On Being Long the US and Short China by Hugh Hendry and a Healthy Gut to Prevent Cancer!

From Aditya Rana
Date: Sun, May 6, 2012 at 12:22 PM
Subject: On Being Long the US and Short China by Hugh Hendry and a Healthy Gut to Prevent Cancer!


The irrepressible Hugh Hendry (who manages the London based hedge fund Eclectica) is back after a two year hiatus from writing his periodic must read newsletters. While you may not agree with all that Hugh says, he is an entraining writer (and speaker) and provides “out-of-the box” insights which should be dwelt on. His got cautious on markets in 2006 as he saw a deflationary outcome to the bursting of the US housing bubble and was very vocally bearish during the initial stages of the European debt crisis . His performance backs his words, with his flagship fund returning about 10% compounded over the last 9 years. The theme of this letter is the rationale for being selectively long the U.S. and short the BRICs (in particular China!). The letter is long and covers a lot of ground (link below) and I have summarised below what I believe to be the key points:

-The world remains distorted by the adherence to fixed exchange rates, in particular within the Euro zone and the dollar/renminbi peg, which are creating financial stresses much like they did in the 1920s and 1930s when currencies were pegged to the gold standard.

-The economic crisis which started in the US and made its way to Europe, could now migrate to Asia with the focal point being a “hard-landing” in China. They believe that the US is at a turning point with the momentous advances being made in shale oil and gas extraction, an acceptance of the unpleasantness of debt and the price restructuring of labour.

-Thus makes them bearish on most Asian stocks, bearish on industrial commodity prices, and think that Japan could become the focal point of the next global crisis. At the same time, they think we are closer to the beginning of a major bull market – perhaps like 1982, after a final leg-down.

-From the mid-90s until 2005, the renminbi was pegged to the dollar which appreciated by 3.5% per year until 2001 (as investors poured capital into the US TMT sector), which kept the US current account surplus in check at about 2% of GDP. The currency peg also allowed China to keep a lid on its inflation.

-This all changed after China’s entry into WTO, together with the bursting of the TMT bubble in the US which led to a weaker dollar. This in turn led to a export boom in China, with net exports doubling in two years from 2005 and then doubling again, with the export sector contribution to GDP rising from 5% to 20% during that period.

-According to traditional economic principles, this should not have happened as the renminbi would have appreciated to keep a limit on export growth. However, FX intervention by the Chinese central bank kept the currency weak and led to a massive accumulation of FX reserves.

-However, this came at a serious cost, as the Chinese government was effectively buying US treasuries by printing renminbi and this new money overwhelmed the domestic money supply, which exceeded that of the US whose economy was three times as large. This should have led to runaway inflation, instead inflation stayed at 3%. Why?

-The Chinese were able to effect this through financial repression on a gigantic scale – with demand deposit rates being fixed at 0.72% from 2002 until 2008. With inflation running at 7.9% by 2008, the real rate on deposits was an incredible -7.2%.

-This negative real return on deposits was a major contributor to the 20% decline of household disposable income to GDP from 1992 until 2008, and the consequent collapse in consumption from more than 50% of GDP during the 1980s to just 34% by 2010.

-The unintended consequence of this financial repression was property speculation on a unprecedented scale – with investment in residential real estate rising from 2.4% of GDP during the 1990s to 9.1% of GDP in 2011.

-Mass urbanisation is not an explanatory factor for this dramatic increase – with mass migration to the cities peaking at 24 million people per year during the period 2000 to 2003, corresponding to residential investment at 4.1% of GDP and housing starts at 440m sqm per year. Mass migration then declined to 19 million people per year, but housing starts exploded to 1,290m sqm in 2011 and residential investment went to 9.1% of GDP.

-This took place against a backdrop where housing ownership rose reached 80% in 1998 and has grown very slowly since then.

-So it was not urbanisation, or the rise of house ownership from a low base, which drove the massive increase in residential investment – it was simply housing price appreciation. With first time buyers able to borrow at a discount of 15% to 30% to the benchmark rate, and no property tax, the cost of owning an empty flat was modest.

