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The Daily Reckoning | Thursday, July 8, 2010 Stocks bounce off a two-week losing streak...and other non-events, The world's producers begin out-consuming the consumers, Plus, Bill Bonner on what actually causes a depression and why they aren't all bad... ------------------------------------------------------- Is China Really in a Bubble? A first-hand account of what’s going on in the Middle Kingdom Joel Bowman Reporting from Shanghai, China... Stocks rallied yesterday...hard. After only one session out of the previous eight in the black, we were beginning to wonder when we might see a "pop." After all, nothing trends along an uninterrupted trajectory - neither up nor down - forever. Straight lines are for geometry classes, in other words, not stock markets. So what now? Will 274 Dow points be enough to purify the gushing torrent of putrid economic indicators that pour forth from the world's data machines? Can a one-day stock market bounce erase $12 trillion dollars worth of phony stimulus programs, dodgy bailouts and make-work scams? Can they unwind six decades worth of over-spending and under- producing in the old world economic powerhouses? Or, put a slightly less-dramatic way, can a 274-point rally fend off the corrections necessary to get the world economy back into tip-top working order? Almost certainly not, we'd guess. In any case, it's probably better not to think about it too much. The more we do, the worse the answers get...and the more our head hurts. Bill has more on the non-recovery below... In the meantime, your managing editor is hanging out here in China for a while. (Fellow reckoners will recall that we are technically homeless at the moment, a situation we are in no great hurry to remedy.) We journeyed to Beijing with Bill, Addison and Chris Mayer a couple of months back, trying to get the lay of the land. On that visit, our first to the mainland, we met with economics professors, financial publishers, professional money managers and industry insiders from all over the capital city. The Chinese economy, most then agreed, was almost certainly in a bubble. Property prices, for example, were increasing at an unsustainable rate, prompting many leading economists to declare the residential real estate sector the mother of all bubbles. Jim Chanos even went as far as comparing it to "Dubai...times a thousand" adding later that the Middle Kingdom's runaway economy was on a "road to hell." "The residential real estate market, the general consensus seems to agree, is particularly worrying," we reported from the nation's capital at the time. "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." Central planners in Beijing had already set to work attempting to relieve some of the price pressure in the real estate sector by curbing lending, demanding higher reserves be kept in bank vaults and curtailing mortgage lending for second and third homes. Despite their "cooling" efforts, the Chinese economy still managed an incredible 11.9% annual growth rate in the first quarter, it's fastest rate of expansion since 2007. And, although the total value of property sales fell by 25% in May from the previous month, prices continue to climb, albeit at a slightly muted rate (down from 12.8% in April to 12.4% in May.) For a growing number of those famous migrating workers, property prices in "tier-1" cities like Beijing and Shanghai are increasingly out of reach. Almost certainly, there will be a correction...perhaps even a violent one. Earlier this week, Harvard professor Ken Rogoff joined the "bubble" crowd when he told Bloomberg News that we're already "starting to see that collapse in property and it's going to hit the banking system." All this is not lost on investors, of course. The nation's benchmark index, the Shanghai Composite, tumbled more than 6% last week. Already the worst performing major index in Asia for the year, last week's dismal performance pushes it down over 26%, well into "official" bear market territory. That said, bubbles and corrections are not the same as irreversible crashes and multi-generational economic heat deaths, such as those unfolding across the aging, moribund western powers of the world. Meddlers will be meddlers, after all, whether they are American, European, Chinese or otherwise. Making the same mistakes again and again is part of their political DNA. And it's just a small part of what doesn't separate them from the apes. But the emerging markets of the world have a few very key ingredients that are conspicuously absent in the developed economies of the world. Perhaps primary among those advantages is that the numbers on their balance sheets are mostly written in black, not red. Most run extraordinary trade surpluses, while the west digs itself deeper and deeper into debt with each and every new welfare/warfare program dreamed up and dollar borrowed/printed to finance them. Right now, China holds the world's largest stockpile of foreign reserves at $2.45 trillion. While a good portion - about $900 billion - is held in value- atrophying US dollars, the Chinese are wasting little time in converting additional surpluses into tangible assets. We'll have more on that in the weekend edition... In today's essay, Chris Mayer digs much deeper into the kinds of opportunities the world's developing markets offer the contrarian investor... The Daily Reckoning Presents Why Your Portfolio Should Not Speak English Chris Mayer When Gen. Cornwallis surrendered to Gen. Washington after the Battle