Short China and the Not So Great Depression

By: Peter_Navarro

Since February, I have called the market trend as a sideways pattern.  This kind of trend dictates a move out of equities for the small active retail investors.  I reiterate that call now and see far more risk to the downside than reward to the upside.

I note that anyone moving to cash as of my February call would have given away no upside profits and would, at this point in time, have been protected from a more than 10% loss.

I also note that since February, Investor’s Business Daily has repeatedly missed the market trend, suckering participants into the market with announcements of “an upward market trend,” only to reverse itself in the face of obvious evidence to the contrary.

Finally, I note that the financial press has a strong aversion to cash calls and any urging to “stay out of the market.”  It’s all about the day to day action for the business journalists and pundits – but that won’t make you a dime unless you are a very active day or swing trader.

At a personal level, I continue to hold roughly 20% of my portfolio in non-cyclical small cap biotech while – and I don’t recommend this to others – I have been short the Chinese market using FXP.  For reasons I explain below, China’s equity market offers far more downside risk than upside at this point.

Finally, in what may be my version of Custer’s last stand, I am scaling into a short of the long bond by buying TBT below $20.  This is an ETF loyal readers will know that has taken its toll on my own portfolio over the last year because I failed to see the importance of periodic flights to dollar safety from Europe despite the weakening of the dollar.  But just as I kept nibbling at shorting the housing market pre-2008 and kept getting burned, I will continue to short the long bond as I see an eventual huge gain – just like the housing short.

Here’s an overview of the foundations of my cash call: The central problem facing global stock markets are major structural imbalances across regions that prohibit a robust economic expansion that all parties can benefit from.  In a nutshell, the U.S. and Europe still consumer too much and export too little while massive fiscal stimulus is now giving way to a rapid contraction in government spending.  China, for its part, remains far too export-dependent while Japan is simply over and only South Korea, Thailand, and the Philippines are likely to be resilient enough to prosper over the longer term.  And yes, Vietnam will be the next big growth story in Asia – after the current recession/depression runs its course.

Now a bit of a closer look:

The United States: America’s economy is looking increasingly like an economy only capable of generating meager GDP growth rates -- in the realm of 1% a year rather than the greater than 3% we need to get over 20 million Americans back to work. 

Consider that from 1947 to 2000, America’s GDP grew at a rate of 3.5% a year.  From 2001 to now, however, we are averaging less than half that!!!!!!!!  Yet most politicians and economists are in denial about this.  They think what is happening is a short run cyclical phenomenon and keeps recommending stimulus – government spending if you are a Dem and tax cuts if you are a Rep.  It’s all so much garbage.

In fact, America’s central problem is the offshoring of the U.S. manufacturing base which simultaneously depresses domestic investment and boosts the trade deficit.  These two drags on our GDP growth equation account for most of the slow growth we are experiencing. 

On the face of it, it is remarkable that our President and Congress and members of the financial press don’t want to acknowledge this drag.  However, the reality is that the big multinational corporations like Apple, GE, GM, Caterpillar, Intel, and so on that benefit the most from offshoring are the same corporations that finance our political elections.  These multinationals also either own our financial media or advertise heavily in the papers and on the networks.   So both the electronic and paper media are reluctant to bite the hands that feed them.

My view is that is borders on criminal for our politicians and pundits not to acknowledge the importance of trade reform in restoring American prosperity.  By that standard, most of Washington and much of the media should be locked up.

Europe: The euro is about to collapse amidst a sovereign debt crisis likely to lead to the same kind of meltdown the U.S. experiencing in 2008.  I’ve noted this problem for over a year now – just go back and read previous newsletters -- yet many in our mainstream media seemed surprised the very idea that the euro is bankrupt and Emperor Europe has not clothes.

Asia (AKA China): China is on the verge of a housing bubble collapse.  A combination of rapidly rising inflation due to an artificially under-valued yuan and too much government stimulus is about to collide with falling export demand from the U.S. and Europe as slow growth/recession woes take hold.  This is an economic house of cards with enough jokers in the deck to warrant a short.

