Baruch was pondering the apparent excesses of the Chinese stimulus package today, and stumbled on what may be a most interesting hypothesis. Possibly, if he is right, the most important investing insight for the next 10 years.
The Chinese stimulus quite incredibly big; $600 billion is 15% of Chinese GDP. But it is being more than matched by “private investment”; for every dollar spent by the government on a project, 3 are being lent by the banks, either willingly or unwillingly. So unlike the US trillion dollar package, it is hugely leveraged. Did you know they will be spending $146 billion over 3 years on their 3G wireless rollout? Bet you didn’t. That’s a lot of money. But it was a dry, contextless datapoint until today, when Baruch found out what that level of network spend actually means: just 1 of the 3 wireless operators there, China Unicom, will be building 125,000 base stations in year one of the rollout. This might bore you but hear me out. That’s more 3G base stations than all the operators in Western Europe have rolled out in the 9 years since the 3G wireless standard has been in existence.
The majority of phones sold in the past 3 years in Europe have been 3G enabled, and Baruch imagines that 60%-70% of EU wireless subscribers are at least partly on 3G networks. That must be like 150-200 million people, and it isn’t like you get a weak signal over here. OK not all of them are heavy data users but this is changing rapidly. That’s more network capacity than Unicom 3G subscribers could possibly want until like, 2014-15, given the rosiest takeup scenario; true, there may be many more Chinese people than there are Western Europeans, but right now there are precisely zero “proper” 3G subscribers in China, ie those that aren’t on operator sponsored trials. This is future-proofing a network taken to an absurd degree. There is no way that this can possibly make any financial sense, in the way we currently understand capital budgeting.
And it struck Baruch; these guys are in a hurry.
Think about it. China and the US are locked in an embrace I discussed here a couple of months ago. China Inc owns the biggest pool of USD assets outside the US that the world has ever seen. It is their nest egg stored away for a rainy day, the reward of 10-15 years of saving and hardscrabble labour, making widgets and assembling them into finished goods for largely American consumers. For their part, American consumers desperately needed someone to backstop their addiction to buying stuff, someone who would lend them the money. It was vendor financing on a epic scale. And while the US consumer junkies needed their fix, their Chinese “pusher man” formed an economy dedicated to supplying it.
This created a mutual co-dependency, which is sadly no longer viable. The Americans now are desperate to reflate their currency and thereby their economy, while the Chinese are equally keen to diversify out of their dollar assets into something else. The problem, the prisoner’s dilemma, is that in doing so each would hurt the other. The US, on losing its lender of penultimate resort, would see their bond yields balloon, potentially choking off any recovery, whereas if the US successfully inflated their debt away, the Chinese would see their nest egg devalued; they would be the neighbours beggared. The more vulnerable partner in the embrace has to be China, however. Inflation is the time honoured tool of the borrower state to weasel out of paying debts; the temptation is eventually irresistible. The US economy is likely more flexible than the Chinese, and likely to better withstand the shock of the breakup better. Finally, the chinese government fears unrest and revolution more than any US administration; there’s many a precedent of the officials deemed responsible losing more than their jobs when things go wrong.
So the Chinese know they have the weak hand. They have a lot of money right now that may well be worth less, far less, in possibly an undefined period of time. It’s a version of the problem faced by Richard Pryor in Brewster’s Millions, but on a galactic scale. Baruch will call it the “Brewster’s Trillions” dilemma (OK, it only bears a very vague similarity to the movie, but I love the clip). And like Brewster, like any sane person would do, Chinese are going to spend it before it goes away, but unlike Brewster, they hope they’ll end up with at least something of value at the end of it.
That’s why they are investing more than they could conceivably need, for example, on a 3G network which under current plans will be simply the very best in the world, and the most under-utilised — a 6 lane superhighway to every town in a country currently without cars (if you see what I mean). That’s why the previously successful rural subsidy for electronic goods, ostensibly in the name of rural development, is now being duplicated in the big cities where there isn’t any developmental need for it except to goose demand. It’s why the latest plan for renewable energy involved a 2000% increase in the production of solar energy in China from 1-2 gigawatts today, to like, 20 in I forget howevermany number of years (or is it 20 to 200? I don’t remember, but a gigawatt is a lot, I think), a plan that dwarves any other national energy proposal in any other country, on technology that for most people just isn’t efficient enough to justify without subsidy. It isn’t a waste, in their mind; it would be a waste not to use it while they have it, to try and turn it into something worthwhile and lasting.
Money just became very cheap in China; their inflation expectations have clearly skyrocketed and it is about to shift from the global lender of last resort to the global consumer of last resort. And as we all know, its consumer expectations of inflation that matter more than the actual expansion of the money supply in an inflationary environment. Previously a deflationist, Baruch wasn’t sure about where he stood on the inflation-deflation debate, but given all of this he may have just become a radical inflationista.