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China: Yesterday’s WSJ article on Bo Xilal (page A11) highlights the issue that should provide pause to anyone blindly bullish on China and materials stocks. It reveals a story of monstrous leverage using property as collateral. When Bo Xilal rose to the top political seat in Chongqing, the city’s debt was estimated to be 162 billion yuan. At the end of 2011, at least one informed estimate approached 1 trillion yuan. I like the sound of “trillion” but it only translates into roughly $150 billion, perhaps not bad for one of China’s fastest growing cities. And maybe that’s not a lot by Western standards for a permanent population of 28 million but the rate of change is significant and places Chongqing’s debt at 100% of GDP versus China’s broader estimate for the country at 22%. The proceeds of borrowings and land sales went into highways, state owned businesses and social welfare programs. But unfortunately, these expenditures don’t throw off enough “income” to offset the cost of the leverage. (Let me know if you’ve heard this story before – perhaps while travelling through the warmer climes of the EU.) Taking on debt against land at all time high prices is exactly what got the rest of the world in trouble. Add in the debt on developers’ balance sheets and leverage at the business level through off-balance mechanisms such as LOC’s and household real estate purchases at prices that exceed current levels and the only difference between China and Spain will be the color of the rice. Of course that’s an exaggeration but suffice it to say that perhaps China does not have the iron grip on its politicians, people and economics that so many pundits, economists and portfolio managers give them credit for. With the central government’s decreasing appetite for individual excess – 感謝什麼，博 (Translation: Thanks for nothing, Bo) I doubt that there will be as much sympathy for fat cat capitalists who have traded their Mao suits for Prada as was shown to the indebted by the rest of the world. And I doubt Chongqing is the only city modernized by taking on significant debt as Bo is not the only politician seeking to climb the political ladder by leveraging the future. In fact it is estimated that local property sales accounted for approximately 40% of revenues and lending for cities throughout China. Wu and every other politician has been very clear in stating that property prices remain too high. Three cities, including Shanghai, have tried to ease property controls but the government forced their immediate cancellation. Yup, the rulers on high are resolute n sending a message that excess, driven by inflating property values at the risk of the people, is over. The only question is if they caught it in time. Fortunately, I don’t have to answer that question since the near term impact will be the same.
The great unwind in China is on its way. Let’s see how that works out as their export economy fades. And how it works out for us.