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Will China Collapse?

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Gordon Chang of Forbes.com and author of the book, "The Coming Collapse of China," believes the miracle that has been Chinese growth (or perceived growth) is finally going to end.

He delivers compelling evidence - some of which has been supported by the Wall Street Journal and other sources. Here's the argument why China will collapse in the next six months.

Following this discussion, I'll play devil's advocate and tell you why China won't collapse. The source for this information comes from an interview with Gordan Chang on Yahoo! (YHOO). You can listen to that interview here: http://finance.yahoo.com/blogs/daily-ticker/wheels-coming-off-china-economy-gordon-chang-132618523.html#more-7963

I've also grabbed snippets from the summary article on Yahoo!. The same URL will get you that source.

As a quick (very quick) motivation as to the importance of China, let's just take one short quote from an interview today with Goldman Sachs (GS) executive Jim O'Neil - the man who coined the concept of BRIC (Brazil, Russia, India and China).

"Our future prosperity depends on China being successful."

So what happens if China is unsuccessful?

Why China Will Collapse in 6 Months

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Gordon Chang, author of "The Coming Collapse of China" and a columnist at Forbes.com, has been sounding the alarm bells about China for years and backs up his prognosis with recent government data: electricity consumption is flat, car sales - a bellwether for consumption - are flat, property prices are collapsing - even in cities like Shanghai and Beijing, industrial orders are down - especially those relating to the domestic economy.

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What does Mr. Chang mean by collapsing property values? According to him, property values fell by 30% in Shanghai and Beijing in the month of October, alone. 30% !? If true, that's, well... it's unbelievable.

The Chinese government (and the world at large) has been vigilant if not obsessive about China's rate of inflation. Most of the focus has been on keeping it from going too high as elevated inflation would prevent them from flooding the economy with money. But, the numbers reported by the Chinese government state that inflation fell from 5.5% in October down to 4.2% in November. Good right? Well, Chang claims that inflation dropping is a problem if it's too fast - and he's right. If those numbers are accurate - 1.3% in a month is almost preposterous. If repeated, that's not a slowdown - that really is a collapse.

China's fix (actually the entire world's fix) for a potentially fledgling economy has been to pump money into the economy. But, there's a problem with that now.

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Gordon says China cannot pump more money into the system to stimulate growth because of "questionable bank loans" and the high number of local Chinese provinces in debt.

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That doesn't sound very good. Actually, it sounds pretty bad. Chang then drops a bomb with a statistic on Chinese M2. He claims that China's M2 at the end of November was 34% larger than the United States' even though the US economy is more than twice the size of China's. In other words, there is money and liquidity - some could say, a glut of liquidity. In English, the liquidity that's present isn't getting used so adding more money won't do anything. As Chang puts it, "They've already built their ghost cities."

Let that last quote ring in your ears...

So why the slowdown? Why is the money not going anywhere? According to Chang the EU (collectively) is China's largest trading partner, and well, we know about the EU.

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There are several factors contributing to China's slowdown, and Europe certainly plays a big factor. Europe is China's largest trading partner and Chinese export orders in November dropped sharply from October, rising 13.8% last month from 15.9% in October. As reported by The Wall Street Journal, China's labor costs are no longer considered "cheap" as fewer migrant workers choose factory jobs, thus "pushing up labor costs."

"We'll see more obvious signs of deterioration in the Chinese economy over the next six months," says Chang.

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Slowed growth is scary, but 13.8% month over month seems pretty good. Of course, unless the number is fictitious.

Chang claims that throughput stats and air cargo numbers combined with worker malcontent - protests, etc, point not to growth, but to a massive slowdown. In English, while the slower growth that's been reported in and of itself is a signal of a potential collapse, he seems to be hinting that there isn't a slow in growth, but rather an actual decline. A decline large enough to cause riots.

But, it gets worse... Chang says, "China has political paralysis right now. [...] This is a critical period for not only the economy but also for society."

The Yahoo! Article reads:

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China's recent economic problems may be disconcerting, but the country faces a much bigger dilemma: its political system. Chinese officials have cracked down on recent protests, such as last week's social unrest in the village of Wukan. The Chinese government has been unable to silence media reports, an unusual outcome for a country that closely monitors and censors the daily interactions and Internet activity of both dissidents and citizens. Chang says the riots, bombings and insurrections taking place in local villages and provinces has led to an "unprecedented campaign of coercion" by Chinese military and police but "the more they clamp down, there more protests" will result.

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Chang points to not only the number of protests and protestors (which he put sin the hundreds of thousands), but that they have turned into "insurrections" - riots, bombings and violence.

He claims that there's a standoff in a village in Wukon which he refers to as "the heart of the export belt" which if not handled properly by local authorities could spread throughout China and cripple China.

On a side note, I have written a few times about specific Chinese companies and what seems like openly fraudulent accounting. I wrote an article posing the question if China is the largest accounting fraud in the history of financial markets - a state backed epidemic. You can read that article here:

Focus Media (FMCN) - Is China A State Backed Accounting Fraud Epidemic? http://livevol.blogspot.com/2011/09/fmcn.html Ok, that's the doomsday scenario. Here's another take.

Why China Will Not Fail

Henry Blodget goes on to remind us that it's been nearly two decades now since analysts with expertise in China have been claiming the collapse is coming. But... it hasn't yet. Or at least, we don't think it has. During the 2008 financial collapse China pumped money in and... it worked.

Going back to the number, China reported that inflation fell from 5.5% in October down to 4.2% in November. And Chang claims that the inflation dropping is a problem if it's too fast. But, in the same breath, he says that inflation is likely twice the number that the Chinese government is reporting. So either inflation is dropping too fast, or it's over inflated - which one? If it truly is twice the reported number, then the M2 glut is working - the velocity of money is high and more pumping will work.

The thing is, we just don't know. But we haven't known for a long time with China - it's all coerced data - internally and externally. And if that's the case, is it possible that it's neither too high nor too low inflation? Or, maybe more accurate, is it possible we just don't know, and if so, then we can't take a stand one way or the other? Certainly not to the point of calling for a collapse.

My View

Anytime a government (especially in a Command Economy) is accused of hiding and manipulating data (and propaganda) it's troubling. China has gotten to the point where it's almost just accepted - yeah, they don't tell us the real stuff, either on a macro level or on a micro (company-by-company) level. That's worked - whatever the numbers, that country has been pushing global markets and demand with cheap labor costs.

But, we need not look further than our own fraud epidemic in 2000. NASDAQ fell by 70% -- remember those days? If China follows that model, but worse as the above analysis accuses, the result could be... well... Cataclysmic.

But then again. We'll recover, and move on to our next fraud or bubble.

Right?...

OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits.

Ophir can be followed on Twitter at twitter.com/Livevol_Pro.

At the time of publication, Ophir Gottlieb held no positions in the stocks or issues mentioned.

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