This week's lazy Sunday upload is going to be a little different i've been a china watcher for years ever since reports of ghost cities started to emerge almost ten years ago i think china is probably the biggest bubble economy in history and i'm not the only one Jim Chanos and Carl bass are both very successful and renowned short sellers and although they come at the Chinese economy from different angles they reach very similar conclusions the following is cut from a panel at last year's Vanity Fair new establishment summit on the global economy and stock markets the full session runs just over half an hour and is well worth a listen especially if you're interested in the art of short selling which I personally find fascinating so with that out of the way please enjoy Jim Chanos and cold baths talking about the Chinese bubble economy I want to start with the topic that's of major importance for the global economy and that's China let's begin with a question for the audience how many of you are optimistic about China's economy can we see a show of hands interesting so surprise our two guests are not optimistic about China and haven't been for quite some time Jim you've got a great story about what piqued your interest in China will you share it well I mean we got interested in China were stock pickers and we're not so called macro investors and our interests in China came about in the fall of o.9 when we were trying to figure out why it was that some of the commodity producers were reporting record profits into the teeth of the global financial crisis and we knew it inherently it was due to China and we're talking about iron ore company steel companies aluminum cement copper and my real estate analyst was putting some figures on the board and said currently China has under development 5.6 billion square meters of high-rises roughly half residential and half office and mixed-use and I said he was a young man I said well Alex you're getting your nominal HR wrong because we think in square feet and their square meters it can't be 5.6 billion square feet they're meters that's 60 billion square feet and he looked at me it's only sort of a terrified young analyst good he said I triple-checked it it's 5.6 billion square meters and it sort of hit me that if half of that was office space roughly 30 billion square feet that was a five foot by five foot office cubicle for every man woman and child in China and that's been built over twice now since 2010 and it really rammed home to me the scope of the urban build-out that was occurring in a very short period of time in China and just how much debt was being taken on to do it and and what a basically one-off for the world economy this is turning out to be and we still believe that so back in 2011 another prominent Wall Street are dismissed you by saying shorting China is basically starting the march of history and even today people say that you're wrong because China's official growth figures have been strong and are projected to continue to be strong what do you make of those arguments well I always point out first it's a communist totalitarian state so the figures are gonna be what they want you believe more importantly though even with that when we started looking at China China's nominal GDP rate was about 16 17 % and that's the important one for paying off their internal debt and it's now about 8% if actually ticked up from 6 because they've gone back to slightly inflation versus deflation so their nominal growth rates been cut in half in the last 5 years their markets have gone nowhere they'll be it with a lot of volatility but more interestingly we've been involved in sort of the first derivatives of China Macau iron ore companies cement companies shipping companies and they've been just absolutely terrific on the short side so in a general global bull market one of the few places you've been able to hide it's been in the China play Kyle you went public with your views on China a year ago and for you it's all about the banking system you have a great chart can we show it and can you help explain it sure this chart is a subset of what's most relevant the banking system to to the crowd what's important to understand what what Jim just said is is absolutely it's earth-shattering we're given given the build-out in both commercial and residential insistence oh we studied the banking system in the US Europe Japan and China and that's where I think our expertise is but when you look at their banking system they have an economy today of about 12 trillion dollars in GDP they have 37 trillion dollars worth of banking assets save 330 percent of their GDP in their banks to put it into context the u.s. going into the financial crisis was about a hundred and seventy percent of GDP including the non banks the fetty's the Freddie's the Fanning's and all the non-bank deposit or non depository institutions this chart here is a subset of that banking system and what's in what's relevant here if you remember the asset liability mismatches those vehicles that called structured investment vehicles or a BCP conduits those kinds of things where the liability side rolls very quickly but the assets inside are like seven ten thirty or assets so these are asset liability mismatched products in the banking system at our worst we were two-and-a-half percent of our system in asset liability mismatches and things that really brought the acuity of the crisis to the banks right away in China there's four and a half trillion dollars worth of asset liability mismatches today as per Chinese bank annual reports and that is almost four times as bad as the US was and so the point I'm trying to make is with the slide is in in kind of