– As per official figures, households increased their borrowing by $400bn and $460bn in 2009 and 2010, which was 4x the increase seen in 2008. By 2009, individual mortgage borrowings were increasing rapidly as banks lent out a third of their total mortgage loans outstanding.

-By 2010, the share of residential properties purchased as an investment reached an extreme peak of 40% , and the central bank estimated that 18% of households in Beijing held two or more properties, many of which lay vacant.

-The result was that household debt to income rose by almost 20% between the end of 2008 and 2010, a change which was greater than the change which took place during the peak years of the US housing bubble. China has spent twice as much on its property bubble than the US, relative to the size of its economy.

-However, official numbers had a household debt-to-GDP ratio of just 20% at the end of 2007. In addition, Chinese banks demand 40% down-payments on new mortgages.

-This discrepancy is explained by the growth of the shadow-banking system, as savers combated financial repression. The underground lending network is estimated to be $1.3 trillion, and has likely financed a large part of the upfront deposits for housing.

-Soc Gen estimates that the entire shadow banking system totals $2.4 trillion (equal to the entire stock of US consumer debt) if the “wealth management” products (with dubious underlying risks) offered by the official banking sector, to compete with underground lending, are included.

-However, America’s QE2 programme announced in the second half of 2010 was a game changer as the US tried to grapple with its long term rise in unemployment , partly due to the Asian mercantilist policy of the previous ten years, and China was forced to raise interest rates in response to it.

-This brought to an end the unity displayed in the London summit G20 summit in April 2009, where China agreed to spend to get the world out of trouble. And spend it did – with 50% of all bank lending directed by the state to infrastructure projects. And it worked- while global output fell by 2% in 2009 and rose only by 3.9% in 2010, in China it grew by 9.2% and 10.4% respectively. In 2012 , such state directed lending is expected to contribute 60% of the 8% growth rate.

-While many believe China to be financially stable – the state’s finances have become increasingly imperilled. Local government debt has been estimated at 25% of GDP, but the real problems lie with the central government’s finances which could bring the total to 80% of GDP as per some estimates, as deficits and spending have grown dramatically.

-The situation in China today draws (inexact) parallels with the hyper-inflationary period of the Weimar republic in the 1920s. Germany then embarked on massive fiscal spending and monetary easing, hoping that a depreciating currency would spark an export boom as the US and UK economies recovered from their post war recessions. Similarly, today China hopes that the fiscal spending and monetary easing would ease pressure for a strengthening Yuan, and recovering economies in the US and Europe would facilitate another export boom.

-However, as the post war recessions dragged on in the US and UK for longer than what the Germans had anticipated, the current balance sheet recession in the West, combined with Europe’s austerity policies, is likely to delay a recovery in their economies for a while.

-China may have jeopardised their economic future by incurring the twin problems of the operational leverage of their manufacturing economy (to external demand) and the financial leverage of their sovereign.

-It is helpful to compare the paths of the US and UK economies in the early 1930s – with the UK, playing the role America plays today, suffered just an 8% decline in output while the US, playing the role of China today, suffered a precipitous 23% decline. In a downturn, a debtor nation can cushion its downturn by importing less while creditor nations can be most vulnerable.

-The next stage of the crisis is likely to play out through the dollar/renminbi currency peg. The Fed’s QE policy has succeeded in creating wage inflation in China to the extent that it is no longer the favoured manufacturing re-location base it was a few years back. In addition, the likelihood of a dollar trade weighted appreciation (for reasons outlined earlier), would further exacerbate the competitiveness problem.

-Without the benefit of a cheap currency, and Europe mired in an austerity drive, China’s exports are likely to collapse and the large scale investment projects would struggle to meet even their operating costs . This could lead to an outflow of hot money, which may have already begun.

-Under this scenario, the likely option for China is to absorb its private sector debts a’ la Japan. While Japan has managed to survive a 10x increase in its debt since 1990, thanks to being able to keep its current account surpluses as the rest of the world boomed, and thereby have the means to transfer wealth to it household sector – China may not have this luxury.