To end, I will reprise the analysis I have been offering since February.  So read below and weep – and wonder why you haven’t been hearing this on TV or reading about it in the Wall Street Journal.  It’s so damn obvious it makes me sick.

1.     My overriding concern stated more than a year ago is that our investment-led recovery would not enjoy a follow through because of high unemployment, stagnant income, continued foreclosures, and high energy prices.  That concern has now heightened as I’ve watched the ISM manufacturing index – the best indicator of the investment led recovery – fall back into the recessionary range.  In addition, consumer confidence is in the toilet.  Ergo, this is a BEARISH signal.

2.     With the investment-led recovery faltering, we have no more ammunition from either a fiscal or monetary policy standpoint to re-stimulate the economy.  In fact, it’s just the opposite.  We are running high  budget deficits with little stimulative effect – this is largely the product of weak tax revenues due to slower than potential growth and excess government spending on our wars in Iraq and Afghanistan.  On the monetary policy front, Helicopter Bernanke has turned the king over on the chess board – and is left with only a swollen balance sheet and a weakened dollar.       Another BEARISH signal.

3.     Despite a weak dollar, we still run large trade deficits in oil and with China.  With China, the problem is the fixed peg of the yuan to the dollar.  As long as this peg endures, America will surrender almost a point of GDP growth annually to China at the costs of almost a million jobs we fail to create.   This is BEARISH, too; and if there is anything that truly ticks me off both about well-coifed airheads like those on the Sunday Meet the Press type shows as well as my doctrinaire colleagues in the financial press it is the stupid and stubborn unwillingness to realize just how destructive this peg is.  Earth to colleagues – you can’t have free trade in a fixed peg world.  It’s the mother of all oxymorons. 

4.     It is essential that we not forget the contractionary effects on the U.S. economy of the deepening state budget crises that have resulted in contractionary cutbacks in state spending.  Here in California, for example, revenues are falling far short of projections; and the state is likely to have to endure another round of what has already been very steep cuts.  From a macro perspective, that’s BEARISH.

5.     Europe’s sovereign debt crisis is deepening.  Italy and soon Spain will have joined Greece and Ireland as the weak sisters on the continent; and all the euros and Eurobonds in the world are not going to save their sorry derriers.   I predicted long ago on the Kudlow Report that the days of the euro are numbered; in truth, the best way for countries like Greece and Italy to rebound is to abandon the euro and devalue.  If the European union persists in enforcing a strategy of fiscal austerity instead of currency adjustments to restore vibrance in the European economy, they – and because America depends on exporting to Europe – and us are doomed to a much slower growth rate.   BEARISH, BEARISH, and BEARISH.

6.     In Asia, at some point, the Chinese economy must stop its export-dependent levitation.  A soft landing would entail the emergence of a robust consumer but policies are not being put into place to make this happen – with those policies being a yuan float coupled with increased health and pension benefits to loosen up savings for consumption.  Ergo, the hard landing scenario is more likely.  This involves interest rate hikes and both monetary and fiscal tightening to fight a spiraling inflation.  A likely result will be the collapse of several asset bubbles, including that in real estate – and no small amount of chaos in the land of unbridled mercantilism.  A Dragonianly BEARISH signal

7.     If – or should I say when – China falters, so, too, will the economies of all of the commodity countries.  These include Brazil, Russia, Australia, and Canada, to name the  most major players.  While Brazil is the most vibrant of the four, as China goes, so goes these countries.  (Canada can fall on both the U.S. and Chinese weakness of course.)    A final BEARISH signal.

Navarro on TheStreet.com

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Professor Navarro’s articles have appeared in a wide range of publications, from Business Week, the Los Angeles Times, New York Times and Wall Street Journal to the Harvard Business Review, the MIT Sloan Management Review, and the Journal of Business. His free weekly newsletter is published at www.PeterNavarro.com.

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