Carson Block Says "Laws Of Economics" Dictate China Will Face "Day Of Reckoning"

Muddy Waters Research founder Carson Block believes that China’s over-leveraged economy will eventually face a “day of reckoning.” He just can’t say when.

During an interview with Bloomberg’s Erik Schatzker, Block, who made his name betting against shady Chinese companies trading in the US, explains how the Chinese government’s massive stimulus has led to a potentially destabilizing explosion of corporate-debt growth in the world’s second-largest economy – and why the Communist Party won’t be able to contain the fallout once its twin bubbles -asset and credit - finally burst.

“I’ve felt for many years that it’s a giant asset and credit bubble. Under the old orthodoxy, that couldn’t be sustained for long, but if you look around the world, the ECB and the Fed are helping to sustain frothy asset values. Japan hasn’t made sense for a while.”

“Ultimately there will be a day of reckoning, I know that. I just can’t say if it’ll be two months, two years or 20 years.”

But even though traders who bet against the Chinese yuan last year made a tidy profit, Block believes betting against the Hang Seng Index isn't the best option for shorting China because the impact of PBOC intervention is too unpredictable on a macro scale. Betting against the Chinese stock market in aggregate could end up being a “widow maker” play like shorting Japanese government bonds was for several years. 

Video length: 00:05:57

Instead, investors should bet against individual firms or sectors – a less-risky option, in Block’s view.

“If you start with the macro thesis and say there are a lot of credit problems in China then start looking at industries that might be canaries in the coal mine or companies that might be canaries in the coal mine, then you might get it right.

However, speculators should be mindful of a trait common among Chinese companies: There are many that somehow manage to keep going even though the financials suggest that they’re doomed. Understanding which companies have the guanxi – a Chinese term meaning business and political connections – to enable them to continue operating, and which companies don’t, is the most challenging aspect of betting against Chinese firms, Block asserts.

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