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The Daily Reckoning Weekend Edition Saturday, July 10, 2010 Shanghai, China ------------------------------------------------------- The view from a “glamorous” bar in the world’s fastest growing economy... The breakneck growth in China a sustainable trend? Revisiting the ABCs and all of the past week’s reckonings for your perusal... Joel Bowman, reporting from Shanghai, China... The “Dress code” section on the bar’s website says it all: “Come dressed glamorously: we love glam grunge, glam & groovy or haute glam couture, but leave the flip-flops and board shorts at the beach...” Shanghai is not the kind of city most expect to see when they visit the world’s largest “Emerging Market.” Perched on the 6th floor of a stunning art deco building in the famous Bund district, this trendy bar (which we will not name for fear of receiving free drinks when we visit again tonight) offers an appetizing taste of the Shanghai of tomorrow, or perhaps even of today. The clientele is a cosmopolitan mix of expats and upper-middle class Shanghainese. We’re told the cocktails and fusion tapas plates are among the best in the city. And that’s to say nothing of the spectacular views... Amazingly, the Pudong area, which you can see just across the Huangpu River in the nearby photo, did not even exist 20 years ago. Construction on the New Open Economic Development Zone, which has grown to become China’s pulsing financial and commercial hub, only really began in the early 1990s...right around the time the nation’s economy embarked on a two-decade long, double-digit annual growth rate transformation. “This,” the unapologetically capitalistic city seems to scream out, “is what ‘Made in China’ built for us.” While the “Developed” world spent the better part of the last few decades buying knick-knacks they didn’t need with money they didn’t have, China Inc. got busy both producing those same products, and lending the world’s consumers the money with which to buy them. The result is one of the largest trade imbalances in modern economic history. At a staggering $2.4 trillion, the Middle Kingdom’s foreign reserve stockpile is by far the largest in the world. And, although a not-insignificant $900 billion of those reserves are held in steadily depreciating greenbacks (not to mention a large euro holding), the Chinese are wasting no time converting those paper cash piles into tangible asset stakes. As we mentioned earlier in the week, China has been on a resource-buying binge over the past ten years, inking deals with major mining companies from Africa to Australia, South America, The Middle East and all over Asia. Just last month China signed more than $8.8 billion of new commercial and mining deals with resource giant Australia, despite its southern neighbor’s onerous new resource profits tax laws. The Middle Kingdom’s voracious industrialization inhaled around $41.7 billion worth of Australia’s minerals in 2009, including almost $20 billion of iron ore and concentrates. Last year China also became Brazil’s number one trading partner when it agreed to lend $10 billion to Petrobras in return for guaranteed oil supply over the next decade. Other projects between China and its South American BRIC counterpart included a $5 billion steel plant at the Acu port in Rio de Janeiro state. That deal represents China’s largest ever investment in Latin America’s richest resource economy and its biggest foreign steel-plant investment. The world’s fastest growing economic superpower is also looking closer to home in an effort to feed its unwavering appetite and to divest itself of paper promises. “Central Asia is rich in mineral resources, particularly rare metals, copper and gold that China needs for economic growth,” President Hu Jintao announced on a recent visit to Central Asia, where he signed gas and nuclear agreements and promised cooperation in port construction and transportation infrastructure. Conspicuously absent from these and a slew of other high profile deals were the “emerged” markets. While the Petrobras deal was going down, for instance, politicians in the US were eagerly handing out hundreds of billions of other people’s dollars to Goldman Sachs (via AIG), and bribing its citizens to purchase new kitchen appliances...most of which were probably made in China anyway. Of course, all this stimulation comes at a terrible cost. Not only must the US economy swallow the opportunity cost (of the goods and services that might have been produced had those trillions not been siphoned off to bailout the nation’s failed banking/insurance/auto industries), it must also contend with seemingly uncontrollable debt loads. Barely 9 months into the current financial year, the US this week passed the $1 trillion annual deficit mark. Though marginally smaller than last year’s total at this point, such a figure is hardly cause for celebration. The world’s most indebted economy – on a gross basis – is also notching up a worrying tally of single day records. The Washington Times reports: The one-day increase for June 30 totaled $165,931,038,264.30 - bigger than the entire annual deficit for fiscal year 2007 and larger than the $140 billion in savings the new health care bill will produce over its first 10 years. The figure works out to nearly $1,500 for every US household, or more than 10 times the median daily