The Signals that Tell Us to Short China

Bill Bonner - Tue 19 Jan, 2010

Typically, investment wisdom evolves over generations of trial and error...

Waterford, Ireland

Oh happy days are here again. Obama is going to get our money back from the banks. Jeffrey Sachs is telling Haiti how it can get its economy back in order (with other people’s money, naturally). And Thomas Friedman is offering investment advice.

This should be fun. We’re all on the bus... and it’s driven by the blind, the deaf and the very dumb. Oh, sorry, we meant the visually impaired... the hearing impaired... and the mentally deficient.

Friedman is, as we all know, full of advice on just about everything. He advises finance ministers on how to soup up their economies. He advises the Arab world on how to update its religious institutions. He advises whole nations on how to improve the future before it happens.

And here he is now counseling Mr. James Chanos, noted short seller, on how to make money:

“China’s markets may be full of bubbles ripe for a short-seller, and if Mr. Chanos can find a way to make money shorting them, God bless him. But after visiting Hong Kong and Taiwan this past week and talking to many people who work and invest their own money in China, I’d offer Mr. Chanos two notes of caution.”

First, he says: “Never short a country with $2 trillion in foreign currency reserves.”

Typically, investment wisdom evolves over generations of trial and error. People come to see what works and what doesn’t and pass on this wisdom in the form of cautionary rules. But how many times have investors shorted a country with $2 trillion in foreign currency reserves? Where does this wisdom come from? Not from experience. Nor from any theory we’ve ever heard. Which makes Freidman’s first bit of advice no better and no worse than every other bit of advice he’s given over the years.

It’s his second bit of counsel that causes muscle cramps:

“Second, it is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called “excessively rising house prices” in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles.

“And that’s the point. I am reluctant to sell China short, not because I think it has no problems or corruption or bubbles, but because I think it has all those problems in spades — and some will blow up along the way (the most dangerous being pollution). But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us).”

Get it? Like... China has all these problems... see? And, of course, its problems developed because of or with the connivance of its government. But it’s gonna solve these problems... see? Because its political class is focused on them.

We can hardly type the sentence. Our diaphragm is contracting in such spasms of delighted cynicism; our fingers shake... our brain recoils.

Yes, dear reader, China’s political class – communists, remember – are going to solve the problems of a dynamic, market economy headed for a blow up.

That settles it for us. We have friends on both sides of this play. Jim Rogers is long China. Others are short. But Mr. Friedman has just given us the Sell Signal of All Time. Every smart investor on the planet – all two or three of them – should short China now. If Friedman is long; you have to be short. Heck, even the angels are selling their China shares and the gods themselves are calling their brokers.

Friedman is long China. What’s he short?

“I’d rather bet against the euro,” he says.

Well, there you have it. A buy signal for the euro.

Nobody has ever liked the euro. The typical analyst is against it. “The US government stands behind the dollar,” he says, “but who stands behind the euro? Nobody.”

That’s as deeply as most analysts care to think about the subject. If no one stands behind the euro, it must be a weak currency. If it is weak, it must be weak as compared to something. The dollar, for example.

Here at the Daily Reckoning, we think the typical analyst errs. As for Friedman, he is beyond error. Mistakes only happen to people who bother to think about things enough to make the wrong choices. Friedman’s thoughts are not that profound. He errs like a squirrel or a donkey errs, not by thought but by instinct. He is wrong, not by accident, in other words, but by design; he is made for it.

Friedman’s pensée is not prone to error; it is fundamentally flawed, like a kitchen sink that is plumbed backward. You turn on the cold water, and it comes bubbling up out of the drain. You turn on the hot water and you hear Frank Sinatra.

How else could a walking, talking human being believe such preposterous and foolish things? Don’t bet against China because its political class is focused on its problems? Oh stop... our stomach muscles can only take so much...

Economic problems, meltdowns, and crises can be caused by politicians; there is not a single example in the historical record where they have cured these problems. (The only exception is when they stop doing damage... temporarily, like a boxer who lets an opponent get up from the mat before slugging him again.)

Which brings us back to the euro. The continental currency is despised for the wrong reason: because no nation is actually capable of beating it up. All the world’s other paper currencies are controlled by people intent on weakening... or destroying them. The euro’s out of the ring... controlled by... well, no one in particular. It’s run by a group of countries that can’t agree on how to ruin it. The euro benefits from eurosclerosis. The Irish and Greeks want a weaker currency. The Germans want to keep it strong. The French can’t decide what they want. Result: paralysis. No one will rush to save the euro. But no one will rush to kill it either.

Besides, if Friedman is agin’ it... we’re for it...

More news and investment ideas… from behind closed doors:

“The world we live in is changing fast,” writes Victor Hill in the latest issue of the monthly investment communiqué from The Zurich Club. “The earth’s climate is changing, the economic balance of power is shifting, resources are becoming more scarce and consumption patterns are radically altering.

The Zurich Club doesn’t make general statements about the welfare of our planet without there being a point. It’s a private group of investors who pool their expertise and share their ideas about how to make money in the markets.

So moving right along, here’s Victor’s money point...

“One of the biggest investment stories this is going to create over the coming ears is that of a boom in land-grown commodities.

“The prices of coffee, cocoa, sugar, grains, fruit, cotton, edible oils et alia are going to soar. In fact, it has already started.”

[Many Daily Reckoning readers will already know about the huge rally that has been seen in the price of sugar over the past year. It more than doubled in 2009 and has recently hit the highest price in 29 years…]

“Cotton prices have more than doubled as global production has declined and consumption had rebounded.

