Hugh Hendry remains bearish on China

Hugh Hendry of Eclectica Asset Management hasn’t written for quite a while, nor has he been actively out there on the telly as his clients “ban him from media appearances”.

Hendry has been bearish on China for quite a while, since he posted a video talking in his Scottish accent in front of large empty buildings in China talking about bubbles. That was long time ago, and bulls must have thought that he was wrong.  But he made money from his short China positioning.

In his latest commentary to clients, I was therefore interested to find that, if anything, Hendry is more bearish on China and Japan, but relatively optimistic on the US:

This might be the year everyone else notices this; the year panic over Chinese economic growth comes to replace the market’s morbid fascination with the travails of the European continent and the year in which we see that the US is not giving way to China in terms of global economic leadership. There is a near consensus that China will supplant America this decade. We do not believe this. We are more bullish on US growth than most. The momentous nature of recent advances in shale oil and gas extraction and America’s acceptance of the unpleasantness of debt and labour price restructuring looks to us as if it is creating yet another historic turning point. By embracing his inadequacies and leaping on his luck, the strong man may have finally broken the binds that had previously held him back. We are also more pessimistic on Chinese growth than ever. This makes us bearish on most Asian stocks, bearish on industrial commodity prices, interested in some US stocks, a seller of high variance equities and deeply concerned that Japan could become the focal point of the next global leg down. On the plus side we also believe that we are much closer than before to the beginning of a bull market of perhaps 1982, if not 1932, proportions. We just need the last shoe to drop.

In his view, the problems we are see right now in the economy is a result of fixed exchange rates like the euro and the Dollar/RMB peg, somewhat akin to what happened in the 1920s and 1930s in terms of creating global imbalances:

Back then the relevant fixes were around the gold standard. Today it is the dual fixed pricing regimes of the euro countries and of the dollar/renminbi peg.

On China and the dollar/RMB peg specifically, he has rightly pointed out how we have come down to this.

China got accepted into the WTO, America set a course for a weaker currency post the NASDAQ crash and the dollar’s real trade-weighted value took a nose-dive. This was initially great news for the Chinese. Net exports as a percentage of GDP doubled in the two years from 2005. Then they doubled again. The overseas sector contributed less than 5% of GDP growth in the four years to 2004 but 20% between 2005 and 2008. At the same time the current account surplus reached its zenith at almost 10% of GDP.

According to the rights of economic principle at this point the renminbi should have appreciated considerably. This was not allowed to happen. The scale of Chinese FX interventions became legendary as bureaucrats sought to maintain the cheap currency…

… The central bank kept the deposit rate low, incredibly low…This appalling rate of return on bank deposits probably accounted for 20% of the decline in household disposable incomes as a share of GDP over the period 1992 to 2008 and significantly contributed towards the consequent collapse in consumption relative to GDP… Instead of accepting low rates on their money in the bank, they became a nation of property speculators…

To his mind:

It has long seemed to us to be the case that this economic crisis would start in the US and make its way to Europe. That has happened. However, we also think it will end in Asia.

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  1. He also ended the note with this:

    “We are, as a result, long the debt saddled west and short the vastly over vaunted and over owned BRICs.”

    The US might do better than China but I think he’s overly optimistic. This comes down to whether you think deleveraging will return to trend (Hendry?, Terry McFadgen) or whether you think total private debt to GDP needs to drop to 60s and 70s levels (Keen,Koo). The latter view would suggest a bottom occurring further out from now (5-10 years).

  2. Just Dismal 2

    China has built a vast economic time bomb, in my view. It now has fixed asset investment exceeding 50% of GDP, and yet to hold up the superficial GDP, fixed asset investments are growing at 25%, far exceeding the GDP growth itself. Jim Chanos is absolutely right, that this is a treadmill to economic hell.

    Speaking of hell, recent events have shown conclusively and beyond reasonable doubt that the political regime over there is evil. Perhaps it is inevitable then, that the Chinese economy is being led down the path to hell. It is better that Australia should unhinge its economy as quickly as we can from the runaway train driven by an evil regime.

