China too big to fail

In case you have missed it, there's a growing chorus of disaffected and probably dispossessed bears on the stock market who are doing their best to spook the market. One has got so desperate to be right that he's trying to short China!

In case market lingo escapes you, to short something means to short sell, say, a company that you think is overpriced and is heading for a share price fall anyway.

Short sellers are trying to either benefit from seeing a future price fall or to actually help bring it on.

One of world's most famous short sellers is James Chanos, founder of Kynikos Associates, who became well known for taking sets with his hedge fund against the likes of Enron before it collapsed and in 2007 went after Macquarie Bank's share price as it was heading towards $100.

The China bear

Now his new target is something somewhat bigger than either of those companies - it's a country called China.

The media has tagged Chanos as the China bear and he has christened China as the paper dragon.

He doesn't believe the country's economic statistics and effectively thinks the Chinese statistician along with the country's leadership is cooking the books!

If he didn't have such a memorable track record I reckon many analysts would simply say: "Sure, move on" but this guy is too big to ignore.

On the other hand, considering the critical and pivotal role that China plays in this 'Escape from Great Depression Mk II' drama we have all been living through, it has to be argued that like some of America's big banks, China is too big to fail.

Consider this, if Chanos is right, and let me hasten to add that I think he's wrong, then many of us would be heading to the soup kitchen in 2010!

The repercussions

From an Australian point of view, companies such as BHP Billiton and Rio Tinto would see their share prices decimated. This would take the Aussie dollar down to the 50-cent level, interest rates here would head to US-zero levels and in a letter we would be F'd!

I wouldn't want to even think about the double digit unemployment levels we would endure - it would be the economic Armageddon that many economists and media alarmists, sorry I mean commentators, warned us about around a year ago.

Chanos has room to manoeuvre, as there have been lingering doubts about Chinese numbers for many years.

I recall John Hewson once joking at a public conference that some government economic projection "had all the credibility of a Chinese GDP number" which drew a big laugh from the assembled media.

Hard to believe

However, I just don't believe that our Reserve Bank would not have pondered the credibility of the Chinese statistician. I don't believe the IMF, the World Bank, the US Federal Reserve and many of the international corporations that have invested billions into China would not have tested out the veracity of China's numerical portrayal of its economic health.

On the other hand, this week I interviewed Gerard Ryle, the author of the book Firepower, who pointed out that the 'magic pill' that promised to boost petrol productivity in cars was never ever tested!

Only when a sports reporter at the Sydney Morning Herald went to a Firepower sporting launch and was given some of the pills, which he then tested with no result, did anyone ask any serious questions. The same reporter also asked why he couldn't buy the petrol pills in any stores?

China watch

So, the obvious questions in the world of business can sometimes be ignored, especially when the business is founded by a genius of a conman, but a China fraud defies logic and other supporting measures. Measures such as the Baltic Dry Index, which is a gauge of the health of international shipping, is just one that has been heading up and confirms that the Chinese are in there buying.

There are also other measures that economists watch to verify China's GDP numbers.

The US connection

And the US Government and Federal Reserve have a major watch on Communist China for important reasons - it bankrolls American capitalism!

The US buys cheap Chinese exports with dollars and China uses those dollars to buy billions of dollars of cheap Treasury bonds, which underpins more US borrowing.

Under George W. Bush, the Government deficit-to-GDP ratio was 6% - similar to the Reagan era. However, since the GFC Obama and his team have pushed it to around 10%.

Now, given how important China is to the US recovery story, I just can't believe that there aren't seriously pointy head types in the USA, in the G20 and in major players such as Goldman Sachs and even our own Macquarie Group that haven't just tested out the China story.

Best bet

At the lowest points in the credit crunch after Lehman Brothers failed, I wrote in this column, and I was telling my business audiences, that we all had to pray for China - it was our get out bet.

Now I recommend two prayers. First, keep on praying for China and second, pray James Chanos is wrong this time!

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