of Yorktown, the British band supposedly struck up the tune "The World Turned Upside Down." After all, such an outcome would have been unthinkable at the start of the American Revolution. That is in the nature of things, however. No one stays on top forever. Only recently, the mighty US consumer - long the dominant force in world trade - has lost its top seed. There is a brave new world emerging, and it has a brave new consumer. This time, it's Americans that might want to strike up that old ballad. Consumers in emerging markets are now the dominant consumer group in the world, surpassing the US. We've crossed an important threshold. Emerging Market economies now represent about 33% of consumer spending worldwide. US consumer spending, at 27% of worldwide GDP, trails for behind. As recently as 2006, US consumer spending was greater than that of the Emerging Market economies. As The Economist notes, "The emerging world is enjoying the most spectacular growth in history." Some of the growth rates are just blistering. Thailand grew 15% on an annualized basis in the fourth quarter. Taiwan grew 18%. "Multinationals expect about 70% of the world's growth over the next few years to come from emerging markets," The Economist adds, "with 40% coming from just two countries, China and India." It's a great time to be an investor as we witness this history-making shift in global markets that will surely create great opportunities for us. Just look around and you can see the impact already. For instance, Coca-Cola reported a 20% increase in first-quarter profits despite the fact that North American sales declined. Sales in emerging markets, such as India (up 29%) and Turkey (up 18%), made it possible. About 75% of Coca-Cola's sales are now overseas. This is just one example. There is a whole slew of iconic companies that now generate more sales overseas than in the US. It's still early. The next big consumer market to open up might be Indonesia. It's the world's fourth largest population, behind China, India and the US, with 240 million people. Ford just opened its first dealership here. Honda says it can't make motorcycles fast enough. And H.J. Heinz reports that Indonesia is a big part of why its Asia sales rose 41% last year. So the long-awaited emergence of the emerging markets consumer is at hand. More than that, the emerging markets are also becoming a source of innovative ideas. Fortune 500 companies are happy to set up brainy shops in emerging markets. They already have 98 R&D facilities in China and 63 in India. GE has a vast R&D facility in Bangalore, its biggest in the world. Cisco is spending $1 billion on a second HQ, also in Bangalore. Accenture has a quarter of its work force in India. Microsoft's biggest R&D center, outside of Redmond, is in Beijing. And they are enjoying tremendous success. For example, GE's Bangalore laboratory invented a new hand-held electrocardiogram that sells for $800, instead of the usual $2,000. The cost per test is only $1 per patient. As The Economist put it, emerging markets have become a "fizzing cocktail of creativity." Moreover, it's not just Western companies doing the creative work. (Huawei, a Chinese telecom giant, is now the world's fourth largest patent applicant.) Companies in China, India and other places outside the US are inventing game-changing technologies. A few of the stories The Economist highlights in its report are simply amazing. In Chennai, a Tata company created a water purifier that uses rice husks - a common waste product. A family can enjoy bacteria-free water for the grand price of $24. New filters every few months will cost $4. It's cheap and portable and will make a big impact on the poor the world over, most of whom lack access to clean water. Another Indian manufacturer concocted a $70 fridge that runs on batteries! A Chinese company, Mindray, makes a lithium battery for $12, compared with $40 previously. Bharti Airtel, an Indian company, has the lowest cell phone fees in the world - 2 cents a minute and nationwide coverage. The company is worth $30 billion. One of the most startling tales was that of Devi Shetty. He is applying Henry Ford's assembly-line techniques to hospitals. Shetty's flagship hospital in Bangalore has 1,000 beds. (The average American hospital has only 160.) His team of 40-some cardiologists cranks out 600 operations a week. Open-heart surgery costs about $2,000 - compared with $20,000-$100,000 in an American hospital. Shetty and his team have performed tens of thousands of such operations with results as good as the best of American hospitals. Incredibly, these hospitals even make money! According to The Economist, "Dr Shetty's family-owned hospital group reports a 7.7% profit after taxes, compared with 6.9% in American private hospitals." So where are the opportunities? I believe that the biggest opportunities and the biggest rewards will go to the homegrown companies in these markets. The biggest winners won't be the multinationals, their present success notwithstanding. (And it hasn't all been sugar and spice. Ask Google or Yahoo or Black & Decker or a host of others who met defeat in foreign markets.) As in baseball or football, the odds favor the home team, which has more knowledge of local markets, customs and the like. For example, China's auto market grew 45% last year to become the biggest in the world. GM, for the first time ever, now sells more cars in China than in the US. But Chinese automakers have made the largest market share gains. As of 2004, Chinese automakers