Monday, January 09, 2012

China's Obvious Growth Troubles Have Non-Obvious Effects

I haven't had much to say in detail about China's economy so far in 2012.  The accumulated evidence for the end of the Chinese growth miracle is now impossible to ignore.  Overall trade volume growth is slowing.  China's export markets in the U.S. and Europe are tightening their belts and its own domestic consumers are not ready to spend at Western levels.  Curtailing shadow banking will be harmful in the short run as it will force a credit crunch on real estate developers and risk popping the urban real estate bubble.  It will of course benefit China in the long run by putting its capital markets on a more transparent footing so creditors can avoid funding malinvestment.  A trilateral free trade agreement may be in the works.  This would amount to a structural revolution for Japan and Korea, as both grew their economies from state-managed export growth, and a strategic breakout for China.  An alternative to the WTO would appeal to China as a way to exert indirect influence over neighbors who also have strong trade links with the U.S.

The temptation to completely sell out of a long position in Chinese stocks is strong given the country's obvious problems with environmental stewardship and social discontent.  The case that emerging economies eventually re-emerge from any temporary difficulties they experience is also strong.  It is difficult to accumulate wealth by running away from every sign of trouble.  It easier to accumulate wealth by staying invested in an economy with untapped natural resources and an enormous population.  The United States was in a similar position in the 19th century and turned out just fine.

Full disclosure:  Long FXI with covered calls.