-They are positioning for this scenario by being short Japan (via credit default swaps) , rather than China, as Japan is most industrially exposed economy to a China slowdown.

-It might take several years, before the debt and deflation threat is finally removed from investors minds. If the above scenario were to unfold, and leads to significant sell-off in risk assets leading to 30-year treasury yields back to their 2008 low of 2.5%, and the VIX index above 80, it would herald a once in a lifetime buying opportunity for risk assets.

Link to the full letter below:


A well argued and researched piece – and somewhat disturbing! However, while I agree with Hugh’s points on the issues arising from excessive investment spending in China, I do not agree with his thesis that a likely trigger is “hot money” outflows from China. Rather, China’s policy of financial repression is likely to continue for a while with the objective of deflating the problem over time. With deposit rates at about 3%,an economy growing at a nominal rate of 13%, and a 54% savings rate provide significant resources (about $320 bn a year) to combat the problem of overinvestment. This feature, together with predominantly domestic financing and a non mark-to-market system, is highly unlikely to provide a trigger for a “hard-landing”. In addition, it is likely that the savings rate in China will remain high (with low consumption), and with investment spending likely to come down, it implies that the current account will remain in surplus (albeit lower than in recent years) which will further reduce the likelihood of a trigger to a crisis.

In conclusion, stay with long EM risk assets (particularly China and India) and energy, natural resources and multinationals in the US and Europe. Yes, it is likely to be a volatile ride, but with an expected superior return over the course of this decade!

Why a healthy Gut is crucial for preventing Cancer:

An interesting piece I came across recently:

(NaturalNews) April 14, 2012 It is said that roughly 80 percent of human health and immunity originates in the gut, which includes, of course, the body’s ability to ward off cancer. And a new study published in the Journal of Clinical Investigation has found that poor gut health is directly responsible for causing cancers, that would otherwise be blocked intestinally, to enter the body and proliferate.

Dr. Scott Waldman, M.D., Ph.D., chair of the Department of Pharmacology and Experimental Therapeutics at Thomas Jefferson University, and his colleagues discovered that guanylyl cyclase C (GC-C), an intestinal hormone receptor, plays a key role in suppressing tumor growth. This enzyme helps maintain a healthy intestinal wall, which effectively keeps cancer cells at bay by blocking them from entering the body.

But when GC-C is at suboptimal levels in the gut, the intestinal walls become more prone to protrusion, which causes inflammation of the intestinal lining and the eventual leakage of cancer cells and other harmful materials directly into the body. If left unchecked, this enzymatic abnormality ends up resulting in damaged DNA and the development of tumors in various places in the body, including in the liver, lungs, and lymph nodes.

"If the intestinal barrier breaks down, it becomes a portal for stuff in the outside world to leak into the inside world," said Dr. Waldman. "When these worlds collide, it can cause many diseases, like inflammation and cancer."

The entire intestinal environment, in other words, has been specifically designed to protect the body from foreign invaders, whether it be toxins, harmful organisms, or malignant cell growths. But when this system is disrupted by a lack of proper nutrients, for instance, or from damage caused by antibiotics and genetically-modified organisms (GMOs), the intestinal lining gradually loses its ability to protect the body against harm.

Irritable bowel syndrome, Crohn’s disease, ulcerative colitis, inflammatory bowel disease — these and many other intestinal problems are the direct result of a gut that has been compromised by things like bad diet, vaccines, GMOs, antibiotics, and a lack of probiotic foods. But they are also conditions that can be effectively mitigated and even reversed through improved diet and supplementation with probiotic foods and nutrients.

Numerous studies have already found that probiotics are effective at preventing cancer. And perhaps their ability to not only maintain but also improve the integrity of the intestinal lining is one specific way in which they effectively accomplish this task.

So make sure you are having your probiotics (natural via yoghurt or supplements)! The traditional Ayurvedic powder Triphala (three fruits) is also a great gentle de-toxer for the gut!




Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: