easy money (nov-11)

輕鬆賺錢

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How Do You Say “Easy Money” in Mandarin?

Conference Dial-In Number: (218) 339-3600 Participant Access Code: 722682#

Conference Playback Number: (218) 339-3699

Access Code: 722682#

Thursday, November 3rd, 2011

The call will begin promptly at 11:00AM EST

Agenda

Characteristics of a Bubble

Cyclical Slowdown

Logical Fallacy

Food for Thought

Agenda | 4

Bubble

Behavior

Manias, Panics, and Crashes

1. Compelling Growth Story

2. Blind Faith

3. Misallocation of Capital

4. Surge in Corruption

5. Fixed Currency Regimes

6. Credit Boom

7. Moral Hazard

8. Madness of crowds

9. Ponzi Finance

10. Bubble Valuations

Bubble Behavior | 6

Source: GMO White Paper, China’s Red Flags, March 2010

A Compelling Growth Story

CHINA’S CONTRIBUTION TO WORLD GROWTH

Bubble Behavior | 7

Blind Faith

Advantages over market economies

An advantage of a planned economy, one which was among

the most important for socialist economists of the early 20th

century, is that it is theoretically not subject to major pitfalls

of market economies and marked-oriented mixed

economies. A planned economy, in theory, does not suffer

from business cycles; it does not experience alleged crises of

overproduction such as the one that was believed to have

contributed to the Great Depression. From the modern

perspective, planned economies theoretically do not result in

asset bubbles – massive misallocations of resources such as

the dot-com bubble of the late 1990s or the housing bubble

of mid-2000s. Source: Wikipedia

Bubble Behavior | 8

Misallocation of Capital

Source: JPMorgan

CHINA CONSUMPTION & INVESTMENT AS PERCENTAGE OF GDP

Bubble Behavior | 9

Investment Boom in Historical Context

Source: Knight Capital

CHINA’S BOOM HAS SURPASSED ANYTHING WE HAVE EVER SEEN HISTORICALLY

Bubble Behavior | 10

Corruption

Bubble Behavior | 11

Fixed Exchange Rates

ACCUMULATION OF RESERVES FINANCED BY AN EXPANDING MONETARY BASE

Bubble Behavior | 12

Easy Money

LOCAL GOVERNMENT DEBT GREW 36-FOLD IN 13 YEARS!

Bubble Behavior | 13

Moral Hazard

GROWTH RATE OF LOANS & DEPOSITS

Bubble Behavior | 14

The Madness of Crowds

Bubble Behavior | 15

Ponzi Finance

OFF-BALANCE SHEET FINANCING HAS GROWN IN IMPORTANCE

Bubble Behavior | 16

Bubble Valuations

A TALE OF FOUR HOUSING BUBBLES

Bubble Behavior | 17

China’s Ghost Cities

Bubble Behavior | 18

http://www.youtube.com/watch?v=wm7rOKT151Y&feature=related

Cyclical

Slowdown

Yield Curve Warning of Imminent Growth Slump

Cyclical Slowdown | 20

Source: Bloomberg

CHINESE YIELD CURVE AT “LEHMAN LEVELS”

Chinese Credit Expansion: Too Far, Too Fast

CHINA IS A HIGHLY INDEBTED COUNTRY

Cyclical Slowdown | 21

Monetary Conditions Have Become Restrictive

CHINESE M1 & M2 GROWTH (YOY%)

Cyclical Slowdown | 22

Source: Societe Generale

Tighter Credit Driving Underground Lending

WENZHOU PRIVATE LENDING RATE

Cyclical Slowdown | 23

Large Volume of Shadow Banking Flowing to Real Estate

Source: Societe Generale

CHINESE PROPERTY DEVELOPERS ARE LOOKING EVERYWHERE FOR FUNDING

Cyclical Slowdown | 24

The Result – A Decline in NPLs?

The amount of bad debt held by mainland commercial

banks declined during the second quarter, the China Banking

Regulatory Commission said.

