That’s probably the best way to describe it…
If you saw the James Bond movie Skyfall, perhaps you were struck by one image in particular.
In the movie, the villain’s lair is located on an overdeveloped island covered with decaying buildings and empty streets. There’s something so off-putting about it, you’d think the whole thing could only be a Hollywood fabrication.
But it wasn’t.
In fact, the true story is even creepier.
The island is known as Hashima. It’s also known as Gunkanjima, or “Battleship Island.” It sits roughly nine miles off the coast of Japan in the East China Sea.
Starting in the 1880s, the island housed workers who harvested coal from the surrounding sea floor.
But in 1974, the coal ran out and the island was abandoned – leaving it a ghost town. Millions of dollars of infrastructure development were rendered virtually worthless overnight…
Today, we’re seeing something similar happening in a neighboring country… only on a much larger scale – and the financial fallout is going to be extraordinary.
I believe that what happened to Hashima Island in the past is happening right now in China.
Only much worse.
In fact, what we’re seeing right now in China could be the single greatest example of malinvestment in world history.
When I write “malinvestment,” I’m referencing a glut of Chinese infrastructure projects – buildings, roads, stadiums, bridges – all of which were simply not needed. These were investment dollars wasted on pointless projects.
Now, there’s a price to pay for that sort of financial irresponsibility. But it gets worse…
You see, there’s another force intersecting this malinvestment that’s going to act like kerosene dumped on a flame…
The U.S. dollar bull market.
A huge volume of China’s malinvestment was financed with debt – much of it U.S. dollar debt. Chinese banks and corporations hold up to an estimated $3 trillion in U.S.-denominated debt. So, as the dollar’s value increases – courtesy of the dollar bull market – the cost to pay back the debt also increases.
Worthless investments generating no financial return… and a rising cost to repay this debt… It’s a toxic combination.
And that’s why I see an imminent collapse in China.
But this financial contagion won’t be limited to just China. You see, our global economy is so interconnected that when China falls, it’s going to affect certain Chinese trading partners as well.
That’s why I’ve identified 10 toxic exchange-traded funds (ETFs) you need to avoid as this massive bankruptcy unfolds. If you’re holding them, you’re going to want to get them out of your portfolio immediately. More on that later, though…
“Ghost Cities” and “Bridges to Nowhere”
When the Communist Party rose to power in China in 1949, there were only 69 cities in the entire country.
Today, there are 658.
No civilization in world history has built so much infrastructure in such a short time.
But there’s a catch…
Many of China’s new high-rise apartment and office buildings are totally empty.
Miles of highways are not only devoid of traffic – there are no cars on the roads at all.
Parks and playgrounds look like the set of a zombie movie.
According to a report from China’s National Development and Reform Commission, the Chinese government “wasted” $6.8 trillion building ghost cities between 2010 and 2014.
To put that number into perspective, $6.8 trillion is double Germany’s annual GDP. It’s also four times more than the total dollar amount invested in S&P 500 Index funds.
You might be wondering about specific examples of this malinvestment…
Well, there were the three giant sports stadiums built specifically for China’s “ethnic minority traditional sports games” of 2015 that remain totally vacant.
A recently constructed, and completely vacant, stadium in China
Then, there were numerous bridges costing billions to build, while experts claim they were largely unnecessary.
Take the Qingdao Haiwan Bridge for example…
Qingdao Haiwan Bridge (completed in 2010)
This recently completed bridge (the white line across the middle of the bay in the image above) holds the world record for the longest bridge over water.
Spanning 42 kilometers, it’s long enough to cross the English Channel.
Built at a cost of 56 billion yuan ($8.7 billion), the bridge crosses Jiaozhou Bay and connects the main urban area of Qingdao city with the Huangdao District.
The span has cut 30 km of distance (about 20 minutes of travel time) between the two areas.
While some would celebrate the triumph of this project, not all are equally enthusiastic.
In fact, some would argue it’s a waste of taxpayers’ money to build a 56 billion yuan bridge to save 20 minutes.
Many have questioned the specific route of the bridge – regardless of the cost. As you can see from the satellite image, the bridge spans the longest possible route between the two shorelines.
The image above shows that if the bridge had been built along the red line, the distance between two sides would have been reduced to a mere 4.5 km.
These are just a few examples of spending that’s questionable, if not downright inexcusable. The reality is billions – if not trillions – of dollars spent on Chinese infrastructure now sits idle. It’s a country dotted with ghost cities and bridges to nowhere.
And now, it’s time to pay for all this wastefulness.
China’s Major Malinvestment
Is Starting to Roll Over
The Financial Times states that banks and bond investors paid “scant attention” to company fundamentals when lending to state-run companies. Banks and bond investors assumed the Chinese government would continue to bail everyone out. Polled economists told the Financial Times this has led to a “moral hazard, enabling state groups to rack up even more debt and engage in wasteful investment.”
