Monthly Archives: November 2011

A brief thought about growth risks facing China over the next 3-5 years

Extracted from an email sent to a friend:

I reconsidered our conversation over the weekend – if I may, I would like to add three points to crystallize my view on the growth challenges/risks facing China in the next 3-5 years:

First, China’s medium-term (3-5 year) problems are originated from the structural problems underlying the country’s credit/banking system. What we saw in the past decade were consistent financial repression, overdue preference to SOE lending over SME financing and regulations that stifle the development of non-bank financial activities. It resulted in problems such as over investment, excess liquidity in the system, fast accumulation of overall indebtedness of the economy and lack of SME financing.

Second, excess credit growth in China has led to another severe problem: many stakeholders in the economy are increasingly rely themselves on pro-cyclical sectors such as land, housing and commodity (including rare earth). It is hard to estimate the severity of impact on China’s financial system and whole the economy once those sectors face serious external shocks.

The third is the political issue. China is going to face major change in political leadership next year. Before the official announcement, there are already some speculations on new political leaders and future agenda. New authorities (both central and local) tend to “take a great leap forward” in their first few years of governance by, for instance, boosting short-term GDP growth while putting the sustainability of growth into secondary concern. That would possibly risk delaying the reform in China’s financial system and is not helpful to “unwind” China from pro-cyclical sectors.



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Buying luxury?

An FT article last Friday “China’s elite have new international outlook” ( )talked about an “elite” fair held Beijing where rich Chinese people were eager to chat with agents of foreign luxurious assets (eg. French wine, Manhattan penthouses and alien islands), and attempted to search a “safe” place abroad to store their massive wealth. The article went to say elite’s worry about future domestic economic crisis in China and outburst of political instability.

While I agree that the next crisis in China would almost definitely be a domestic one not one driven by external shocks, I attempt to avoid the guessing of the timing in political fight and social issues, given my shallow understanding in political issues. Therefore, I am more interested in exploring the cause of the “off-the-table” export of Chinese wealth and their impact on both senders and recipients.

Start with the impact. From the perspective of the wealth owners, it is definitely not a good financial decision, despite the fact that luxurious assets are able to absorb the massive wealth in one go. They are luxurious assets whose prices are pro-cyclical in nature. In other word, if one puts the bulk of their wealth in such assets, they have to actively manage them (eg changing their weight in the portfolio based on the timing of business cycle) in order to achieve the goal of capital preservation. Nonetheless, most of the Chinese buyers certainly do not have the ability and time to actively manage these assets – they have misunderstood the pro-cyclicality of the luxurious assets and mistreated them as assets of safe heaven.

From the perspective of recipients, ie the foreign countries with luxury brand of assets to sell, two things need to be considered. On one hand, inflow of capital is generally beneficial to these countries who usually have to finance their current account deficit. On the other hand, though, luxurious assets tend to increase the income inequality in the society. One of the most obvious channels is inflation and government tends to fight that with increased benefit and social welfare. However, in today’s world whether governments in the developed countries have to tight up their belt and hence reduce their ability to contain wealth inequality, receiving capital in luxurious assets may not be doing good to the economy on balance.

A view from capital allocation is also worth mentioning here. What today’s world needs is financing and investment in the real productive sector, as banks are deleveraging and people are reluctant to lend to even profitable businesses due to economic and political uncertainty. Against such backdrop, massive wealth exported to non-productive (at least not the most productive with the most profound impact on the economy) sector such as the luxurious assets is definitely ironical and worth serious concern. As a separate note, taking the view from capital allocation can help derive the conclusion from taking on the view of wealth owners and/or recipients.

As to why this happens, most Chinese should have already known the answer: the illegitimate element in the accumulation of wealth in the past two decades motivates people to find “safe heaven” without considering whether it is financially rewarding. Ineffective property/wealth protection discourages people to store wealth domestically. Business hurdles, political intervention into business and poor property (including intellectual) protection are obstacles to setting up business and making investment in domestic companies. More importantly, the existing capital control prevents a healthy outflow of capital and diversification of wealth into foreign assets. People simply lack legitimate channels to export wealth to profitable assets, eg setting up offshore funds/account to invest in foreign real sectors.

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