Is China set to go the European way?

Jun 14, 2011

In this issue:
» China's ravenous appetite for commodities
» US in worse financial shape than Greece
» QE3 seems inevitable
» QIPs are losing flavour
» ...and more!
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Debt is the big bad ugly word that is wreaking havoc in the US as well as the European economies. While the EU is grappling with the possibility of Greece defaulting on its obligations, the US is racked up so much debt that the US Fed has had to intervene in the market to buy a significant part of it. And so with the state of affairs looking quite bleak in the developed world, all hopes are on the emerging nations to rebalance the global economy.

But for that to happen, one will have to be assured that the emerging nations are not dealing with serious problems of their own. And that sadly is not the case. For while the developing world is growing at a healthy pace, this growth has brought with it the problem of inflation.

And that's not all! The massive amount of debt amassed in the developed world has so far grabbed the headlines. But one would be mistaken in assuming that these are the only economies that are dealing with the debt problem right now. For debt has become a burden for the emerging economies too. Take China for instance. The pile of debt incurred by local Chinese governments is being seen as a key threat to the world's second-largest economy. An estimated 20-30% of the loans are deemed to be at risk of defaulting. Official figures report that China has borrowed in excess of US$ 1.9 trillion (approx. 9 trillion Yuan) which could well be an under estimate. With the global economy already burdened with the sorry situation in the US and Europe, default on debt by the Chinese is something that it will be unable to cope with. And it's not just China. India too has been trying to bring its fiscal deficit lower. But the target now seems way beyond reach as subsidies rise on account of firm crude prices. Thus, a debt build up in the emerging nations of the kind seen in the US and Europe could have unfathomable repercussions on the health of the global economy. Best to assume that a major correction in asset prices is not impossible as the debt positions begin to unwind. It is now not a question of 'if' but 'when'.

Do you think that besides inflation, rising debt will be a major concern for the developing economies? Share with us or post your comments on our Facebook page.

 Chart of the day
China is a commodity guzzling behemoth. As today's chart of the day shows, the dragon nation accounts for a huge chunk of world consumption of various commodities. This when it accounts for only 9% of the world's GDP. With rapid industrialization, urbanisation and population growth, demand from China has seen a phenomenal growth. This has made the country the fastest growing in the world. Little wonder then that global commodity prices are becoming increasingly dependent on the actions of this Asian country. And a slowdown there would certainly have an impact on overall commodity prices.

Data Source: Business Insider

Just yesterday Greece became the country with the lowest credit rating in the world. This was after Standard & Poor's downgraded its long-term sovereign credit ratings by three notches to CCC. To give you a picture of how bad this is, let us tell you that this is only four steps away from default.

Now the shocking part...Several economists and investors think that the US is in an even worse financial shape than Greece. If you account for all the money needed to cover future liabilities arising thanks to programs like Medicare, Medicaid and Social Security, and other debts raised during the 2008 financial crisis, the total figure magnifies to nearly US$ 100 trillion. That kind of debt is much bigger than Greece or for that matter any other developed economy.

The US Fed has to stick to its deadline this time. Come June 30, 2011 and the US central bank must unwind the second round of cheap liquidity (popularly known as QE II). But what next? Will this be the inflection point for high interest rates in the US and other developed economies? Will this mean that the US and other debt burdened economies will soon succumb to a default? Legendry investor Jim Rogers does not think so. And the rationale that he offers for his argument has sufficient logic to it. Rogers believes that a third round of pumping cheap money is inevitable. Just that the Fed may not call it QE (quantitative easing) this time to avoid criticism. The Fed is well aware of the fallout of continuation of cheap money policy. But it can do little to avoid bankruptcies. The bond markets are giving out very clear signals of higher interest rates on the anvil. And the US Treasuries will be the worst hit with few takers. We agree with Rogers that QEIII, by whatever name, is very much on the cards. Taking away the punchbowl when the economy is still weak is just not an option for the US Fed.

There is an old saying in finance that one should borrow money when it is available and not when needed. This is exactly what the Indian companies seemed to have on their minds when they went on a fund raising spree in the form of QIPs in 2010. As per reports, QIP were amongst the most sought after fund raising route by listed companies in 2010. The bull run that happened that year helped firms get the best prices. Sadly, the event did not turn out to be a win-win situation for both the parties involved. Shares of 33 out of the 50 companies that raised Rs 225 bn combined through QIPs are trading below their issue price! Not surprisingly, shares of companies in sectors like real estate, textiles and construction have seen the maximum erosion. We of course agree that a period of one year is too short to arrive at correct conclusions. But the fact that the same deals done in 2009 - when the broader market was far more attractively valued - would have yielded much better returns cannot be ignored either. Clearly goes to show how even the most well informed investors don't like being greedy when others are fearful. And in the process, miss one of the most important market beating strategies.