    From here, the regime will either be burned in the fire of rampant inflation as they desperately print money to keep the ship afloat in a sea of unrecoverable bad debts to SOEs, corrupt cronies and local governments; or risk being frozen to death in a deflationary spiral as the gigantic investment bubble burts. Negative real rates for an economic supposedly growing at 10%pa? Things just don’t add up.

    There is no way out.

  3. Cognitive Dissonance

    I admire this guy for a number of reasons and would part with much more to have lunch with him than post 2007 Warren Buffet.

    As always a fuller qualification of what he mains when he says things are , in my view, most important.

    The full letter here :

    I am undecided on the USA outlook, part of his optimism is based on the large gas findings in the States but they also have too many reasons to over state these

    I find myself taken by his China view

    • interested party

      He mentions shale oil as well but the EROEI doesn’t stack up to meet current lifestyles. I don’t dispute what he is saying at all, on the contrary, I am asking myself “what am I missing here” in regards to a long call on the US.

      • Yeah, US gas production is booming (due to fracking etc) but oil is a different story. I very much doubt we’ll ever see US oil production come close to the 1970 peak.

    • US gas production is not booming. It has merely managed to remain on a long running plateau.

      Shale gas has made a difference because it has let them maintain gas production where conventional gas sources have been depleted.

      Note that they still do not produce more gas then they consume, thanks mainly to imports from Canada.

      I’m not disputing the current benefits of shale gas to the US economy. But they have a way to go before they become energy independent. From memory roughly one third of all US energy is still imported.

      • From memory roughly one third of all US energy is still imported.

        No, more like 50%.

        Pie-in-the-sky projections see this falling to about 36 percent by 2035. Never happen, IMO.

    • His conclusions make sense to me fo a number of reasons: US has favorable underlying demographics, has been deleveraging since 2006 (even if there is still a long way to go) and has the potential for manufacturing, innovation etc plus a large economy and the reserve currency among other things.
      China has a bubble of unknown dimensions and has only recently started the battle to tackle it.

      It is stunning how people still believe that full blown bubbles can somehow be managed in a controlled fashion.
      IMO they can’t be managed any better than a soapy bubble while it’s bursting in front of your eyes.
      Bubbbles can be prevented and their formation slowed down. They should never be blown on purpose.

      That’s why I think Hugh Hendry may well be right. US could quite possibly be the first on track towards recovery from this mess while some of us are only about to enter the mud pool.

        • I’ve tried to reply a few times but cannot get them through. Can’t be bothered with a long response anymore but just saying that I expect and fear a global depression and then the US being amongst the first to recover.
          We are not there yet, IMHO.

          • interested party

            Sad to say but I agree.

            I don’t know about the recover bit….can’t get my head around what that picture looks like.

            Feels like we are rearranging the deck-chairs and going through the motions, but the direction seems set in stone.

            I would love to be wrong.

          • My long response included wondering who controls the oil prices.

            And a silly thought,wondering whether defaulted US home owners end up renting the house they used to own from the government. DC dared to say that aloud the other day and the thought has crossed my mind. Could happen if oil is a persistant obstacle to QEing?

          • interested party

            I have read somewhere that the Saudi’s need $100+ to pay for the social promises made during the Arab spring( to retain control) and put this with the work of Chris Martenson and you get a pretty good idea on the price drivers.
            I believe housing will revert to being shelter again and will fade as an investment vehicle(mostly). Society won’t support another binge like the one we all took part in of late, and I believe we will need something of that magnitude ( another binge) to clear the crap to set another one up……I just cannot see it.

            Peak Hopium!

      • interested party

        Nial Ferguson has a valid view of the US as a fading empire and describes the US as a complex system that lives on the edge of chaos. There is a conflict of opinions here and i respect both the guys and pay attention to there arguments. But can they both be right?

        Can’t remember the link for NF though, sorry.