1. China: The Edifice Complex
Wine Country Conference
April 5, 2013
James Chanos
Kynikos Associates

2. The China Way
• What we have learned
– Guanxi is a way of life
– Caveat emptor in acquisitions
– Beware reverse merger listings
– “Audited” numbers?
• What goes on in China Inc.
– Gaming receivables
– Questionable “Other Income”
– Property on the side
– Copper and steel financing
• Foreign technology partnerships
– “Absorb and digest”
– “Re-innovate”
– Undercut partners
Source: shutterstock
2

3. “The Number” Is Paramount
• GDP drives economic activity, not
vice versa “GDP: Killing the Hen to Get the Egg”
• Countervailing priorities
– Set centrally and locally
– Stability for Central Government
– Vehicle of ambition for local officials
• Regional-to-national GDP gap
continues to grow
– Gap of RMB 5.8T in 2012 vs.
RMB 2.6T in 2009
– “Size of Guangdong’s economy”1
• Capacity overinvestment (2008-2012
CAGR)
– Cement 12%
– Steel 10%
– Autos 18%
Source: “GDP gap in China the size of Guangdong economy”, South Source: China Media Project
China Morning Post, February 5, 2013 3

4. The Law Of Diminishing Returns
• Unprecedented fixed asset Gross Fixed Capital Formation/China GDP
investment boom
• Gross fixed capital formation
as a percent of GDP in
China has increased from
previously high levels over
the past decade
• Law of diminishing returns
• Asset depreciation liabilities
Source: National Bureau of Statistics of China
4

5. The ‘Shā Chén Bào’ Of Money is Wealth Destruction
• Large-scale capital projects grow
sillier by the day
Hard To Keep Up
– New South China Mall – world’s
largest and loneliest
– New Ordos – empty city in Inner
Mongolia
– Sky City One – world’s tallest building
to be built in only 90 days
• Massive infrastructure spending
continues
– 1,188 new shopping malls by 2015
– Airports: 14 opened in 2012 and 12
to be constructed in 2013
– Subways: 28 cities get approval to
build or expand subways
• Feasibility is secondary thought
– Overstate revenue and understate
maintenance costs
– Is economic depreciation being
factored in?
Source: Global Times
5

6. Pervasive Growth Of Credit Driving Boom
• Bank lending remains high
– 2012 saw a YoY increase in new bank
lending by 10% to RMB 8.2T
– 2013 new lending forecasted to grow
yet again
• Banks poorly capitalized for potential
losses
• Rapid growth in shadow banking
spurring total social financing
– Greater portion of social financing being
done outside banking system
– Increasing difficulty of controlling
liquidity within the system
• Chinese culture of credit
– The myth: China has no history of
credit-fueled booms and busts
– Reality: History proves otherwise
– Over 40% of banks loans went sour
post-1990s boom
Source: PBOC
6

7. Wealth Management Products are the Democratization of Credit
• The triumvirate of shadow banking
– Local Government Financing
Vehicles
– Trust Products
– Wealth Management Products
• Wealth Management Products
– 66% growth rate in 2012
– Substitute for deposits on or hiding
assets off balance sheet
– Dubious investments
– Investors expect both yield and
protection
• First cracks appearing
– Huaxia Bank
– CITIC Trust: Recent questions on
viability of three trusts
• Warning from bank regulators
Source: CBRC, BoA Merrill Lynch, Barclays, Kynikos Associates
estimates 7

8. Urbanization: Last Refuge of the Bulls
• Goal of 80-85% urbanization
rate
– Bulls look to 600 million people
migrating
– Will be lower based on 250
million floating population and
some farmers
– Cities change boundaries and
definition
• Leads consumption economy
– Urban dwellers consume more
– Increased demand for social
services
• Is urbanization national?
– New theory migration will be
towards the Eastern coast inside
the high speed rail network
– Go West policy in doubt
Source: China Daily
8

9. Property is the Lynchpin
• China’s current urban real estate
boom
– 2012 Total Real Estate Under
Construction approximately
10.6B sqm vs. 5.7B sqm in 2009
– 2012 Total Real Estate per capita:
14.9 sqm
– 2012 Total Real Estate sqm per US$
1M GDP dollars : 1,283 sqm/US$1M
• Oversupply is an overlooked issue
• Property management fees are
rarely paid
• Lack of affordability remains an issue
• No one can identify the buyers
• Commercial real estate is the future
issue
Source: CRI English
9

10. Residential Real Estate Affordability?
• Major Chinese cities versus Residential Affordability Comparison
Beijing
NYC and London 30
28.1 yrs.
• Generational investment: 25
Shanghai
20.9 yrs.
Parental savings funding 20
purchase of real estate by next
Chongqing
generation 15 14.5 yrs. Wuhan
12.9 yrs. London
10.8 yrs. NYC
• Speculative fever provides 10
10.0 yrs.
breeding ground for corruption
5
• Mass market buyers priced out
0
Years to pay off Apartment (Apartment price / Household Income)
Source: Soufun (China), National Bureau of Statistics of China, US
Census Bureau, The City of New York, The Land Registry (UK), 10
Greater London Authority (UK). China real estate values as of
December 2012, NYC 07-11 Average, Greater London Nov 2012