household income. And now that the future demand has been brought forward, through “Cash for Clunkers” and other myopic policy disasters, the western superpower is struggling to keep its economy afloat. They’ve spent their savings AND their future earnings. Meanwhile, China is struggling to cool its own economy down. It’s all the government here can do to keep a lid on growth at 11.9% – the figure recorded in the first quarter of this year. Stronger domestic demand and a rebound in exports forced the IMF to upwardly revise its outlook for China’s 2010 GDP, from 10% to 10.5%. Housing prices are still rising by an incredible 12.4% per month, according to the latest available figures, even after Beijing introduced a series of tightening measures aimed at dampening real estate speculation. Almost nobody expects China to keep such a breakneck pace. In fact, many are warning of sharp corrections ahead. But as our fellow reckoners are well aware, nothing moves up or down without (sometimes major) corrections. Straight lines are for geometry classes, not markets. Over the long haul, however, the trend is pretty clear. Wandering around the bustling, high-end shopping streets and funky fusion eateries here in Shanghai, it’s difficult to imagine the emerging middle-class consumers returning to the lot of lowly-paid factory worker without a struggle; almost as difficult as it is to imagine an American working for less than the minimum wage...but not quite. Cheers, Joel Bowman for The Daily Reckoning P.S. Although China’s benchmark index, the Shanghai Composite, is well into bear market territory, some investors are looking at the landscape here as a ripe buying opportunity. A couple of months ago, we visited Beijing with Agora Financial’s resident value maven, Chris Mayer. Chris specializes in uncovering undervalued companies set to benefit from what he calls “special situations.” On that trip, Chris found a handful of Chinese companies trading on US indexes for extremely attractive valuations. “And, when you strip out their cash,” Chris told us at the time, “the discounts are even steeper.” These are not the kind of investments you’re likely to see highlighted on the evening business news, mind you...but most real moneymaking opportunities are long gone by the time the mainstream media gets a hold of them. ALSO THIS WEEK in The Daily Reckoning... V-Shaped Recovery, Where Art Thou? By Bill Bonner Paris, France Governments can’t make bad debt go away. So they can’t prevent a correction and a de-leveraging; they can only delay it. One way or another excess debt needs to be reckoned with. But when the authorities begin to tighten at the same time that the private sector is tightening, the effect will push the world into a sharper, deeper correction...even into a depression. Avoid Banks Stocks By Dan Amoss Jacobus, Pennsylvania Credit risk always seems to come out of nowhere. But usually it comes out of somewhere...like the dirty, little recesses of a bank’s balance sheet – the places where bankers hide all their unrecognized losses. Ever since the suspension of rigorous mark-to-market accounting rules one year ago, banks have gained the ability to “time” their credit losses. This development does not feel like progress. Banks now possess the ability to defer embedded credit losses for a very long time, in the hopes that a “typical” postwar rebound in house prices and employment comes to fruition. But that’s not happening. In fact, housing and employment conditions are worsening. As a result, the US banking sector has been piling up an enormous stash of unrecognized credit losses. Why Your Portfolio Should Not Speak English By Chris Mayer Gaithersburg, Maryland 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. Shouldn’t do it; couldn’t do it anyway By Bill Bonner Paris, France Paul Krugman, Martin Wolf and the other big spenders are remarkably resilient. And cunning. On their advice, the world’s governments put up as much as 4 years’ worth of the entire planet’s savings to bring about a ‘recovery.’ On the evidence of the last couple of weeks, it didn’t work. The Weekly Endnote: While taking in the views from the aforementioned bar on the Bund earlier this week, we overheard a couple of young ABCs (as “American-Born Chinese” are known here) chattering away over at the next table... “I’ll apply to LSE...Berkeley...NYU...maybe some other programs back home,” announced the girl in a long, drawn-out Californian accent. “Why would you want to do that?” asked her date, trying not to sound too despondent. “Well, they’re...like...the best schools, right?” “I dunno...I guess.” “You know, I’ll...like...be back and everything.” “Yeah?” (The young man chirps up) “I mean...hello!? This is, like, the future, ya know?” Your homeless editor is heading north over the weekend, bound for the nation’s capital city. After that it’s off to Vancouver, Canada, for our annual Agora Financial Investment Symposium. As you may have already heard, the event is officially sold out. BUT, you can still grab a “virtual ticket” – which allows you real time access to all the specific, actionable ideas our world-class line-up of experts will offer. If you couldn’t make the trip, but still wish to learn about our Vancouver Confidential service, you’ll find all the relevant info here. Enjoy your weekend... Cheers, Joel Bowman Managing Editor The Daily Reckoning