(Feb 26, 2015)

Gong Xi Fa Cai! This month saw the greatest human migration of all time. During Chinese New Year hundreds of millions of people joined their families to celebrate the Lunar New Year, enjoy a feast and most importantly of all – rejoice in each other’s company. Long may it continue.

In just the decade that I have lived in Asia, one thing has become undeniably true – China matters. China has become the workshop of the world. Chinese agents roam from Argentina to Angola to Australia buying resources and real estate. Chinese tourists buy coffees next to the Eiffel Tower, students pay for expensive educations at UCLA and speculators snap up apartments in London without seeing them.

The liberalization of the Chinese economy began with Deng Xiaoping’s reforms in 1978 releasing the Chinese economy from a period of stagnation that arguably started in 1839 with the Opium Wars. Almost a century and a half of disaster followed; the Taiping Rebellion, the Boxer Rebellion, the collapse of the Qing Dynasty, the Warlord Era, the Japanese Invasion, the Chinese Civil War, the Great Leap Forward and the Cultural Revolution. By 1978, the Chinese peasant’s life was little better than his great, great, great, great, great grandfather’s.

Once China was able to experience free markets and some version of the rule of law, the Chinese populace proved their ability to build their fortunes. Her GDP went from approximately USD 200 billion in 1978 to USD 10 trillion in 2015. Despite inflation this is still a 50 fold increase in a generation. This has been achieved not via financial wizardry but by making real goods; first socks, then washing machines and now iPhones. Whilst recent claims that its economy has overtaken the USA or Europe are a little stretched, China has been the engine of world growth since the GFC. But it is the manner in which it overcame the financial disaster of 2008 that should make one consider the sustainability of this boom.

As has always been the way and in any country, the government gets to rule on the understanding that the people prosper – especially the rich and powerful. This arrangement is clearly understood by the Chinese government. In response to the GFC, the decision was made by the Western central banks to bail out the same banks that had caused the crisis. The ramifications of this will be felt later. In China, a different postponing strategy was taken; the People’s Bank of China made easy credit available to the oligarchs of heavy industry, many of them government princelings who run state backed companies.

The greatest construction boom in the history of civilization followed. The data dwarfs the housing boom of the US in the noughties. Between 2011 -13 China produced more concrete than the USA did in the 20th Century. 20 cities per year were built and dozens of them became ghost cities. A replica of Manhattan was built on Conch Bay but stands empty. And yet because of the awesome boom in private debt, the Beijing house price to annual household income ratio is approximately 29:1. The same ratio in the US just before the subprime crisis hit was 3:1.

But the Communist Party cannot allow a massive credit crunch to happen. With the property/construction industry accounting for approximately 1/3 of the economy, the consequences would involve mass bankruptcies. In order to avoid significant social unrest, they shall have to copy their counterparts in the US, UK, Europe and Japan and try their best to devalue their currency. China has allowed the Chinese Yuan to appreciate 30% against the dollar in the last decade and has watched her main trading competitor – Japan make her goods and services more competitive by devaluing the Yen by 60% versus the Yuan in the last 5 years. This appreciation has been partly due to the internationalization of the Yuan owing to the resulting increase in demand for the currency.

China may well need to join the currency race to the bottom versus the other major economies. Whilst she faces stiff competition, she seems alone in having an end game plan – quietly stock piling bullion to prepare for the moment that the race is finished and all of the paper fiat currencies are indeed broken. This is being done by proxy via Hong Kong, by decree via state controlled gold mining and by free market forces via the Shanghai Gold Exchange. It is this kind of pragmatic thinking that explains why China has been the world’s largest economy for 17 out of the last 20 centuries.

Both the Chinese government and the Chinese people will continue to accumulate gold and silver bullion than any other nation in the Year of the Goat. We can learn from their example. We wish you all a happy and prosperous New Year. Gong xi fa cai.