and probably higher) to ornately decorated dragon and tiger statues made entirely from the yellow metal. The aisles were packed, elbow-to-elbow. The third floor looks more like what you'd expect to find in a typical, western-style mall. They have designer bags and clothing, make-up and other Saks Fifth Avenue-like consumer items. In stark contrast to the lower levels, that floor was almost entirely empty. At the back of the second floor there is an exchange desk, where people buy and sell their metal beneath a display board, which shows the going price in Renminbi per gram. After a few quick back-of-the-envelope sums, we decided to buy a small amount for our own stash. Unfortunately, we learned that foreign credit cards are not accepted. Addison, who, along with Chris Mayer and Bill Bonner, is also here in Beijing, relayed the event in yesterday's issue of The 5-Minute Forecast: "We asked if they took AMEX - none of our crew had thousands of dollars in the local currency. Nor did we have a local bank account, although those are apparently easy to get. "'We don't accept any foreign credit cards,' came the reply. "'Why not?' we asked a manager. "'No reason.'" Makes sense to us. After all, a paper I.O.U. is bad enough...but plastic promises to deliver paper promises is, apparently, a step too far. We see enough high-end retailers around the city center to suppose there must be SOME demand for these consumer products...but it ain't nuthin like what's going on over at the retail gold market. It's probably not a bad idea to own what the Chinese middle class want and, what they seem to want now is gold...not the flimsy credit cards and combustible currencies of the west. As an aside, if you're interested in getting your mitts on some gold coins from the Middle Kingdom, you might like to check out an offer our friends at First Federal* have on hand as of today. Joe Schriefer, our publisher, tells us they've got a limited quantity of MS69 tenth ounce Chinese Gold Pandas available...as well as an exclusive grab on some perfectly graded MS70 coins. At the moment, the deal is exclusive to Agora Financial readers. But, as with all good things, that won't last. Click here for more info. *Please keep in mind that we do have a business relationship with First Federal Coin Corp. whereby we receive an advertising fee for coins sold. Before buying any coins, we recommend you check out our Beginners Guide To Coin Collecting report. You'll learn the differences of bullion vs. rare/collector coins, how to sell your coins, the importance of grading and much more. And now for today's column... The Daily Reckoning Presents Germans Ban Getting Naked Dan Denning Austria is not Australia. Sorry about that. Late last week we reported that the Australian Mint sold more gold coins in the first two weeks of April than it had in all of the first quarter combined. That was a mistake. It was the Austrian Mint, which makes a lot more sense, given that nearly all of the sales were to Europeans who are in a mild state of panic about the stability of their currency and their banking sector. Speaking of which, a few weeks ago we speculated that Germany might be an earlier victim of the sovereign debt crisis because its various banks and financial institutions own a lot of Spanish and Portuguese debt. Credit default swaps were blowing out faster on German debt than other sovereign nations in which deficits and debt were bigger. But this is really a question of where risk resides in the credit system at the moment. And the market is pointing somewhere in the middle of Europe. So if you were a speculator, or merely wishing to hedge your position in German financial stocks, you'd buy credit default swap insurance. It seems like a sensible thing to do, although apparently you can't do it anymore. Bloomberg reports that, "The euro slid to its least since April 2006 after Germany prohibited naked short-selling and speculating on European government bonds with credit-default swaps and the Bank of Italy allowed lenders to exclude losses on government debt." Hmmn... Is this like not being able to buy health insurance if you have a pre- existing condition? Investors unable to hedge their risk may have to sell. Or, short- sellers will have to cover, which means you could get a brief rally in European shares, the euro, and euro bonds. But it's hardly the sort of thing to boost confidence. Another Bloomberg article elaborates: "Germany will temporarily ban naked short selling and naked credit- default swaps of euro-area government bonds at midnight after politicians blamed the practice for exacerbating the European debt crisis." The key words here are "naked" and "politicians". Naked short selling, unlike the covered kind, is selling a security you don't own instead of borrowing it first and then selling it. There's a healthy debate about whether you can or should be able to sell something you don't own or that isn't owned by anyone. Why speculators are doing it is obvious. Whether they should be able to do it is less obvious. But that it's a good investment idea...well that is another matter entirely. And politicians who are blaming euro bond weakness on short sellers are looking for a villain that is not them. It's a confusion of cause and effect, like blaming the buzzards for the death of the corpse. It does buy them time though, in the blame game. Banning short selling does not improve the quality of sovereign debt or sovereign finances in Europe. And by the way, we've been copping it from European subscribers lately who feel aggrieved. They point out that there are other even more serious debt problems in the UK and the USA. And in terms of flawed currencies, what about the greenback and the pound? Correct you are, aggrieved Europeans! The dollar's day of reckoning will come too. But in the mean time, US bonds and the greenback are enjoying the "flight-to-something-else" bid. We wouldn't call it a flight to safety, mind you. But it does explain the chart below, which shows the gold price in both US and Australian dollars. Note the price rising in both currencies. And note that the Aussie gold price appears to move up as global investors flee risk (emerging markets and leveraged commodity plays). The greenback gold price is climbing too, but less fast. Meanwhile, will the centralized slap down on markets in Europe work? The authorities are trying to protect vulnerable institutions by preventing short sellers and speculators from attacking them. And the Bank of Italy's decision to exclude losses on government debt from capital adequacy considerations is nothing less than inspired. It could start a trend. It's not a loss if you don't count it! More seriously, why institute the ban on naked short selling now? And why take the extra step of preventing anyone in the market from going short government bonds? To be charitable, you could assume that the asset price falls (especially in government bonds) are the work of evil speculators (the global wolf pack) who are unfairly damaging and destroying confidence in otherwise credit-worthy securities and sound government fiscal policies (cough). But more likely, if asset values on bank balance sheets are falling (principally government bonds) then it could again trigger the whole deleveraging vicious cycle we saw in 2008 where institutions are forced to sell some assets to cover losses on other assets or loans. You get a whole lot of selling and much lower prices, which is of course exactly what needs to happen...and which is exactly what will happen...eventually. Dan Denning, for The Daily Reckoning Bill Bonner Chinese Boomtown: A Report from Big, Bustling Beijing Bill Bonner Reckoning from Beijing, China... Deflation! Yes, dear reader...prices are falling. In April, the US producer price index fell 0.1%. Oil fell to $72 yesterday. The Dow fell 114 points. Copper is down more than 20% from its high. Chinese stocks are down 21% so far this year. The CRB - a measure of commodities prices - is down about 12%. Even gold got whacked yesterday - down $13. What's going on? Well, we're in that long period of adjustment known (to us!) as the Great Correction. In the first stage... ..the markets discover that its assets aren't worth as much as investors had thought.... ..creditors find that their credits aren't as good as they had believed... ..consumers realize that they don't have as much money to spend as they had hoped... ..businesses find that they don't have as many sales as they had projected... ..and governments wake up to the fact that tax revenues are coming in at less than expected levels. Boo hoo. This leads to all sorts of gnashing of teeth and congressional hearings. But it's just the way the world works. Unfortunately, the way the world works includes a lot of preposterous ideas about the way the world SHOULD work...and a lot of scurrilous efforts pretending to make them work better. So, while the private sector generally de-leverages - with lower prices and lower debt levels - the public sector tends to leverage up. And to hear some economists tell it, if the feds don't come to the rescue with bailouts and boondoggles, the whole world economy will sink into a Dark Age. A few even say the feds have no choice. Richard Koo maintains that if governments stop their stimulus spending - which, of course, adds trillions to the world's public deficits - the deficits will go up! Come again? Yep. Koo's point is pure Keynesianism...probably correct...and completely absurd at the same time: try to cut your deficit by reducing stimulus spending, he says, and you're likely to destroy the economy, and increase the deficit too. More on that later in the week... We're not going to bore you with economics today - not while the world's biggest and most dynamic country lies right outside our hotel. We're