Problem, or “non-performing” loans dropped 2.4 per cent

to 422.9 billion yuan at the end of June while the non-

performing loan ratio slipped 10 basis points from March to

1 per cent in June.

- South China Morning Post

Cyclical Slowdown | 25

Logical

Fallacy

Consumption Share of GDP

2001 45.3% 34.6% 16.0% 4.0%

2002 44.0 36.2 15.6 4.2

2003 42.2 39.1 14.7 4.0

2004 40.6 40.5 13.9 5.1

2005 38.8 39.7 14.1 7.4

2006 36.9 39.6 13.7 9.7

2007 36.0 39.1 13.5 11.4

2008 35.1 40.7 13.3 10.9

2009 35.0 45.2 12.8 7.0

2010 33.8 46.2 13.6 6.4

Source: Michael Pettis, China Financial Markets

Logical Fallacy | 27

CONSUMPTION INVESTMENT GOVERNMENT TRADE

The Arithmetic of Consumption

46.0% 50.0% 54.0%

GDP Growth

2.0% 5.1 6.0 6.8

4.0% 7.2 8.1 8.9

6.0% 9.3 10.2 11.0

8.0% 11.3 12.2 13.1

10.0% 13.4 14.3 15.2

Source: Michael Pettis, China Financial Markets

EXPECTED CONSUMPTION AS SHARE OF GDP

Logical Fallacy | 28

The Implications

As consumption declined as a share of GDP, investment

increased. By definition, as China rebalances, this must

reverse.

Consumption has grown at a very rapid 7-8% annually over

the last decade. If it remains at this level, China can slowly

rebalance with GDP growth of 4-5%.

But history suggests that if GDP growth drops this sharply,

it will be incredibly difficult for income and consumption

growth to be maintained.

Logical Fallacy | 29

Food for

Thought

These Things Aren’t Banks

Food For Thought | 31

Chinese banks have very little breathing

room to absorb potential losses. A 12-

15% NPL ratio would erase all bank

equity.

Fitch reports bad loans could rise to 15-

30% of bank assets. NPL’s reached 40%

during China’s last financial crisis and

these loans are still lingering on China’s

balance sheet.

The recent surge in Chinese debt

exceeded credit expansions during the US

credit bubble, in Japan prior to its

property bubble and in South Korea

before the Asian Financial Crisis.

Copper Hangover

“China has for the first time revealed the estimated size of

its copper inventories, shedding light on one of the

commodity market’s biggest mysteries.

“Chinese copper inventories stood at 1.9m tonnes at the

end of 2010, more than the US consumes in a year,

according to estimates by the state-backed China Non-

Ferrous Metals Industry Association. The estimate is

significantly higher than the 1.0m-1.5m tonnes range that

foreign executives have assumed in the past.”

- Financial Times

Food For Thought | 32

Hot Money Indicator

RATES, RENMINBI, & HOT MONEY

Food For Thought | 33

Remnants of Smoot Hawley

CHINA’S LIQUIDITY PUMP HAS JUST BEEN SWITCHED OFF

Food For Thought | 34

Bottom Line

Every single case in history where countries have undergone

decade(s) of investment-led “miracle” growth has ended far

worse than even the most pessimistic forecasts during the

boom period.

China is the most extreme version of this growth model to

date. Why should it somehow find itself immune from the

consequences that have afflicted every one of its

predecessors?

Food For Thought | 35

Related Investment Positions

0.5%

139.7%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

Capital at Risk Notional Exposure

Chinese Yuan Puts

0.9%

81.5%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

Annual Carry Notional

Related Credit Default Swaps

1.9%

128.5%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

Capital at Risk Notional Exposure

Australian Interest Rate Swaptions

1.0%

112.9%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

Capital at Risk Notional Exposure

Australian Currency Puts

Food For Thought | 36

For more information please contact:

Mr. Christopher R. Pavese, CFA

chris@broyhillasset.com

Broyhill Asset Management

800 Golfview Park

Post Office Box 500

Lenoir, NC 28645

Phone: 828 758 6100

Fax: 828 758 8919

Contact Information