China: Economic Miracle Or Government Sponsored Fraud?

A few months ago, we asked, “is China an economic miracle or one giant government sponsored fraud?” Our views were the latter with corruption as one of the key driving forces for wealth creation and economic growth in China.

Consider the following:

1) In 2010 alone, 146,000 cases of corruption were launched in China (that’s 400 PER DAY).

2) Of the 14 cases that were actually reported in the Chinese media, the average amount stolen was 18 MILLION RMB (for perspective, the average college graduate in China earns 2,500 RMB per year).

3) Between 1991-2011, it’s estimated that between 16,000-18,000 Chinese officials fled China taking 800 BILLION RMB (roughly $125 BILLION) with them. Bear in mind China’s entire GDP was just 2.1 trillion RMB in 1991.

4) It’s estimated that on average bribes comprise 5-10% of a given project’s costs in China today.

Indeed, things are so corrupt in China, that as soon as the new Government stated it would crack down on corruption, a fire sale of luxury properties began as corrupt officials sought to dump their illegal holdings.

Thousands of Chinese communist officials have been panicked into a fire sale of their illicit properties and billions of pounds have been smuggled overseas as the country’s new leaders intensify a campaign to root out corruption…

It said the volume of deals had intensified by “a hundred times” after Xi Jinping, the incoming Chinese president, warned that corruption could kill the party and put one of the country’s most vigorous and resolute politicians, Wang Qishan, in charge of stamping out graft…

The CDIC report, which was obtained by the Economic Observer newspaper, suggested that nearly 10,000 luxurious homes had been sold by officials in Guangzhou and Shanghai last year.... Li Chengyan, a professor at Peking University, suggested that about 10,000 officials had absconded from China with as much as pounds $US100 billion. (link, here)

These individuals fleeing China have been buying up luxury properties outside of the country. As you likely have noticed, the world has experienced a wave of Chinese buyers for high-end real estate. While some of them are indeed individuals who have made legitimate money from business, many are in fact corrupt officials who have fled the country with vast quantities of loot.

A new wave of buyers from China is snapping up luxury properties across the U.S., injecting billions of dollars into the country’s residential-real-estate market.

The industry is scrambling to court the new buyers. Some developers of new projects are installing wok kitchens, following feng shui principles and putting lucky numbers on choice units; others are packaging property sales with government programs designed to encourage foreign investment. Real-estate agencies are flying representatives to China, and hiring Mandarin-speaking agents.

In Los Angeles, New York and even Miami, buyers mostly from China—and some are from Hong Kong, Singapore and Korea—are radically altering the landscape. Last month, a Chinese couple paid $34.5 million for a Versailles-style mansion on Sunset Boulevard in Beverly Hills, Calif. A year earlier, a Hong Kong businessman paid around $28 million for a nearby estate. Over the last six months in New York, several full-floor apartments in a new Manhattan high-rise called One57, each with a price tag of roughly $50 million, have gone into contract with Chinese buyers, according to two people close to the situation. (WSJ)

This sort of fraud and corruption is systemic in China but it doesn’t show up in the GDP or other economic figures the country posts. After all, if a poorly constructed bridge collapses China can always build another one and count it twice for GDP growth. And since the Government controls the media, no one is the wiser.

As a final example of how the China story will likely turn out, consider the following:

Caterpillar Inc. believed acquiring China’s Zhengzhou Siwei was a way for the U.S. company to boost its fortunes in a lucrative but challenging market.

Siwei’s sales and profit growth were surging. And the company offered access to China’s mining industry, where domestic companies were prospering.

Siwei, which sells mine-safety equipment, also boasted an American pedigree. Its controlling shareholders were James E. Thompson III, the scion of one of Asia’s most successful expatriate families, and Emory Williams, a former head of the American Chamber of Commerce in China. Caterpillar paid about $700 million in June for Siwei’s parent, ERA Mining Machinery Ltd.

Caterpillar, known for bulldozers, excavators and wheel loaders, will have to write off about $580 million over alleged accounting misconduct at a Chinese maker of mine-safety equipment it bought in June. The WSJ’s James T. Areddy talks about what this means for the big U.S. industrial company.

But now, the purchase has dealt a blow to Caterpillar’s already lackluster performance in China.

The Peoria, Ill., construction-machinery maker on Friday said it would write down ERA’s value by $580 million, blaming “deliberate, multiyear, coordinated accounting misconduct” that was designed to overstate profit at the unit before the deal. The accounting surprise contributed to the departure of a senior Caterpillar executive, a person familiar with the matter said. (WSJ)

What are the odds that this is an isolated case?

If Caterpillar (CAT), one of the largest corporations in the world, with its army of accountants and consultants was duped by a Chinese company run by American executives no less… what are the odds that ordinary investors can accurately value Chinese businesses or the Chinese economy?

This is just one example of how a popular theme in the investment community (in this case that China is a superpower) can in fact turn out to be total bunk. Given how many investment professionals are banking on China leading the world to economic growth again, this trade is extremely crowded on one side.