Conclusion and Investment Review
'All you do with your talent is wear dressing gowns and make witty remarks when you might be really helping people, making them think!'
-Noel Coward, Present Laughter
China's economic reversal was not remedied by a violent currency upheaval or corporate and bank failure. Instead, the recovery happened after an enormous and still ongoing subsidy from the household sector to both the banks and the manufacturing sector. It is as if nothing really bad happens in a Chinese recession: problematic debts are rolled over and restructured (that is to say, forgiven), and the banking sector accepts low credit and capital costs. It is a Hobson's choice.
It is now commonly accepted that the magnitude of the financial problems confronting the world economy are so great that in all likelihood we will be confronted by a hyperinflation allowing sovereign debts to be paid off in worthless fiat currency. Just like the Bolsheviks in 1918 and 1919, the machine-gun of the Commissariat of Finance will pour fire into the rear of the bourgeois system.9 We do not dispute this outcome.
However, it remains our contention that policy makers can only gain the political legitimacy for such extreme behaviour if the world is once more confronted by a profound and debilitating deflationary event. We therefore find it a more profitable exercise to envisage what such a catastrophic event might look like.
Above, we have outlined two game changers: a slump in China's rate of economic growth and a sudden and dramatic appreciation in the yen that would bankrupt its domestic export base.
But opinions are cheap and plentiful. I believe it is more instructive to consider what people do with their opinions. So let me tell you what I have done with mine. The investment team and I have carefully constructed a short credit portfolio made up of over twenty single-name industrial, cyclical businesses which have the dubious distinction of suffering from gigantic financial leverage and Asian/commodity overdependence. Without a doubt, some of these businesses will not survive; others will have to be radically overhauled and restructured and we will make money.
The Sky Doesn't Have to Fall Down for Us to Make Money
I suspect we will succeed with or without an economic slow down in mainland China. For if it continues with its linear GDP growth of 8 to 10% per annum, we can be assured that it will have made further investments in adding to its considerable industrial capacity. Much like the Japanese at the end of WW1, China finds itself on a collision course with the rest of the world. Its future economic success could lead to increasing skepticism as to the viability of many industrial businesses located both in Japan, Europe and the US as going concerns.