According to an old American Indian saying, "Only when the last tree has died and the last river been poisoned and the last fish been caught will we realise we cannot eat money". Over the past few decades, the world may have progressed in many ways. But it seems like we have fallen behind where it really matters. According to the Food and Agriculture Organization (FAO), the number of undernourished people in 2010 was estimated at 925 m. This is higher than what it was 40 years ago!

The adverse situation appears to be caused by the Green Revolution of the 1950s. This movement introduced more productive food grains like rice and wheat to the world. It relied on high levels of fertilizers and pesticides which boosted food production immensely. But, at what cost? Gains in food production on one hand led to negative effects on natural resources. Land degradation, groundwater depletion, pollution etc, have become so serious now that it is threatening the future productive potential of land. FAO says that the global population is forecast to climb to 9.2 bn in 2050 from an estimated 6.9 bn in 2010. This would need a 70% jump in world agricultural production. Farming thus needs a major shift to more sustainable practices. Global leaders need to reach take strong action before it is too late.

In the meanwhile, the Indian stock markets have been trading in the green over the last two hours of trade. At the time of writing, the benchmark BSE Sensex was up by 38 points (0.2%). Capital goods and healthcare stocks were trading firm while oil and gas and consumer durables were trading weak. All Asian stock markets were also trading in the positive except Hong Kong. Europe too has opened in the green.

 Today's investing mantra
"Someone's sitting in the shade today because someone planted a tree a long time ago." - Warren Buffett

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4 Responses to "Is China set to go the European way?"


Jun 15, 2011

Who is to blame for the current situation that most countries have landed themselves into? Why do all the countries make the same mistake simultanously? All the countries have a huge mechanisim of financial planning and implementation. What motivates the Governments falling into the debt trap? WHO WILL HAVE TO INTERVENE TO CORRECT THE IMPENDING DISASTER ACROSS THE PLANET ? Real Estate is a major culprit which triggers the aspirational need of the citizens, the desire of living in bigger, better homes is one trigger which leads to debts being contracted.THE ANSWER to the current problems is to INVOKE the GOD of THREE.Let each man limit his needs to three of any thing. three sets of clothes, three family members, three meals, three rooms in a house,three vehicles, three of evry thing and no more; where FOUR or even the concept of FOUR is a sacrilage/ blasphemy.Let this religion of three continue to be practiced for Three years and the world will be a better place rid of all the evils. QED



Jun 14, 2011

Rising debts and fiscal imbalances are going to harm the Indian economy as well. The fundamental stimulus for both the chinese and indian economy was a large infusion of FDIs , whose outflow at any stage would cause difficulties for these two economies . The Indian economy in particular is needed to cut down its fiscal deficits drastically and the wasteful expenditures are needed to be curbed. The all round growth of rural economy is very much desired and the mindless urbanisation is needed to be stopped, so that the national development can take place. An important fact must be kept in mind that the prescription which suits a amall country like Singapore can't suit a country like India having a mammoth population.



Jun 14, 2011

"....Land degradation, groundwater depletion, pollution etc, have become so serious now that it is threatening the future productive potential of land...."

Finally something sensible from EM with respect to agriculture.



Jun 14, 2011

Eq.Master Team,
With all my humility fortified with abundant ignorance,I am prompted to observe a thought which flashed through my simple mind thus :

When an automobile goes up a mountain road with many "U" turns/bends, you may have to apply brakes to slowly negotiate the U Turns/Bends encountered while driving up the Hill !! But when you are coming down the hill( with the force of Gravity accelerating your vehicle)you require the brakes all the more as in a situation when the Inflation as well as Debt pile up
for many of the economies of the World !!

I had also read about the Four different forces acting on the Aircraft in four different directions called as "LIFT", "THRUST"," WEIGHT" and "DRAG". To make it a little more simple :Lift and Thrust have to balance as also the Weight and Drag before the aircraft could take off and be airborne !!
Similarly the economy also is to be balanced on all the four directions to facilitate it being moving at take off speed and to be airborne and gliding smoothly !!

I hasten to conclude !!

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