the worst possible kind of assets it's four times worse than we were at our peak in 2006 so for those that believe somehow China with a declining working age population in a banking system that's been recklessly built if we think China is going to grow six and a half percent from now on or eight percent nominally I just think that that they're wrong and I think that if you follow what's happening right now sometime in the next 18 months you're going to see a real banking crisis in China even even though they are a communist totalitarian government economic gravity takes over well to amplify on Kyle's point what you have know is you still banking system that is growing assets at two to three times depending on how big the shadow banking system is of nominal GDP so we think banking and shadow banking assets will grow somewhere around 20 percent this year put that in perspective that as he points out that will be new debt to the tune of six seven trillion US dollars in a ten eleven trillion dollar twelve trillion dollar economy and I would dare say that if the u.s. did a similar type stimulus say 10 trillion and new debt on a 17 trillion dollar economy we'd be growing at 6% – there's no magic to this I mean they're literally almost half of the economy's construction still after all these years it's still investment and so of course the problem becomes every time you finish a building you reset to zero you've got to start a building a building and this is the inherent problem and it's by the way very similar to something Kyle knows better than I do it's very similar to the Japanese model in late 80s except this was on steroids there's a big difference cell and molecular will let you start a big difference between China and Japan is China doesn't have any international assets right the Chinese people in general only have about 20% of their GDP invested externally so which China has this impossible trilemma they want to try to hold their exchange rate on constant they want to liberalize their capital counter to open their economy and yet they can't do those things all at the same time because it will decimate their currency so they made a lot of money by basically exporting cheap labor or cheap Labor's benefits to the rest of the world but if the Chinese are allowed to travel some more and buy some foreign assets it basically means it's just China's going to need to readjust that's not the end of the world this isn't a Lehman moment it's a moment that those are allocating money to Southeast Asia need to be really wary of in the next two years so just as with Jim a lot of people think that you are dead wrong you noted earlier this year that you've had numerous discussions with various Wall Street firms consultants other respected China experts and they almost all think you're wrong does this bother you when most people think that your own I know Jim Jim yes it bothers me play but I love to tell an anecdote so I'll leave the person's name out of the other conversation but last week the chief economist and one of the biggest investment banks in China came to see me and she had written a rebuttal to something that I wrote in February basically saying that the Chinese foreign exchange reserves aren't exactly what they're reporting and I went through a very detailed analysis using all the facts provided by China's two statistical services showing how the number didn't reconcile and she said well it haiman doesn't know what they're talking about Kyla's and he's talking about that the the sovereign wealth assets for the sovereign wealth fund are not included in the FX reserves and so I put a I put the sheet of paper in front of her that showed ten years actually for 20 years of this data series and I said well if it had been subtracted you'd see a step function change in the PBOC data series and she said well reporting out better in 2010 you just have to believe me you know and I think this this belief and I call it this apostolic belief in China's Chinese government's omnipotence is what everybody tends to believe in yeah right and if you just look at the facts right you wouldn't invest in China today and that that's the point that I make so all the arguments that I try to make are fact-based and not yea just believe in the in the in the government and I think that's a lot of what Jim does what I do and unfortunately it's a lonely place right you know what what's wrong with trust me what's wrong with apostolic belief in omnipotence oh it sounds very reassuring to me it does it it can be more profitable for a while but ultimately reality does tend to hold and you know look I'm being used to be called wrong I was married for 20 years so you know that's something that's something that Jim you get used to pretty pretty easily but but again the data the data is is telling us that something is unprecedented happening in this country and I think that that for those that believe in in the omnipotence of the Chinese Communist Party I would just simply point to 2015 as as the summer of 2015 when the government which had promoted the stock market and told people to go buy stocks on leverage in late 14 early 15 suddenly realized they had a problem on their hands and tried to put it in reverse and caused the crash and then just put out a series of just mind-numbing conflicting directives and orders to the financial markets and if anyone really thinks that this group of seven guys in a room has the markets figured out it has financial plumbing figured out they didn't it was very clear and so I think that you only need point to a little over a year ago to see the response in what was basically a stock market crisis
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