“Wheat prices also have risen dramatically. The price per tonne in March 2009 was $200, while it hit $247 in June 2009.

“A similar story could be told for many in the long list of agricultural commodities available.”

OK, so we get the picture. The price of ‘stuff’ is going up in a big way – just like commodities guru and friend of The Reckoning, Jim Rogers, said it would in his 2004 classic, Hot Commodities.

Why, though, Victor? Why will land-grown commodities keep going up from here. And how do we play it?

Victor explains in his very revealing 2-part article: “There are many discrete little reasons for the coming boom. But essentially there are three forces in play.

“The first is population growth - in particular the rise of a consumer-oriented middle-class in the BRIC ( Brazil, Russia, India and China) and other developing countries.

“Second, high oil prices are boosting the demand for bio-fuels. This means energy crops such as wheat and rapeseed are in high demand.

“Third, climate change means that rising temperatures may retard agricultural growth in traditional producer countries – especially the USA and Australia, where a prolonged drought has already had a seriously negative impact on production.”

It would be easy to play this trend through a soft commodities exchange traded fund. There are many to choose from – just google “agricultural commodities ETFs for a few ideas.

But Victor has worked a little harder than that. He’s found a couple of far more interesting and unusual plays.

For example, one is a way to earn a decent yield from land in the Ukraine. Land is cheap there at the moment. But that should change.

“ Ukraine enjoys a favourable climate for growing crops. It has superlative soil quality. And farming techniques in the country are constantly improving,” writes Victor.

That means prices should go up. And Victor’s found a simple way to buy into that trend. You can read about it in the latest issue of The Zurich Club’s communiqué.

Click here to discover how to access this and all of The Zurich Club’s impressive investment ideas. (Note: Make sure you learn also about the Club’s much talked about “blue chip landlord” strategy. You’ll discover this, too, when you follow the “click here” link above.)

Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.

And more opinions... thoughts and reckless reflections...

*** Markets were closed in America yesterday. In the rest of the world nothing much happened. This leaves us free to talk about whatever we want.

What do we want to talk about?

Let’s talk about Japan. You remember, Japan? It’s the country with the 20-year on-again, off-again depression. You could have bought stocks in Tokyo 20 years ago... held onto them... and guess what you’d have today? Well, for every dollar you invested two decades ago, you’d have about 25 cents. How’s that for ‘stocks for the long run?’ How’s that for capital appreciation? How’s that for getting rich from investing?

Stocks in Japan are back to their levels of the mid-‘80s. So, an investor who was 40 in, say, 1984, is now 66. He’s retired. During his ‘investing years’ he made zero... nada... rien... zilch... from his money.

What to make of it? Is the whole promise of investing nothing but a Wall Street fantasy? The idea is that you can give your money to Wall Street... put it in a fund... in stocks... in some sort of investment... and it will grow larger. You will pay Wall Street a fee for this service. In fact, you could pay a lot of money... trading in and out of various investments.

And where would you end up? Well, if you were the typical Japanese investor you’d end up with less than what you started with.

The lesson we draw from that is that you only make money from investing when you buy assets that are cheap and sell them when they are dear. ‘Buy and hold’ doesn’t work. ‘Stocks for the long run’ is a trap.

But what about Japanese stocks now? We thought you would ask. Since we announced our new ‘Trade of the Decade’ – sell US Treasury bonds/buy Japanese stocks – we have gotten nothing but grief on the subject. Everyone thinks he knows what will happen to Japanese equities over the next 10 years; and everyone thinks they will go down.

Here is Ambrose Evans-Pritchard in London’s Daily Telegraph:

“... 2010 will prove to be the year that Japan flips from deflation to something very different: the beginnings of debt monetization by a terrified central bank that will ultimately spin out of control, perhaps crossing into hyperinflation by the middle of the decade.

“Once a country embarks on such policies, the game is nearly up. The IMF says Japan’s gross public debt will reach 227pc of GDP this year. This is compounding at ever faster speeds towards 250pc by mid-decade.

“The only reason why this has not yet blown up is because investors (mostly Japanese) have not yet had the leap in imagination required to understand their predicament, and act on it. That roughly is the argument of Dylan Grice from Societe Generale in his latest Popular Delusions note released today. “A global fiasco is brewing in Japan.”

We don’t doubt it. Evans-Pritchard is right. So is everyone who thinks Japan is going to meltdown or blow up. A global fiasco is brewing. But it will not necessarily be bad for Japanese companies. Investors will leave Japanese debt and buy Japanese equities. Inflation will reduce the real cost of operation for Japanese companies. Frugal, solvent, efficient Japanese companies will prove to be a refuge, not a trap.

More on this subject as the decade progresses. We will be proven right... or wrong... Geniuses... or idiots... Visionaries or hallucinaries... depending on how the chips fall.

Until tomorrow,

Bill Bonner
For The Daily Reckoning

P.S. Back on the subject of the euro, one guy making real money from betting against it is our friend Tom Tragett. We told you about him in our email on Saturday (it had the subject line: “Good news is: you could be involved in the next incredible trade”).

You may recall that Tom recently opened up a trade for his readers, betting the euro would fall against the pound sterling. Well it still is. Tom explained this morning: “Continuing concerns over Greece’s future is a massive drag on the Euro. Another show in that respect, say Portugal or Spain and Trichet will get the weaker Euro he seemingly so desires…”

It’s too late to enter this trade now. But Tom’s looking for a new Forex trade right now. You could be involved in that next trade.

Spread betting is not suitable for everyone - ensure you fully understand the risks involved and never risk more than you can afford to lose. Fleet Street Publications Ltd. 0207 633 3600.

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