Important questions about Chinese banks...
This is no longer a story about Longtop, and it is not a story about Deloitte. Given the centrality of Chinese banks to the global economy, it's a story much bigger than Deloitte or Longtop. – John Hempton, chief investment officer of Bronte Capital, an Australian hedge fund, as quoted in the New York Times.
Sean Goldsmith is off this week. Thus, our long-suffering subscribers will have to suffer a bit more this week, as I'll be writing the Digests personally. I want to start with a follow-up to some of the questions I raised on Friday about the economic "miracle" in China.
You'll recall the data showing that China, which contributes about 10% of the world's GDP, has been consuming more than half of the world's concrete and almost half of the coal, along with a sundry list of other strategic commodities. These numbers, best summarized by measuring the rate of fixed-asset investment, suggest that China is caught up in a huge – and unsustainable – investment binge.
We've long suspected at least some of China's supposed economic might would be revealed as nothing more than a new credit bubble. And now, we're more certain than ever that's the case. Furthermore, we're more and more convinced the next big blow to the world economy will be the growing recognition that China's banks are thoroughly corrupt. Given the huge expansion of the banks' asset base since the fall of 2008, that's going to be a big problem.
The latest swath of Chinese fraud to hit the stock market has spread beyond the typical fly-by-night, small-cap Chinese stocks. Longtop Financial Technologies, which blew up in May, was a $2.4 billon software company with real customers and products. What Longtop apparently didn't have, however, was much of the cash it claimed in various Chinese banks.
The company's auditor, Deloitte, confirmed Longtop's cash deposits over the years with local branches where the software company did business. However, for this year's audit, Deloitte insisted on getting its confirmations from bank headquarters. That created an immediate panic at Longtop. Its executives admitted they had claimed "fake cash" in the banks reflecting "fake revenue" in the past. Since that May 16 admission, the stock has not traded. We don't know for certain what it is worth – perhaps nothing.
This situation, while unfortunate for investors in Chinese companies, also raises a much bigger question. If Chinese banks are deeply involved in these corporate frauds... what can we believe about any of the other assets on their books?
The world's largest single economic region is Europe. At least four of the major economies in the European Union (Ireland, Greece, Spain, and Italy) are likely to default on their sovereign debts within the next 12 months. On the other side of the world, China, the world's fastest-growing economy, now seems to be riddled by bad loans and a banking system that's so thoroughly corrupt that even its best companies – those allowed to list shares in New York – can't be trusted. And in the middle, you have the United States, supposedly the land of the "free" and the cradle of capitalism.
The problem in the U.S. is twofold. First, the government now makes up 45% of GDP(!), resulting in huge annual deficits (10% of GDP). And our country's total debt level – 400% of GDP – makes the Greeks look like conservative Swiss bankers in comparison. Worst of all, we're destroying our greatest economic advantage (the dollar's status as the world's reserve currency) by printing trillions of dollars each year to pay our debts. Bernanke is lighting up the printing presses at the Fed like a coke addict freebasing his stash on the way to rehab. And like cocaine, printing money is a hard habit to break.
My question to you, dear subscriber, is: Which part of the world's economy seems sustainable and reliable to you? I'm not a bear by nature or disposition. But when I look around the world, none of these things makes any sense to me. How long do you suppose German savers will bail out Greek civil servants who "retired" at age 40? How long do you think investors will continue to keep their funds in Chinese banks that fabricate the cash balances of their corporate customers? How long do you think America's creditors will willingly take dollars that are hot off the presses as payment for strategic commodities like oil?
And what about America's voters? When do you think any election will be won by a candidate who promises to balance the budget by killing off an annual deficit equal to 10% of GDP? Given that half the country doesn't pay federal taxes, my bet is never.
Like U.S. voters, the entire world has become accustomed to economic fictions. What will happen when the lights come on and the fantasy ends? More on these issues tomorrow...
New 52-week highs (as of 6/17/11): None.
In the mailbag, more praise for the most recent issue of my newsletter, Stansberry's Investment Advisory. We've gotten dozens of requests for permission to pass this issue around… to share it with friends and local newspapers, etc.
We've never done so before... But, yes… in this case, we'll grant a blanket group permission to share the June issue of the newsletter. You may forward it to as many people as you'd like. (Please just ask them to subscribe in the future...) If you share the letter, please let us know what your friends think about our ideas here: feedback@stansberryresearch.com.
"I must commend you on your latest newsletter, 'New American Socialism.' I think you have presented the most succinct, comprehensive, and convincing argument about current American policy and particularly the US housing market as I have ever seen. Would you mind if I were to copy some parts of your letter (entirely attributed to you, of course) to a dozen or so friends? All are potential subscribers. I appreciate your valuable insight and wish you continued success." – Paid-up subscriber Mark Elardo
Porter comment: Yes, as I detailed above, I've issued a "blanket" permission to all subscribers to share the June issue of my newsletter. Please, pass it along to anyone you believe would value the insights I offered.
"Porter, I read your June issue 'New American Socialism,' and was blown away. I used to write for a living and truly envy your ability to express such complex, complicated concepts in a clear, concise composition. Keep up the good work.
"On a separate note, I just read your comments about China, after having listened to, and read, many reports about Jim Rogers saying China is where all the action is and will be. What say you about Mr. Rogers' position related to yours?" – Paid-up subscriber John Barrett
Porter comment: In regards to Jim Rogers, he's warned many times that China's economy will have dozens of booms and busts along the way to greater prosperity – as have all the other great economies throughout history.
"Porter, Excellent June issue... Historical Note: ironically, many centuries ago the Hebrew prophets pronounced God's wrath and judgment upon nations (not just Israel) that deliberately allowed inaccurate 'weights and measures' and that debased honest money (gold and silver) with dross (other metals), creating inflation, thereby robbing their citizens and increasing the misery of the poor.
"I know you do not claim to be able to predict the future, being neither a prophet nor the son of a prophet. But the principles haven't changed throughout the course of history. Being able to 'read the signs of the times' is usually just a matter of the application of timeless principles to present predicaments. You don't have to be a prophet, preacher, or economics professor to acknowledge one other timeless and inviolable principle: sooner or later, one way or another, 'we reap what we sow.'
"I wish you were wrong. I pray for a different outcome. But the facts, truth, and reality will not allow me to ignore that it looks like we're about to 'reap the whirlwind.' Please, keep up the good work. We desperately need truthtellers and leaders in this present and future crisis. Thank you for your service to us all." – Paid-up subscriber Ricky Van Massey
Porter comment: There's nothing new under the sun – especially not in economics. The entire history of paper money and fractional reserve banking is nothing more than a series of cons, all of which attempt to create credit where there is none. These schemes, which create the illusion of prosperity, all have one thing in common: None of them last.
Regards,
Porter Stansberry
Baltimore, Maryland
June 20, 2011
Important questions about Chinese banks... Pick the worst economy... What part of this is sustainable?... "Like a coke addict freebasing his stash on the way to rehab"... Blanket permission to share the last issue...