were 21% of the market; today, they are 32% and rising. Of the 89 new models unveiled at the global auto show in Beijing recently, 75 were Chinese brands. We are now at a point, too, at which we can list a host of companies that are world-class in what they do and call an emerging market home. Mittal as recently as 1990 was an unknown steel maker in Indonesia. Today, it's the world's largest steel company. China's Lenovo didn't even exist in 1990 and today is the world's fourth largest PC maker. There are many more examples from Brazil's Embraer to China's battery maker BYD. Warren Buffett bought a piece of the latter company in September 2008. BYD went from about $7 to $80 in about 18 months. Needless to say, investors in these kinds of companies have reaped huge gains. And some of the biggest opportunities in the next 10 years will come from the next crop of Mittals and Embraers and BYDs. The above is just a sampling of the mind-bending changes taking place right now in the Emerging Market economies. As the explorer, Marco Polo, once said, "I have not told the half of what I saw." Chris Mayer, for The Daily Reckoning Bill Bonner In Defense of Economic Depression Bill Bonner Reckoning from Paris, France... Warning: serious thinking here... Big rally yesterday. The Dow was up 274 points. Gold went up very slightly and still closed below $1,200. What gives? A big change in direction? It's probably nothing. Markets don't go up or down all in one straight move. They play with investors like a cat with a mouse. They tempt him into bear markets and scare him away when prices are rising. They shake his courage at bottoms and addle his brains at tops. An investor never knows for sure what the market is up to. And he's better off not worrying about it. He should look for acceptable value and nothing more. If he finds a company he likes...if he understands the business model...if he has studied the company's financial picture and satisfied himself that management knows what it is doing...and he can buy it at a price that gives him a fair return on his money...then, he can buy the stock. And then he shouldn't worry if the price goes up or down. Trying to make money by guessing the stock market's direction, on the other hand, is likely to be a losing proposition. It only works, marginally, at the extremes. And we're not at an extreme now. But if we had to guess, we'd say the market is headed down. But we'd rather wait and see what the market has to say for itself. In the meantime, let's turn to the economy where we can have more fun. In the markets, the bulls could be right. Or the bears could be right. Who knows? But the economy seems easier to understand and predict. And economists? That is where our doubts disappear. We know most of them are wrong most of the time. Paul Krugman rants and raves. He thinks governments are making a big mistake. They should forget about saving money and cutting deficits, he says. They can worry about that later. What they need to worry about now is a depression. Unless the feds get on the ball and spend money, we could sink into another Great Depression, he warns. Martin Wolf at The Financial Times in London makes the same point. He mentioned 'depression' yesterday. The private sector is saving; without a lot of 'demand' courtesy of the state, he says, we run the risk of depression. The two of them are so sure a depression would be a bad thing, it makes us wonder. Maybe a depression wouldn't be so bad, after all. The gist of the argument against depression is that people lose their jobs, incomes go down, companies go bankrupt and so forth. Is that all? Well, in general, people have less stuff...and less money to buy more stuff. If that were all there was to it, it would seem like a small price to pay for the benefits of a depression. After all, a depression would wring the debt out of the economy. It would get rid of weak businesses. It would turn spendthrift households into savers. That's got to be worth something. The large presumption behind these worries is that, in a depression, people do not get what they want...they are disappointed. They are poor. They wear shoes with holes in them and drive old cars. They vote for Democrats and start reading Das Kapital. Big deal. What actually causes a depression, anyway? People choose to save rather than spend. Reduced demand causes a drop in sales...an increase in unemployment...falling prices and all the other nasty things we associate with a 'depression.' And yet, behind it is something people really want - savings. And behind the desire for savings are very real calculations and concerns. Without savings, people cannot retire comfortably. Without savings, they cannot withstand financial shocks and setbacks. Without savings, they may not be able to take advantage of opportunities that come their way. In other words, there is a depression because people would rather have savings than a new car, or a new pair of shoes, or a vacation. In other words, people choose to have their cake rather than to eat it. What's wrong with that? Nothing. But it causes the economists' GDP meters to tick over in a direction they don't like...or at least in a direction they think they can do something about. The economists' answer to this is to let the people have their savings...but to counteract the economic affect of higher savings rates with increased government spending. It sounds so neat...so clean...so symmetrical. You might almost think it made sense, if you don't think about it too much. But wait. Where do the