But now, the billions, even trillions, in malinvestments are starting to roll over.
China’s currency, the renminbi (or yuan), is too strong. (And billions in debt are denominated in U.S. dollars. This is reversing the carry trade.)
The renminbi has been artificially pegged to the U.S. dollar for the last decade. And the dollar has been climbing in value for the past few years. The renminbi, having been pegged to the dollar, has appreciated alongside it.
This has not been good for China’s economy.
You see, a stronger renminbi has resulted in China losing billions in export sales because its goods were simply too expensive (factoring in the “strong” renminbi when making currency conversions into other “weaker” global currencies). Countries looking to buy Asian goods were choosing China’s cheaper Asian neighbors, like Myanmar, Vietnam, Taiwan, or Thailand.
That’s why we’ve seen China’s gross domestic product (GDP) decrease every consecutive year since 2007. And it’s now growing at its slowest pace in 25 years. China’s GDP is expected to contract even further next year.
The billions of dollars in lost export revenue are now no longer available to service bad debts.
The lost revenue was the cash flow that kept the show going. Without it, those who have partaken in this grand scheme will have their legs swept out from under them.
China will now have to find new ways to service its public debt – which is enormous. According to the consulting firm McKinsey & Company, China’s public debt, as a percentage of its GDP, is the highest in the world. It stands at 282% of its GDP. Comparatively, the United States’ debt is 100% of its GDP.
We’ve already seen a consequence of this type of “contagion” in the Chinese stock market. The Shanghai Composite Index dropped over 40% in just 18 trading sessions. It is still down over 30% from its June 2015 peak.
Defaults could be one trigger for a market selloff.
China’s state-owned power equipment manufacturer, Baoding Tianwei, defaulted in April. It couldn’t make a $14 million payment. Baoding’s default was the first Chinese state-run company to default on its U.S.-denominated debt, according to Bloomberg.
Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai said, “If China’s credit environment doesn’t improve, more defaults will come.”
Then, Sinosteel Co., a Chinese state-owned steel producer, defaulted on its $315 million interest payment in October. This default comes after the government pledged to step in and help provide payment but ended up reneging.
Ivan Chung, an associate managing director at Moody’s Investors Service in Hong Kong, said, “Sinosteel’s default means we will see more and more real bond defaults.”
China Shanshui Cement Group Ltd. became at least the sixth company this year to renege on domestic notes in November, up from one last year. Sichuan Shengda Group Ltd., a producer of pig iron, said last week it may not be able to repay bonds on December 5 if investors demand early redemption. Fertilizer maker Jiangsu Lvling Runfa Chemical Co. is asking its guarantor to repay debt due December 4.
More defaults are exactly what we’re going to see play out over the coming months and years. Both in the public and private sector.
The Chinese government will do everything in its power to prevent this. It has already taken measures to ease the pain. It implemented debt-swap facilities to reduce financing costs for local governments. It has lowered the reserve-ratio requirement – the amount of cash reserves needed to be held by banks – three times in the past 18 months.
Deutsche Bank Greater China Rates Strategist Linan Liu said, “It’s a tricky balance [for China’s government] between providing real structural reform and avoiding triggering credit events that would create systemic threat.”
We’re seeing the credit defaults seem to take the upper hand.
Eventually, China will be forced to further devalue its currency in an effort to make up the cash flow it once had. It has cut interest rates six times in the past year. And its biggest devaluation came this past August. It let its currency free float, which immediately sank 3% versus the dollar.
Let me be clear, the Chinese government isn’t going to go bankrupt. And China isn’t going bankrupt. With a country as vast and full of natural resources as China, there will be pockets of growth and opportunity.
But on the broad scale, in the coming months and years, we will see so many debts go bad and default, throughout both the private and quasi-government sectors. It might feel like the whole country is going bankrupt.
The dollar will continue in its bull market. And China’s $3 trillion in U.S.-denominated debt will rack up devastating losses.
Avoid These 10 ETFs
This list comprises 10 of the largest Chinese ETFs.
Each of these ETFs have Chinese exposure. We recommend you avoid them as the dollar bull market cements itself. It will punish China’s stock market as the country falls further into a major bust cycle.
Editor, The Palm Beach Letter
P.S. The devastating losses in China could trigger another global financial crisis. And after watching my father’s retirement get completely wiped out during the last financial crisis, I vowed to prevent that from happening again.
That’s why I’ve spent more than $3 million investigating reliable income sources for seniors. And now, I’ve uncovered two huge Social Security income loopholes that could bring you as much as $60,000 in extra benefits over the next 25 years. But thanks to a backroom deal between President Obama and Congress, you only have four months before these loopholes are closed off.