11. Rising Wages: No Longer the Workshop of the World
• Chinese wages are up
“Evil Factory! Return My Annual Bonus”
– Private sector manufacturing
pay up 20% in 2011 and 16% in
2010
– Minimum wages continue to rise
13% through 2015
• Margins are thin, profits down
– SOE profits down 11.4% first
nine months 2012
– SOEs under local governments
profit decline 20.4%
• Regular protests for back wages
• Chinese unit costs to the US not
as cheap as they were
• Factories offshoring from China
Source: “Chinese SOE Profits down 11.4% in the first nine months”, Source: The Epoch Times
Gov.cn 11

12. Wealth Gap: Straining the Harmonious Society
• Popular resentment growing
• Gini coefficient is “out of the lamp”
– Not released for ten years
– January 2013 official release:
0.474 in 2012 with peak 0.491 in
2008
– Academic study estimates 0.61 for
20101
• The New Government plan
– Raise low incomes and “adjust
over high incomes”2
– Details vague with watered down
proposals and loopholes
• Corruption crackdown?
– New regime vows to crack down
on corruption
– Recent restriction to property
ownership information
Sources: 1) “More Findings from the China Household Finance Survey”, Source: China Daily
Li Gan, Texas A&M University, January 2013 12
2) “China approves income distribution strategy”, Reuters, February 5,
2013

13. Property Graft Is An Issue
• Dirty money hides in property
– Exposed officials have multiple Official sacked over property scandal
properties
– Not concerned with liquidity or
mobility
• “Home Purchase Restrictions are
only for the ones not smart”
• Fake Hukous can be bought for
RMB 30,000 to RMB 50,000
• Foreign passports advantageous
• High profile catches
– Newspapers carry rogues galleries
of corrupt officials
– “Grandpa of Property” -
Guangdong Policeman with 192
properties
– “House Sister”- 41 properties
Source: “Hukou forgery scandals highlight police corruption”, Xinhua, Source: China Daily
January 24, 2013 13

14. Faith in Government: Are People More Satisfied Today?
• Leadership change was not "This is us [China] today!”
seamless
• Frustration with self interest
– New anti-corruption policy
– Netizens are the Fourth Estate
• Quality of life
– Pollution blots out the sun
– Food and baby milk scandals
– Cancer villages
• Demonstrations are a way of life
– 2010: mass incidents estimated
between 180,000 to 230,0001
– Environmental protests
– Selected local strikes
• More spent on internal security
than the military2
• Will there be real reform?
Sources: 1) “Social Unrest in China”, Europe China Research and Advice Source: China Media Project
Network, 2012 14
2) “China's defense budget outweighed by internal security”, Want China
Times, March 11, 2013

15. Shifting the Focus from the Real Problems
• Cold war tactics in
Senkaku/Diaoyu dispute
• Staged demonstrations
• Pressuring neighbors
– New Chinese official map
includes disputed islands
– Hainan Province announces
policy to board and search
vessels
• Reaction to foreign press
– Newspaper hacking
– Reporting equipment stolen from
hotels
– Visas revoked
• Attempts at intimidation
Source: Global Times
15

16. Chinese Proverb: “When the Tree Falls, the Monkeys Scatter”
• Unprecedented fortunes
amassed by leaders’ families Tunneling Out of China
• Buying foreign property and
citizenship
• Getting the money out
– $2.7T cumulative outflows
from 2001 through 2010
– 2010 estimate of $420B
almost 3x 2001 estimate
• “Playing” in Macau
– VIP Baccarat is the channel
– Estimated in 2012 at $18B
Source: Global Financial Integrity “Illicit Financial Flows from Developing Source: China Media Project
Countries: 2001 – 2010” 16

17. Don’t Take our Word for it
• “GDP figures are ‘man-made’ Li Keqiang, 1st Vice Premier China
and therefore unreliable, Li US Embassy Cable March 15, 2007
Wikileaks – December 4, 2010
said.”
• “To some extent, this is Xiao Gang, Chairman Bank of China
“Regulating shadow banking”
fundamentally a Ponzi China Daily, October 10, 2012
scheme.”
• “The bubble must be Wang Shi, Chairman China Vanke
“Vanke boss sees bubble in spike”
controlled, or both the real Standard , January 29, 2013
estate market and domestic
economy will be jeopardized”
• "The government has Chinese Netizen
“Chinese companies trusted in China, says US
already been considered report; Nope,Say netizens”
untrustworthy, let alone Want China Times, February 6, 2013
businesses…"
17

18. Thank You to
the Wine Country Conference and
the Les Turner ALS Foundation
18

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