staying at the Grand Hyatt. But we could be in any one of dozens of international hotels in Beijing. The city is full of bright, modern, new buildings...bright, modern, new hotels...and bright, modern, new people. "There's a HUGE generation gap in China today," said a dinner companion last night. "People our age [he was about the age of your editor] remember the Cultural Revolution. The only way to survive was to keep your head down. You learned not to stand out in any way. Everyone wore the same clothes. Everyone said the same things. If you didn't you might get sent to a labor camp...or worse. "But the younger generation has grown up in a China that is completely different. All they've seen is progress...spectacular progress...incredible growth. And they know that the way to succeed in this new China is to take chances..." Keep reading... China has become a nation of entrepreneurs...risk takers. It resembles the US in the '20s - before the country was taken over by corporate managers and political mandarins. China is a good place to make money. 'Rags to riches' stories are so common you wonder if there's anyone left to wear rags. One of those stories had an unhappy ending yesterday when one of China's richest men was sentenced to 14 years in jail for corruption. Today, China seems like a more capitalist country than the US. It is full of gamblers and innovators. The pace of change is breathtaking, with construction cranes all over the city. And the buildings themselves are often daring...the roads are straight in Beijing, but the buildings lean. Some walls lean in. Some lean out. Some lean one way and then the next. The city, what we have seen of it, does not seem anything like a 'third world' hive. Instead, it is a giant, modern metropolis. We came prepared to compare it to Managua or Mumbai. Instead, it compares favorably to Chicago or New York. Beijing is not our kind of city. We prefer places where we can walk around - like Paris, Zurich or London. This is more of a car-friendly town, like Amarillo or Brasilia. The streets are wide. The buildings are tall and isolated. You go from one complex of modern high-rises to another. But this city is much more lively than Paris or New York. It is a city still taking shape...a city that is still figuring out its role in the world. It is "making its way across a river by feeling the rocks," as the Chinese say. Beijing is still a city for tomorrow... But is China a buy or a sell? We asked local experts. The answer: it depends. China probably is a bubble economy, in many ways. Property prices soared as people speculated on real estate. Individuals bought apartments and houses as a way to store the money they'd made in business. But unlike the US, they paid cash. Now, prices seem to be going down. Some areas are going 'no bid,' with prices collapsing. But since there is little mortgage debt, it does not seem likely that the residential sector will suffer the same dramatic decline as, say, Las Vegas... The news this morning is that Las Vegas is in the middle of a housing resurgence. More than 1,000 new units are under construction. But wait. The city has some 15,000 empty units still on the market. "My parents bought a house in Las Vegas in 2000," said one of our new friends last night. "They paid $220,000. Then, in the boom, it went up to about $350,000. Now the price of the house is about $190,000. "There's a house I saw the last time I visited. It was on the market in 2006 for $2.9 million. A big house up against the foothills. With a guesthouse and two pools. A really nice place. It was being offered at only $700,000." While the residential market is not highly leveraged in China, the commercial market floats on a sea of debt. "What happens is that local governments get into deals with local developers," our host explained. "Between the two of them, they borrow huge amounts of money from the banks. Then they build something that feels good to everyone associated with it, but that might not have much commercial potential. Nobody wants to see the project fail, so it tends to be refinanced...and refinanced...until it is carrying a mountain of debt. "What we're going to see, I think, is that all that debt will come crashing down. It's going to be a mess for while. Maybe a long while." Does that mean an investor should stay away from Chinese shares? "Not necessarily," says our local expert. "Many of these companies are still growing very fast...and many are not dependent on the building boom. Some of them have nice little niches...like selling beer and soap to a huge population of people whose incomes are rising. And because their prices have been knocked down, you can buy these companies for about 8 times earnings. It could be that they'll go down some more in the coming crisis. Still, they could turn out to be great investments over the long run." Regards, Bill Bonner, for The Daily Reckoning