feds get any money to spend? They have to take up the savings. They take the cake! And there you have the problem right there. Resources have to come out of some other use - say, inventories, investments, whatever - and be put to use on government projects. We can safely assume that the federal projects are not the angel food, layered and frosted confections that the savers wanted to eat. Otherwise, they would have willingly paid for them themselves and there wouldn't be a downturn in the first place. So, instead of savings and depression, the people get boondoggles and "growth." Only it isn't real growth. It is growth that flatters economists but leaves the rest of us hungry and disappointed. It is empty calories...measurable as "growth" on the economists' GDP meters...but completely phony and not at all what people really wanted. And what happened to their savings? They've been eaten up by the feds and their favored groups. This whole Keynesian stimulus project is scammy from beginning to end. And in the middle too. And more thoughts... We have three sons, more or less all unemployed this summer. We give them projects. We invite them into the family business. But they are not kids anymore. They have ideas of their own. One is pursuing his musical career in a reasonable manner. The others, still in school, have other plans too...but not ones your editor fully understands or necessarily approves. None has a proper "summer job." "When I was your age..." he tells them...followed by tales of unimaginable suffering, hardship and perseverance. "Times have changed, dad," they reply. They have a different attitude... They will work, but only if it 'really makes sense.' What really makes sense? We're not sure...but we hope it includes painting the shutters: "I don't think I fully understood the severity of the situation I had graduated into," The New York Times quotes Scott Nicholson: [He was] speaking in effect for an age group - the so-called millennials, 18 to 29 - whose unemployment rate of nearly 14 percent approaches the levels of that group in the Great Depression. And then he veered into the optimism that, polls show, is persistently, perhaps perversely, characteristic of millennials today. "I am absolutely certain that my job hunt will eventually pay off," he said. For young adults, the prospects in the workplace, even for the college- educated, have rarely been so bleak. Apart from the 14 percent who are unemployed and seeking work, as Scott Nicholson is, 23 percent are not even seeking a job, according to data from the Bureau of Labor Statistics. The total, 37 percent, is the highest in more than three decades and a rate reminiscent of the 1930s. Mr. Nicholson turned down a $40,000 job. It wasn't the career he was looking for, he said. Remarkably picky, for an unemployed man. But this generation seems to feel a little cushier than we did. The college-educated among these young adults are better off. But nearly 17 percent are either unemployed or not seeking work, a record level (although some are in graduate school). The unemployment rate for college-educated young adults, 5.5 percent, is nearly double what it was on the eve of the Great Recession, in 2007, and the highest level - by almost two percentage points - since the bureau started to keep records in 1994 for those with at least four years of college. Yet surveys show that the majority of the nation's millennials remain confident, as Scott Nicholson is, that they will have satisfactory careers. They have a lot going for them. "They are better educated than previous generations and they were raised by baby boomers who lavished a lot of attention on their children," said Andrew Kohut, the Pew Research Center's director. That helps to explain their persistent optimism, even as they struggle to succeed. Optimistic? Turn down work? That's what depressions are supposed to cure! Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com US Still Spending Despite Global Shift Toward Austerity The rest of the world is saving. What happens to the savings? The savers can thank the USA for taking them off their hands. While the rest of the world saves, the US is still borrowing...helping the world get rid of its surplus savings. In effect, the US government is now playing Japan’s role in its long, tired saga of de-leveraging. We guessed that the US would follow Japan into a long, slow, soft slump. Okay...we were 10 years too early! But now, it seems to be happening. V-Shaped Recovery, Where Art Thou? Great Correction Expectations Seriously Underpriced Silver The impetus for my New Mogambo Crusade (NMC) to acquire more silver came as a result of reading in Ed Steer’s Gold & Silver Daily where he noticed in the Comptroller of the Currency’s “Q1/2010 Report on Bank Trading and Derivatives Activities” that “the bottom-line numbers show that two US banks... JPMorgan and HSBC, USA hold between 97% and 99% of all the gold and silver derivatives held by all US banks.” Yow! Government and Economy Decline In Tandem Combating Annuities With Gold, Silver and Oil China Goes on Japanese Bond Shopping Spree China continues to be vocal about its reserves diversification and still mum on the details. Its State Administration of Foreign Exchange (SAFE) is now posting soothing Q&As on its website in order to calm fears about its $2.4 trillion cash mountain without actually offering any specifics about recent changes in its allocation. Municipal Pathologies Come to a Head Global “Pawn Shop” Loans Central Banks Cash for Gold at Record Rate